India could be the next emerging country

Across the world, companies and governments are creating an environment in which innovation can foster growth through startups. Platforms and apps are transforming both B2B and B2C. India has also been a hotbed of activity for both local and global businesses. While some platforms like Zomato and Swiggy are transforming traditional industries locally, others like Nykaa and MamaEarth are making their mark globally.

The venture capital (VC) ecosystem is an important catalyst for entrepreneurship and innovation, providing funding for early stage projects that may not be suitable for the risk profiles of large corporations. Venture capital financing is designed to generate returns on these inherently risky investments through exit strategies that rely on developing the business over a few years to the point where it is attractive to the buyer or (rarely) is able to go public. These exits then enable new rounds of venture capital investment in companies and other young entrepreneurs.

Venture capital funds are becoming increasingly global as investors seek returns, and India is no exception. One factor to choose from among the options (Silicon Valley, Toronto, London, Tel Aviv, Bengaluru, Delhi, Mumbai, Singapore, Shanghai, etc.) is the regulatory environment. Given the inherent risks already present in the venture capital ecosystem, the less hospitable the regulatory environment, the less money will be invested compared to other regions. Rules and enforcement procedures that treat almost any acquisition as an emerging competitor, rather than as a potential complement or penalize companies for their success when consumers are better off and when a platform or application creates value for its users, is more likely to make investments and acquisitions more difficult and expensive, They therefore pose a serious risk of discouraging an important source of investment for entrepreneurs.

Venture capital investment has a local impact. This leads to benefits to consumers within the same dynamic ecosystem, which in turn leads to societal benefits such as job creation, raising the standard of living and overall economic growth due to spillover effects and because entrepreneurs are downstream. This cycle of investment, development, exit and reinvestment – a kind of multiplier effect – can create a more dynamic and diversified market that is the engine of more competition, innovation and opportunity. When an entrepreneur’s company is acquired, there are at least three potential multiplier effects. First, the entrepreneur and its associated venture capitalists may use the returns made in the acquisition process to move out of that project and finance additional projects. Thus the capital invested and generated from the original project continues to fund ideas and companies, generating further innovation in the field. Second, the entrepreneur’s company may have important employees, and the acquiring company may take advantage of this talent as part of its own expansion. This practice, known as “acquisition,” is growing in popularity. Third, the acquisition may lead to “separate” companies. A spin-off refers to a project carried out by a former employee of a large company. This employee will leave a large and successful company, and start a new venture completely separate from the parent company. The recent success of the TV show Shark Tank India, where successful entrepreneurs invest in and mentor emerging startups, is an example of these multiplier effects.

Given India’s robust university system that fosters both domestic and foreign talent, India has a favorable global position to attract venture capital investments. This is evident in the significant advantage that India has over other Asian countries in terms of levels and recent growth in venture capital investment in various sectors. This positive attitude can be threatened by regulations that penalize companies that effectively compete. This is having a special effect in certain parts of India which are part of a second wave of entrepreneurship outside only Bangalore and Hyderabad. For example, recent reports suggest that some recent schemes such as the Production Linked Incentive Scheme (PLI scheme) are showing early promise, at least in some sectors, and show how active policy making can make a difference in industries to scale to global standards. Now, when companies are able to take advantage of such schemes with all the complications that modern technology brings, the stuffing of an entrepreneurial mindset can be enormous.

For India to succeed in entrepreneurship and innovation, it requires a healthy relationship between both domestic regulation that encourages growth and that works in partnership with foreign venture capital firms and technology firms. Indian consumers lose out without platform innovation, such as less participation for disadvantaged groups, and lower prices. The Indians have done very well as the leaders of prominent global technology companies, including Arista, Alphabet (Google), Twitter and Microsoft, among others. For India as a whole to grow, a robust system that rewards investment especially in vital areas like digital health, e-commerce and supply chain is the need of the hour. While the recent rise in the number of unicorns is remarkable, there is still a lot to be desired, especially as China shuts itself down to tech competition.

Opinions are personal. Sokol is Professor of Law and Business at the University of Southern California, and Benjali is a faculty member in the field of economics at the Indian Institute of Management, Ahmedabad.

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