Major challenges in the early-stage investment landscape
Highlighting several challenges that early-stage investing activities face in India, such as finding worthy ideas and companies, policy barriers from the government, high taxation, lack of brand-building skills, etc.
The rise of the startup industry, and technological innovations, leading to a burgeoning entrepreneurial landscape in the country has contributed to the popularization and growth of early-stage financing in the country. The current situation of global competitiveness has also pushed the industrial sector to improve the level of quality for products, while minimizing costs using latest technological skills. The goal for most startups today is to secure adequate finance aided by technology to produce innovative products that are successful and profitable in the present market condition. Unfortunately, our country lacks on both fronts.
The startup boom, aided by rapid globalization in the last decade has led to the expeditious growth in the scale of seed funding activities and private equity investments in the country. Under significant initiatives such as Start Up India and Digital India, the government is promoting growth in capacity utilization of available and acquired resources and entrepreneurship development, by liberalizing norms pertaining to funding of startups. However, there are still several challenges that early-stage investing activities face in India, such as finding worthy ideas and companies, policy barriers from the government, high taxation, lack of brand-building skills, etc.
• Finding great companies
One of the major limitations to early-stage financing in India is the lack of innovative ideas in the market. For every business venture an investor funds, there are between 100 to 400 other companies that pitch ideas to them. Correspondingly, there is the need to maintain a steady deal flow in funding companies, which is not always possible while competing on price and stage with other investors. Investors must scrutinize each aspect of a company through a fine lens to find the right team with the potential to identify opportunities and act on them.
• Portfolio growth and support
The current investment landscape causes a lot of unhealthy growth among companies that investors must resist. Funding a company with an off-the-chart growth may not be as reliable as it is alluring. Companies that rise too quickly, can plummet just as fast, incurring heavy losses for investors. Secondly, it is important to find ways to grow a startup and achieve market dominance, without over-spending. The rising trend today among most big startups is to throw good money at advertising and hijack the media to build their brand. While several entrepreneurs are attracted to that route, the challenge is to build a brand the old-fashioned way – by creating a differentiated product that thrives through word of mouth. Another significant challenge faced by early stage investors is finding the right set of passionate resources to support portfolio growth at early stages, and the right team that can identify problems and effect timely course correction.
• Finding exits
The limited avenues for exit impede the growth of a venture considerably, hindering the process of possible transfer of ownership. In several cases, investors are unable to assess the right time to exit the venture and end up losing the value on their investment. Long-term investment in a company that does not grow results in losses to the investor, the company, and other stakeholders. It is imperative to identify which investments have the potential to yield desired growth and profit in the market for the enterprise, and which do not.
• Policy issues
One of the major policy issues impeding early stage investment in India is the lack of access to institutionalized capital. The dearth of capital sources such as insurance companies, pension funds, etc. is a result of the absence of appropriate policy in place to support risk capital funding, and as an extension, entrepreneurship in the country. In the absence of such necessary policies, early stage funds are restricted to raising capital from family offices, etc., thus blocking the steady flow of funds and investment opportunities.
1. Capital gains tax: While public market investments and real estate investments are not exempt from long-term capital gain tax under certain circumstances, private equity is charged a high amount of capital gains tax on exit. Moreover, foreign investors investing in Indian VC funds are allowed tax exemptions depending on the sectors that they invest in. Indian investors dealing in rupees, however, are subjected to high capital gains tax in India. This also acts as a key barrier to exit for financiers looking to disinvest from a venture.
2. Archaic regulations inhibiting innovation: Outdated regulations and policies on technological innovation inhibit entrepreneurship and negatively impact tech-based startups. As a result of such rigid regulatory policies, many ground-breaking technological innovations and investments end up leaving India for western countries that nurture such developments. Thus, there is an urgent necessity to update policies to catch up with innovation and curb the high amount of brain drain from the country.
• Lack of consumer specialization: The current startup landscape lacks a much-needed consumer specialization to build an Indian brand and survive in the market. Many entrepreneurs disconnected from the market and ground realities, often find it hard to understand Indian consumers. A large section of Indian investment ecosystem focuses on technology and innovative western business models with limited understanding of brand creation which gives rise to companies that fail to build their own loyal following, thus relying on discounting and burning cash to retain customers.