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Is the Venture Capital Market in India Getting Overheated?
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by Evalueserve 48 India

The Venture Capital market in India seems to be getting as hot as the country’s famous summers. However, this potential over-exuberance may lead to some stormy days ahead, based on sobering research compiled by global research and analytics services firm, Evalueserve.

Evalueserve research shows that an interesting phenomenon is beginning to emerge: Over 44 US-based VC firms are now seeking to invest heavily in start-ups and early-stage companies in India. These firms have raised, or are in the process of raising, an average of $100 million each. Indeed, if these 40-plus firms are successful in raising money, they would garner approximately $4.4 billion to be invested during the next four to five years. Taking Indian Purchasing Power Parity (PPP) into consideration, this would be equivalent to $22 billion worth of investment in the US. Since about $1.75 billion (or approximately 40% of $4.4 billion) has already been raised, even if only $2.2 billion is raised by December 2006, Evalueserve cautions that there will be a glut of VC money for early-stage investments in India. This will be especially true if the VCs continue to invest only in their current favorite sectors such as information technology (IT), BPO, software and hardware products, telecom, and consumer Internet. Given that a typical start-up in India would require $9 million during its first three years (i.e., $3 million per year) and even assuming that the start-up survives for three years, investing $2.2 billion during 2007-2010 would imply investing in 150 to 180 start-ups every year during this period, which does not seem practical if the VCs continue to focus only on their current favorite sectors.

In contrast to the emerging trend highlighted above, Indian companies received almost no Private Equity (PE) or Venture Capital (VC) funding a decade ago. This scenario began to change in the late 1990s with the growth of India’s IT companies and with the simultaneous dot-com boom in India. VCs started making large investments in these sectors; however, the bust that followed led to huge losses for the PE and VC community, especially for those who had invested heavily in start-ups and early-stage companies.

After almost three years of downturn in 2001-2003, the PE market began to recover towards the end of 2004. PE investors began investing in India again, except this time they began investing in other sectors as well (although the IT and BPO sectors still continued to receive a significant portion of these investments) and most investments were in late-stage companies. Early-stage investments have been dwindling or have, at best, remained stagnant right through mid-2006.

This article is based on Evalueserve’s experience, which includes several hundred research engagements focused on India and the Indian market for our globally dispersed client-base over the last five years; and also interviews with VCs, Indian entrepreneurs, consultants, and experts within this ecosystem, along with our analysis of data from the Indian Venture Capital Association (IVCA) and Venture Intelligence India. It examines whether this new, very large total investment can actually be ‘absorbed’ by start-ups and early-stage companies in India. We will also describe some of the ‘ground realities’ and highlight a couple of ‘best practices’ that may help VCs to invest more effectively in India.

Note: Most of this article is restricted primarily to early-stage VC investments, i.e., investments in a start-up or a small company when the total amount of external money invested is typically $9 million during its entire period of existence. This will be followed by a separate article, which will focus entirely on Private Equity investments in India.


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