Technology start up scenario and VC,PE funding (India vs. China)


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Technology start up scenario and VC,PE funding (India vs. China)

  1. 1. Technology Start up scenario and VC, PE funding(India vs. China)Written by Amit Goel & Yagna TejaFeb 2012For enquiries please Page 1
  2. 2. Technology startup scenario & VC, PE funding (India vs. China)Technology startup scenario in India & ChinaRecently I read an article in the Business Insider by an entrepreneur Bowei Gai which talksabout the Chinese startup scenario. He put forward a great deal of information to support hisarguments. The informative article induced me to further probe the startup scenario in China &India. A careful examination into the same revealed some interesting findings.Indian startups have come a long way from a handful in 2004 to Bangalore alone having closeto 800 startups in 2011. India is also seeing a shift towards product technology startups.According to the industry body Nasscom India currently houses 2,400 product technologycompanies which earned a combined $2 bn in 2010. Around 1,100 product start-ups werelaunched in the past five years and overall revenues jumped 22% in the same period. The newgenerations of Indian technology startups are developing high value technology products. Toname a few Zoho offers an alternative to Microsoft Office and Google Docs, Tringme provides aVoIP telephony platform; Fusion Charts provides a platform to build graphics.Over the last three decades the Indian I.T. industry has grown from nothing to an estimated $88bn in revenue in 2011. Apart from the growth in the services Industry this has also resulted in astrong growth of technology start ups in India mainly over the last decade. This recent successin the area of information technology has shown that there is a tremendous potential for thegrowth of knowledge based industries. The huge talent pool of software developers anddesigners in India has played a key role behind this growth. There is also an increase in thenumber of incubation centers providing a platform for the growth of technology startups in India.US Telecommunications company AT&T is also planning to act as a business incubator for ahandful of telecom focused technology startup companies in India. The rate of companiesgetting funded in incubators has increased with more than 60 incubators at institutes across thecountry supported by the National Science and Technology Entrepreneurship DevelopmentBoard (NSTEDB). By next year it is estimated that India will produce around 150 startups aidedby a better ecosystem which includes intellectual capital, 300 active VC firms, angels,accelerators and successful companies to partner or hunt down. Intel Capital is set to invest $20 mn in six Indian technology startups from the Intel $ 250 mn India Technology fund. TheIndian government has also come up with a series of initiatives to encourage entrepreneurs inthe early stages like the Department of Scientific and Industrial Research (DSIR)’s MicroTechnopreneurship Support which provides funds in the range of INR 75,000 – INR 4,500,000to the startups in different phases. Also the second generation entrepreneurs like NarayanaMurthy & Azim Premji have started their venture fund to support the new age entrepreneurs. Wecan finally say that the building blocks for the Indian technology startups have been laid.The reverse brain drain to India has resulted in the transfer of cutting edge technologies and abetter understanding of global markets which is helping the entrepreneurs to create productswith a good customer value proposition. According to Vivek Wadhwa, Senior ResearchAssociate at Harvard Law School and Executive in Residence at Duke University, thesereturnees are in the U.S. population’s educational top tier, precisely the kind of people who canmake the greatest contribution to an economy’s innovation and growth. Business research andconsulting firm Frost & Sullivan said that the world will witness reverse brain drain, wherein theFor enquiries please contact:; +91-80-41231576 Page 2
  3. 3. Technology startup scenario & VC, PE funding (India vs. China)vast vacancies for CXOs in countries like India will be filled not only by returning Indians, butalso by Americans and Europeans seeking better prospects. It also listed the most significantfactors drawing both Indian and Chinese entrepreneurs home to be economic opportunities,access to local markets, and family ties. All these developments have made an impact on thetechnology startup ecosystem in India. The accumulation of linkages between entrepreneurs inIndia and China and entrepreneurs in the United States offers opportunities for mutuallybeneficial growth.This can be understood by the way in which India and China have adapted business modelsfrom the U.S. and have been successful. In the online travel space there is an Expedia in theU.S., Ctrip in China and in India we have MakeMyTrip, Cleartrip, Yatra and Travelguru. For jobportals, there is in the U.S., in China and Naukri in India. Yahoo has SINAin China and in India. In digital mapping, there is MapQuest in the U.S., AutoNavi inBeijing and MapMyIndia in India. For online payment, there is PayPal in the U.S., 99Bill inChina, and PayMate in India. Also players like Kreeda, Nazara and Games2Win have come upin the online gaming sector in India. An important reason for the same is that the investors arereadily drawn towards business models that have already been proven elsewhere.Bowen Gai points out in his article that setting up a company in China is an absolute nightmareas China’s incorporation process is a problem, especially for foreigners or any company thatwants to raise US funding. The most popular and recommended procedure is called VariableInterest Entities (VIE), which involves creating a company in the Cayman Islands that controls asubsidiary in Hongkong. This subsidiary controls a foreign subsidiary in China which againcontrols a local subsidiary in China. Gai remarks this procedure to be inefficient. Other problemsinclude acquiring the absolutely necessary Chinese Internet Content Provider license andsetting up Trusts for employees in order to grant employee stock options. He also adds thatstartups are severely deprived of online developer services such as AWS, Heroku, SendGrid,Twilio, BrainTree, Github and Google Apps. Development is China is difficult as one has tomanage their own hardware and write their own email server. He opines that technologystartups in China are a few generations behind as it takes time for hot new technologydocumentations to translate into Chinese. One exception to this is mobile software wherein thedevelopment tools are standardized by Apple and Google. Overall the Technology startupscenario in China is not so good with Beijing being the sole exception.VC, PE funding for technology startups in India & China:Over the last decade and half, Venture capital industry has been one of the most admiredinstitutions among industrialists and economic policymakers around the world. It is a fact thatventure capital is a critical component for the success of entrepreneurial high-technologystartups in India and elsewhere. Silicon Valley presents us with ample examples to understandthis trend and its significance. India also witnessed the growth of technology startups with thepresence of some technology centric investors like Intel, NEA, IDG, Helion, Canaan, KPCB, andDFJ. After the huge takeaways from the Silicon Valley, most VC and PE firms have nowfocused on countries like India & China which present a potential market filled with opportunitiesFor enquiries please contact:; +91-80-41231576 Page 3
  4. 4. Technology startup scenario & VC, PE funding (India vs. China)and diminishing risk. A debate most investors would have is about “Which country offers betterinvestment climate?” VC, PE funding is generally done at different stages which are Buyout,Turnaround, PIPE, Expansion and pre IPO. A better picture can be arrived only byunderstanding the funding in specific stages.Do the Chinese & Indian markets present the VCs & PEs with the same kind of opportunitiesand challenges? The answer - “No, It is entirely different”. We need to understand a few factsabout the VC, PE outlook towards technology startups in India and China before making anyconclusion. In India every technology startup that has just been set up should have a newproduct or a novel way of solving a problem because of well regulated IPO laws. But this is notthe case in China. Bowen Gai in his article mentions that in China there are as many as 3000-5000 clone companies for a product and strategies in China can be deliberately cruel or violentgoing to the extent of buying negative reviews about competitors and outright theft of intellectualproperty. The Organization for Economic Co-Operation and Development (OECD) stated in theirreport that Intellectual Property Rights protection remains a barrier in China both to indigenousinnovation and to the involvement of foreign capital and talent in innovative ventures. It alsomentioned that finance and banking laws and regulations remains a barrier in China.VCs operate with a model in which they invest in a few companies and expect at least oneinvestment to generate huge returns. This is because even if some companies’ fail and at leasta few generate huge returns the fund as a whole can be profitable. India has witnessed thegrowth of novel startups as a result of funding by the VC’s. India in the Technology sector overthe past six years has seen close to 270 deals worth $ 3.70 bn. Total VC investments in India in2010 was about $ 557 mn (6.8 percent of total PE deal value) spread across 115 deals. Datafrom Ministry of Corporate Affairs suggest that entrepreneurial activity in India remains strongwith nearly 65,000 new companies being incorporated during the period April to December2010. This marked an increase of about 41 percent over the number of new companiesincorporated during the period April to December 2009. In the month of November alone, morethan $ 538.6 mn fund has been raised by startup companies in different verticals with over $79.8 million raised by the online vertical alone. China Ventures online database system,CVSource, mentioned that the Chinese VC investment rose slightly compared with the previousyear, with 804 disclosed deals involving a total investment amount of $ 5.7 bn. But the lack ofintellectual property laws in China makes it very easy for clone companies to exist and for thebig companies to imitate any novel idea from a start up and also scale it up. This also meansthat the big companies need not acquire the start ups in China presenting bleak exitopportunities for the VCs. VC firms typically prefer to invest in companies developing a nicheproduct/service, a driven and focused management team and a business model that looksscalable. Knowledgefaber opines that it makes more sense for VCs to invest in India as VCinvestments are mostly in early-stage, much smaller and also focused on a particular sectorwhere the probability of generating returns is high.PE funding is entirely different in China and India for the larger and grown up firms. China andIndia together captured 68 per cent of the total PE investments in Asia, with $ 5.8 bn going intoChina and $ 3.8 bn into India in 2011. India and China accounted for 54 per cent of the totalnumber of completed PE transactions in the January-June period in 2011 with China accountingFor enquiries please contact:; +91-80-41231576 Page 4
  5. 5. Technology startup scenario & VC, PE funding (India vs. China)for 136 completed transactions and India accounting for 142. The total value of PE investmentsin China in 2010 was $ 18.1 bn compared to $ 5.3 bn in India. 490 Chinese firms debuted onglobal exchanges, and raised $ 106.875 bn in 2010. There were 220 VC/PE-backed IPOs,accounting for 44.8% of all the deals, involving 269 foreign institutional investors. The IT sectorhas seen 53 IPOs in 2010 with a total financing amount of $ 6696 mn with an average financingamount of $ 126 mn (China). IT & ITES sector in India accounted for 17% by volume and 7% byvalue of the total PE investment during 2005-2010. PE investments over last 6 years in India isaround $ US 50 bn and the total FDI inflow is $ 116 bn.To understand the reason why grown up firms in India arent getting as much funding as inChina, one has to go back and understand that PE firms here have a lot of different ideas tochoose from, resources are limited and returns are not assured/proven unlike China. PE firmsmake large investments, buy mature, public companies. VC model would never work in PE,where the number of investments is smaller and the investment size is much larger and if evenone company “failed,” the fund would fail. So that’s why they invest in mature companies wherethe chance of failing in 3-5 years is almost 0%. In China the competition is so insane that atechnology startup has to face and overcome lot of difficult battles to be successful. On theother hand in India though there is always a market for innovative technology solutions, thefirms do not face a fraction of the competition that their Chinese counterparts do. The extremelychallenging situation in China also means that only the Herculean last till the end, which makesthem mature firms.Once a company gains reputation in China, the PE firms are putting money more for the brandthan for the actual product since the product can be replicated but the brand value cannot be.The Chinese government encourages PE investments because of the kind of managementexpertise, contacts, technology, skill sets that are associated with it, and not capital alone. InChina businesses are conducted more by relations, trust and networks rather than merit. Thefirst company in an industry to become publicly-traded in China usually has a huge advantageover competitors. A careful analysis of the pattern of funding in India and China reveals theinvestor notion towards these countries. Indian PE market is largely dominated by the globalinvestors who follow a more cautious approach due the risk associated with a particulartechnology. Of the total PE investments during 2005-2010 in India and China 9% came in duringbuyout stage in India compared to 17% in China, 0% came in during the turnaround stage inIndia compared to 4% in China, 27% came in during the PIPE stage in India compared to 25%in China, 58% came in during the expansion stage in India compared to 25% in China. The ratioof expansion investments to total investment in India stands at 96% compared to 41% in Chinawhile 6% came in during the pre IPO stage in India compared to 28% in China. Investors aremore cautious in India due to the longer payback periods and the uncertainty associated with it.PE firms are cautious because many start ups do not have a well defined business modelduring this stage and there have been not many major exits. At the same time valuations forpromising startups are high as there are few firms with very good business models and strongmanagement. Funding in India has been more in the growth stages where the investors areassured of returns. Investors are active during early stages mostly in the mature markets wherethe payback period is shorter. China has received 28% of PE funding in the pre IPO stagecompared to 6% in India. India has not yet produced a great technology company going globalFor enquiries please contact:; +91-80-41231576 Page 5
  6. 6. Technology startup scenario & VC, PE funding (India vs. China)while China has witnessed Baidu, Tencent, ZTE, HTC and Alibaba proving to the investors thepotential of the Chinese market. In addition there is an another Chinese company Jingdonggearing up to raise as much as $ 4 bn to $ 5 bn from an initial public offering in the first half of2012. The economic environment in India is also making it harder for PE funds to fulfill theirprimary competence of building value in the companies they have invested in. And finally,exiting these investments is turning out to be the hardest. With stock markets in a freefall, IPOs,private equitys most preferred exit route in India has slammed shut. On the other hand Chinapresents the PE firms with similar risks compared to India but exponentially high returns. FDI inIndia during the last two years stands at $ US 46 bn where as China witnessed as record FDI of$ 105.7 bn in 2010 alone. This is indicative of the PE investments in India and China. Thedomestic, government funding and FDI in China are higher than India which has contributed tothe growth of China.In the United States, private equity as a percentage of GDP is 3.4%. In China and India its0.3%. In absolute terms China stands at $ 34 bn while in India it is $ 5.5 bn. As a result, theresenormous opportunity in China and India because its still a very small percentage of theeconomy. Though India also presents similar potential for the PE industry, the complexregulatory issues, poor infrastructure and multiple firms looking at a single deal has affected thePE funding for the technology start ups. No major exit for the start ups in India is a matter ofconcern for the investors in India. The biggest barrier for PE firms in India is the lack ofregulatory support as the policymakers still do not regard PE and VC as a distinct asset classwhich can create an environment more conducive to the industry’s growth. China on the otherhand has produced striking private equity returns in the recent years for the investors. Chinahas been very successful in tapping the domestic market which itself is very huge. The investoroutlook towards India is more timid compared to China but still positive. Regulations are aconcern in India for the PE firms. Companies that funds invest in is still a concern butdiminishing with new regulatory policies directed towards opening up investments. FDI policiesand pricing restrictions on entry & exit for FDI is also a challenge for the PE firms in India. Manyfirms operate out of a global fund, so they look at all geographies with the same intention and amuch established market does not subject the PE firms to these issues.Knowledgefaber analysis & the interviews conducted with the VC, PE firms have clearlyindicated that India presents a great market for the VC investors while China is a much biggermarket for the PE investments.Prospects (India):The overall outlook for the PE industry in India is growing more positive everyday with Indiahaving the highest CAGR of PE investments in Asia at 17% during 2005-2010. With a properfunding environment and policy support, there is undoubtedly tremendous potential for PEactivity in India in the technology sector. India is a safer bet in the longer term than China owingto a stable government, as weaknesses in Chinas legal system and political instability remainsa concern for the investors. China attracts deals across multiple industries while in India thefocus is still biased towards technology and services. India presents the PE investors with amuch better environment to invest in technology startups with a mention that only properFor enquiries please contact:; +91-80-41231576 Page 6
  7. 7. Technology startup scenario & VC, PE funding (India vs. China)policies and support from government and financial institutions will help realize its true potential.Increased funding in the seed stages will ensure that over a period of time India will producebetter and a larger number of technology companies given the gap at this stage. The onus lieson the companies to come out with less risky business models and with products which arecommercially viable for the end user. A recent study by IDG Ventures estimates that India willwitness $70-75 bn of private equity and VC investment between 2010 and 2015 of which nearly$10 bn of it is expected to come from VC players, largely in the technology space. India still maynot have an ecosystem similar to Silicon Valley but the basic building blocks of mentors,incubators and investors getting united to help technology startups succeed have beenestablished. Flipkart, InMobi, Zoho, Mango Technologies, Leadforce1, 160BY2, Vidteq, Edujinilabs and SnapDeal are some companies to watch out. Flipkart with the recent round of fundinghas raised $ 31 mn until now. Snapdeal has raised $ 40 mn in series B funding hardly sixmonths after it had announced a $ 12 mn series A funding in January this year. It would bemore interesting to see whether these companies would hit the public market or present a dealand get acquired by bigger firms.A flourishing VC, PE industry in India will fill the gap between the capital requirements oftechnology and knowledge based startup enterprises and funding available from traditionalinstitutional lenders such as banks. However, from the viewpoint of a traditional banker, theyhave neither physical assets nor a low-risk business plan. Not surprisingly, companies such asApple, Exodus, Hotmail and Yahoo, to mention a few of the many successful multinationalventure-capital funded companies, initially failed to get capital as startups when theyapproached traditional lenders. However, they were able to obtain finance from independentlymanaged venture capital funds that focus on equity or equity-linked investments in privatelyheld, high-growth companies. The gap exists because such startups are necessarily based onintangible assets such as human capital and on a technology-enabled mission. Along with thisfinance the investors’ bring smart advice, hand-on management support and other skills thathelp the entrepreneurial vision to be converted to marketable products. India today is at thecusp of becoming an epicentre for global innovation, which is driven by the timely amalgamationof multiple factors viz domestic market, global aspirations of Indian firms and the need forinnovation to succeed. While the private sector has always rooted for technology adoption, thegovernment too seems to be making the strategic shift. The Indian Government has earmarked$ 9 bn for investment in IT initiatives over the next five years; 12 percent year on year rise in ITspending allocation to States. Though several countries are seeing a downturn in fund raisingfor startups due to financial crisis, the scenario in India is very positive. Knowledgefaberanalysis suggests that the eCommerce, data analytics, mobile commerce, and cloud computingare the major areas of interest for the investors in India which is also estimated to receive themajor funding in India.For enquiries please contact:; +91-80-41231576 Page 7