VC funding for IT start-ups dries up

While overall venture capital (VC) funding to the Indian IT industry has risen, the quantum of investments being pumped into start-ups has come down. VCs no longer find worthwhile start-ups to invest in, says Abhinav Singh

There has been a decline of investment opportunities for VCs in the recent times as we haven't been finding deserving start-ups, says K Ganapathy Subramaniam

Indian IT start-ups are reeling from a paucity of venture capital funding, which has reached an all time low, as most VCs are now focusing on companies looking to expand their operations rather than start-ups. The problem has been aggravated by the fact that there are fewer entrepreneurs willing to take a risk and start an IT company from scratch. Even when VCs want to invest, they don’t find quality start-ups to put their money in.

According to Nasscom, the percentage of VC investments going into start-ups declined from 36 percent in 2001 to less than 10 percent in 2002. However, there has been a marginal increase in overall VC and private equity investments in India (with the IT sector accounting for 40 percent of these funds). Nasscom states the total VC plus private equity funding in India has risen from $1.1 billion in 2001-02 to $ 1.2 billion in 2002-03. Most VCs are of the opinion that funding of IT start-ups in India is on the decline and is not likely to pick up any time soon—in fact, it is likely to go down further.

Decline in investments in start-ups

Nasscom figures show that there have been more private equity investments in established companies rather than money flowing to start-ups. The organisation estimates that about half the funding for the IT sector in recent times is accounted for by just 15 firms. Of these, seven had been around for over a decade when the investments were made. Out of the total funding received in 2002 by Indian companies, 90 percent went towards funding expansion of well-established concerns.

Indian entrepreneurs don’t like risk

A primary reason behind the lack of start-up investments has been the lack of risk-taking on the part of Indian entrepreneurs. Ever since the dot-com crash, few Indians have started companies in India. Compared to the scene in Silicon Valley, which continues to see the birth of successful start-ups despite the global economic downturn, there haven’t been many offshoots from larger companies in India either. After the dot-com crash many start-ups in India had to close shop. This failure to take off seems to have instilled a sense of fear amongst entrepreneurs.

Moreover, most VCs look forward to the potential of a company in terms of the intellectual property that it generates, its unique technology and potential growth prospects when they think of funding it. K Ganapathy Subramaniam, managing director, Jumpstartup Fund Advisors, which focuses on start-ups, says, "There has been a decline of investment opportunities for us in the recent times as we haven’t been finding prospective start-ups where we can pump in our investments."

It has become very difficult to get funding as not many VCs are interested in funding companies— especially start-ups, says VIJAY ANGADI

Poor domestic market

When compared to China, India’s domestic IT market, which grew by a miserable 8.5 percent last fiscal, is yet to take off. That’s why few start-ups succeed in doing business here and have to concentrate more on the overseas markets where they become vulnerable to margin pressures and unpredictable business ups and downs. This is one reason behind the poor growth potential of Indian start-ups. Unless these fledgling companies are backed by an excellent management team and have a unique value proposition to succeed in the global market, they have little chance of making it. In China, the domestic market is strong and Chinese companies are shielded from seismic shifts in the global economic landscape as they can survive successfully by concentrating on their domestic market alone. If the Indian domestic market takes off it is quite likely that more Indian start-ups will be incubated and a greater number of them will thrive as they would no longer have to concentrate solely on the overseas market and would then be more likely to receive VC funding.

BPO start-ups continue to receive VC funding

In stark contrast to the IT scene, BPO start-ups continue to receive VC funding in large numbers as they come with lesser risk. That said, the quantum of investment is not as high as was received by dot-coms in the late 1990s. The ITES sector is poised to grow tremendously and attracted around $100 million during 2002. The prospect that larger companies might acquire BPO companies to facilitate their processes makes ITES start-ups more appealing to VCs. For instance, Wipro acquired Spectramind and Customer Asset was acquired by icicionesource.

Future scenario

Though VC investments in the late 1990s and early 2000 were positive, that was because far too many companies in the same niche got funded and market opportunities were grossly overvalued. The resultant backlash has resulted in the sudden slump in VC investments in the past few years. Vijay Angadi, managing director of ICF Ventures says, "These days, even if you are a good entrepreneur, it has become very difficult to get funding as not many VCs are interested in funding companies—especially start-ups. I am hopeful that VCs will again start looking towards funding start-ups in the next few years."

Indian entrepreneurs will be forced to think about new technology areas when forming companies. This in turn will step up VC investments into IT start-ups. Kislay Kanth, director at 2I Capital says, "India has tremendous liquidity right now and the moment banks start giving funds to VCs, they can divert it to fund start-up companies in India. Several state governments have also started investing in start-up companies but this is still in a very nascent stage."

With their fingers crossed, VCs hope that Indian entrepreneurs will come up with innovative ideas and unique technologies in which they will be able to invest. Several hurdles remain to be overcome. What Indian start-ups need more than anything else is a strong domestic market. Is the government listening?

Venture capital & private equity investments (Dec 2001)

Some VC and private equity investments in the Indian IT and ITES sector in 2002