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Private equity/venture capital (PE/VC) are an emerging asset classes in India critical for enabling broad based entrepreneurship and driving economic expansion. The VC industry is expected to fund innovation and ideas that push the frontiers in addressing large unmet market needs – a risky proposition by any standard. The inherently higher risk is the reason why investors expect higher returns from venture capital industry than most other asset classes. And by extension, this is the same reason why venture capital funds expect higher returns from their investee companies.
Unfortunately, the value of this asset class is not as well understood by large sections of the business community. Beyond market and environmental factors, the equation between the investor and the entrepreneur is crucial in driving success. The relationship has to be symbiotic based on a high level of trust and a spirit of partnership. This will not happen at the outset, but both parties need to work hard at it over a sustained period of time to build that platform for cooperation.
The investor needs to be viewed by the entrepreneur as bringing complementary or specialized expertise beyond the financing, which may vary from opening doors to new markets, sourcing talent or improving governance practices. The investor has to be cognizant of his/her role in helping the company achieve its growth targets.
Pre-deal negotiations, post-deal value creation and exit engineering are critical elements in determining success and failure, and would require a more holistic perspective on the part of both parties. The entry valuations negotiated between the two parties should ensure benchmark returns for the investor in a successful exit.
High entry valuations will result in unattractive returns, inhibiting the growth of this asset class, which in turn would have a detrimental impact on entrepreneurial growth, so a virtuous cycle needs to be created.
It is important for PE/VC investors to adopt best practices from mature market experience, so that the entrepreneurial momentum can be sustained over long periods, unlike the boom and bust cycles that we have experienced in the past in India.
Till date, a majority of PE/VC investors in India have been viewed as passive financiers by the entrepreneur. Establishing differentiation by being a trusted advisor and through a more active hands-on role is important for the PE/VC investor to improve credibility and acceptability among entrepreneurs.
Sector specialisation as a strategy for PE/VC investors depends on many factors – sectoral depth in the local market, supportive ecosystem by way of regulations, public-private partnerships, governmental support etc. The viability of such a strategy needs to be evaluated on a case-by-case basis.