CIAO DATE: 01/02

Creating an Environment: Developing Venture Capital in India

In the last decade, one of the most admired institutions among industrialists and economic policy makers around the world has been the U. S. venture capital industry. A recent OECD (2000) report identified venture capital as a critical component for the success of entrepreneurial high-technology firms and recommended that all nations consider strategies for encouraging the availability of venture capital. With such admiration and encouragement from prestigious international organizations has come various attempts to create an indigenous venture capital industry. This article examines the efforts to create a venture capital industry in India.

The possibility and ease of cross-national transference of institutions has been a subject of debate among scholars, policy makers, and industrialists during the entire twentieth century, if not earlier (e. g., Kogut 1998). National economies have particular path-dependent trajectories, as do their national systems of innovation (NIS). ₁ The forces arrayed against transfer are numerous and include cultural factors, legal systems, entrenched institutions, and even lack of adequately trained personnel. Failure to transfer is probably the most frequent outcome, as institutional inertia is usually the default option. In the transfer process, there is a matrix of possible interactions between the transferred institution and the environment. There are four possible outcomes : A) The institution can be successfully transferred with no significant changes to either the institution or the environment. B) The institutional transfer can fail. C) The institution can be modified or hybridized so that it is able to integrate into the new environment. D) the institution can modify the new environment. Though A and B are exclusionary, it is possible for transfer to yield a combination of C and D. ₂

The establishment of any institution in another environment can be a difficult trial-and-error learning process. Even in the U. S., state and local government policies to encourage venture capital formation have been largely unsuccessful, i. e., outcome B (Florida and Smith 1993). Similarly, efforts in the 1980s by a number of European governments to create national venture capital industries also failed.

Probably the only other nation to develop a fully Silicon Valley-style venture capital industry is Israel. Taiwan, perhaps, is the only other country that appears to have developed a venture capital industry, though there has been little research on the dynamics of this process in Taiwan. Given the general difficulties in more wealthy and developed nations, it would seem that India would have poor prospects for developing a viable venture capital community.

India is a significant case study for a number of reasons. First, in contrast to the U. S., India had a history of state-directed institutional development that is similar, in certain ways, to such development in Japan and Korea, with the exception that ideologically the Indian government was avowedly hostile to capitalism. Furthermore, the government's powerful bureaucracy tightly controlled the economy, and the bureaucracy had a reputation for corruption. Such an environment would be considered hostile to the development of an institution dependent upon a stable, transparent institutional environment. India did have a number of strengths. It had an enormous number of small businesses and a public equity market. Wages were low, not only for physical labor, but also for trained engineers and scientists, of which there was a surfeit. India also boasted a homegrown software industry that began in the 1980s, and became visible upon the world scene in the mid-1990s. Experiencing rapid growth, some Indian software firms became significant successes and were able to list on the U. S. NASDAQ. Finally, beginning in the 1980s, but especially in the 1990s, a number of Indian engineers who had emigrated to the U. S. became entrepreneurs and began their own high-technology firms. They were extremely successful, making them multimillionaires or even billionaires, and some of them then became venture capitalists or angel investors. So there was a group of potential transfer agents.

For any transfer process, there has to be some match between the environment and the institution. Also, there must be agents who will mobilize resources to facilitate the process, though these agents can be in the public or private sector. Prior to 1985, the development of venture capital in India was very unlikely. However, the environment began to change after 1985, and continues to change. Even in the U. S., venture capital is only a small component of the much larger national system of innovation (NIS), and as such is dependent on many other institutions. In the U. S. and in India the development of venture capital has been a co-evolutionary process. This is particularly true in India, where it remains a small industry precariously dependent upon other institutions, particularly the government, and external actors such as international lending agencies, overseas investors, and successful Indian entrepreneurs in Silicon Valley. The growth of Indian venture capital must be examined within the context of the larger political and economic system in India. As was true in other countries, the Indian venture capital industry is the result of an iterative learning process, and it is still in its infancy. If it is to be successful it will be necessary not only for it to grow, but also for its institutional context to evolve.

The paper begins with a brief description of the development of U. S. and Israeli venture capital industries. Particular attention is given to the role of the state. The second and third sections discuss the Indian economic and financial environment that forms the backdrop to the formation of the venture capital industry. This is followed by a brief overview of the Indian information technology (IT) industry and a section on the role of non-resident Indians (NRIs). These sections set the stage for understanding the development of venture capital in India. The actual development of the Indian venture capital is set forth chronologically. The first period is when government and multilateral lending agencies are the primary actors and investors in the Indian venture capital industry. The second period is the result of an increasing liberalization of the venture capital market and the entrance of more private venture capitalists particularly from the U. S. The final sections reflect upon the progress of the Indian venture capital industry, while also highlighting the institutional barriers to continuing expansion.

Endnotes

Note 1: On path dependency, see Arthur (1994) and David (1985). For NIS, see Nelson (1993) and Lundvall (1992). Back.

Note 2: For a more general conceptualization, see Kogut (2000). Back.

Full Text of Governance and Creating an Environment: Developing Venture Capital in India (PDF, 48 pgs)