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Watering The Seeds Of Growth

Both Indian industry and the government agree that the economy needs a spurt of innovation. While industry has produced innovations such as the Tata Nano, the government has proposed to create dedicated venture funds for start-ups in certain areas. A coal cess was introduced in this year’s Union Budget with its proceeds earmarked for a clean energy fund. In July, the government said it is considering setting up a Rs3,000 crore venture fund to encourage innovation-driven pharmaceutical start-ups.

While these are welcome steps, some key issues need to be kept in perspective for such initiatives to be successful. First, the government has to facilitate creation of the right ecosystem. Second, it has to adopt effective mechanisms for injecting public funds into the ecosystem.

Under the highly successful US model for technology commercialization, it’s the universities that have been the fountainheads for innovation. Stanford, Harvard and the Massachusetts Institute of Technology have all successfully moved technologies from the laboratory to the market, producing companies such as Bose Corp., Akamai, Genentech, Genzyme and Google, which have created tens of billions of dollars in value. It’s important to note that the enterprise capacity of universities and research institutions is a function of the broader economic system in which they exist, and the culture and policies this system cultivates.

While India is gradually moving towards a similar knowledge-based market economy, the culture of encouraging scientists to commercialize inventions is yet absent; in many cases, they are even debarred from starting ventures. Rules and guidelines governing the entrepreneurial involvement of scientists with new ventures are loosely framed or absent. With a few exceptions, processes for managing intellectual property and the know-how to structure intellectual property deal terms that facilitate long-term monetization are lacking even in some of the top-ranked institutions. These gaps need to be bridged urgently to develop a vibrant start-up ecosystem.

A frequent complaint among technology-driven, product-oriented start-up founders is the dearth of seed financing for such ventures. Along with a supportive ecosystem, early-stage financing and venture capital are critical for nurturing innovation. For instance, the Deshpande Center at MIT has provided $10 million as catalyst grants to over 80 start-ups in the US over the last eight years. Twelve of them have built a total market value of over $180 million and created more than 200 jobs. A key element of the grant programme is the mentoring provided by seasoned entrepreneurs.

Effective venture capitalists not only provide finance, they also contribute proactively to the development of a start-up. They work as partners with start-up founders in building a business, providing visibility to new ventures and access to the right contacts through their business networks. This can be decisive when hiring senior management or raising growth capital. In a nutshell, venture capitalists create within the start-up ecosystem what economists term social capital.

All this means that the government’s proposed funding scheme has to be able to meet such standards. Otherwise, it will be unable to fulfil its mandate of nurturing innovative start-ups.

Yet, seductive as it may sound, government bureaucrats directing the precise allocation of seed capital may not work out as well in practice. Besides the opportunity for nepotism and rent seeking, there’s little evidence to suggest that governments can manage money well. That’s why one idea worth considering here is that professional, independent fund managers should be engaged to manage the proposed government funds.

An alternative mechanism is for the government to invest in existing venture funds—public pension funds or financial institutions could do the actual investing—which share a similar vision for nurturing start-up innovation. In venture capital parlance, the government could play the role of a limited partner, or LP, in venture capital funds that would have the mandate—and a proven track record—of investing in high-risk innovation in specified domains.

In fact, this could even stoke the local venture capital industry. So far, it’s primarily foreign investors who have backed Indian venture funds. India’s private and government financial institutions, major corporations and high networth families haven’t nearly invested in venture funds on the scale that they should. The symbiotic inclusion of Indian investors will be transformational for India’s start-up ecosystem. Industry stalwarts could inform the investment decision-making process at funds and allow start-ups to tap networks and best practices suited to the Indian context, improving investment decisions, start-up operating performance and capital allocation across the economy.

The stakes are very high. If the government’s initiative is not able to show success, the essential mission of nurturing innovative start-ups would also be tainted. This would be undesirable for both Indian industry and the aam aadmi. Research published by the Kauffman Foundation in July has shown that start-ups are not just major contributors to an economy, but the only contributors to net job creation and job growth.

If India is to become a knowledge economy and translate its scientific prowess into equitable, sustainable economic growth, it is imperative that policymakers make the right choices to nurture India’s nascent start-up ecosystem, and structure any proposed funding initiative optimally.

(Co-authored with Dr Shiladitya Sengupta.)

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