The importance of finding funding

Image for representational purposes only   | Photo Credit: C. Venkatachalapathy

Last week saw an outpouring of grief nationwide over the tragic decision made by an Indian entrepreneur to end his life. V.G. Siddhartha of Café Coffee Day had built a pioneering consumer business and acquired one of the largest retail footprints in the food and beverage space in India, attracting marquee investors. His story is a stark reminder that entrepreneurship is a journey of highs and lows, which doesn’t just require capability and risk appetite on the part of the promoter but also demands great resilience.

Along with commiserations, the incident has also attracted some sweeping criticism — uninformed and unjustified — of the business practices of the private equity and venture capital industry. The truth is that the risk capital supplied by venture capital investors has been invaluable to entrepreneurship in India, where promoter funding by banks is frowned upon and founders are forced to rely on family and friends or take recourse to high-cost informal debt.

Spigot remained open in tough times

In the past decade, the ₹14 lakh crore of capital supplied by private equity and venture capital funds has played a pivotal role in birthing and scaling up over 4,000 Indian ventures. In addition to creating millions of jobs, firms funded by these investors pay more taxes, are better governed and make efficient use of scarce capital. This has resulted in the co-creation of popular consumer franchises like Ola, Swiggy and Paytm; bankrolled roads, airports, oil pipelines and telecommunications assets; and aided the crucial economic task of deleveraging distressed firms. This spigot of private capital has remained open for Indian ventures even as the economy and public markets have witnessed sharp ups and downs.

In fact, private investors have come to play such an important role in the Indian economy that their annual investments amounting to 1%-1.5% of the GDP, once believed to be sufficient to meet the country’s growth aspirations, are now proving inadequate. India’s economy is reaping its demographic dividends and young entrepreneurs and mature mega firms are taking make-or-break bets on the consumer markets.

Banking and insurance companies require billions of dollars in equity capital, privatisation is now on the anvil and an ambitious infrastructure build-out is transforming Tier-II towns. India will now need to attract private capital amounting to 3%-4% of GDP for the ‘Great March’ that Prime Minister Narendra Modi has flagged off to $5 trillion GDP. This is why it is important that policymakers or entrepreneurs do not take their eye off the ball based on one-off incidents.

The equity vs. debt argument

There has also been criticism of private equity investors for focussing on debt deals. Today, private capital pools offer many classes of assets, from venture to private equity to venture debt to promoter funding to hybrid instruments. It is only at the promoter’s behest that private capital providers structure capital infusions as debt rather than equity deals. Further, promoters are often reluctant to cede control in their ventures and hence end up taking capital in the form of debt.

That’s the fallacy of the infamous Indian promoter’s ‘curse’. Promoters embrace the double jeopardy of wanting to be in ‘control’ (the magic number of 51%) of their venture, while also believing that their equity is undervalued by the markets. Full of optimism about future pricing, they often resort to high-cost borrowings by pledging their shares. The result becomes evident during volatile times. As to the cost of debt, it must also be understood that the main mandate of private equity investors is to measure, underwrite and price risk. Structured as a limited-life closed-end funds, they have a contractual obligation and fiduciary duty to meet the return expectations of their investors and to return the capital within a relatively short time frame of five-seven years.

But the Siddhartha incident does have one major takeaway: founders in India need more equity funding, so that they can avoid the curse of overleveraging. When entrepreneurs take on aggressively priced debt payable within stringent timelines, it exposes their venture to extreme fragility.

Equity capital in contrast is patient. Companies with growth ambitions should therefore be ideally funded with 40%-50% equity, which can act as their lifeboats in difficult times. Equity funding makes sense for private investors too, as it allows a longer runway to scale up a business. This results in a larger pie for everyone — the founder, investors, lenders and the economy. However, punishing capital based on one event can prove to be a capital punishment for India’s entrepreneurial ecosystem.

Gopal Srinivasan is the founder of TVS Capital Funds & the former Chairman of the Indian Venture Capital & Private Equity Association (IVCA)

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Printable version | Jun 10, 2021 5:00:38 AM |

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