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Photo: iStock
Photo: iStock

The big heroic role that venture capital can play

A post-pandemic economic revival calls for innovative ventures backed by VC funds doing the sort of high-risk intermediation that only they can. Don’t count on priority-sector credit

By the time the covid pandemic is done, the world may well have changed forever. It is a pivotal event, potent enough to reset social life, individual behaviour, consumption patterns, business prospects and public policy in unforeseen ways. In other words, it is a perfect time—pardon the phrase—for bellies to acquire the fire of new entrepreneurial ideas. With the world swamped with excess capital, one may have expected a flurry of venture capital (VC) activity. So far, though, all we have are a few flickers of hope that VC funding is set for a revival in India after a corona slump. According to Venture Intelligence, the number of VC deals had declined from a monthly average of 50 in the first four months of 2020 to just 20 in May. A recent report by Tracxn, which also tracks this arena, said that the sum invested by VC firms fell by 29% to $4.2 billion in the first half of 2020 over the same period of 2019, with education and fintech ventures attracting a sizeable chunk of the money. While most VC investment since then has gone into existing start-ups, some industry watchers detect a slight recovery in new- venture funding over July and August. This may feel heartening, but the country would need an all-out VC boom to go with a burst of innovation before we can justify much optimism over the adaptability of our economy.

There is good reason for new ventures to be funded by private risk capital. The odds of success are steep and the financial burden of failure is best shared among those ready to take what is essentially a partly-scaffolded wager. Specialized VC firms are well-suited to this. They have a close grasp of the bets being made, act as consultants to entrepreneurs, stand to make huge gains by cashing in their chips once these start-ups go public, and typically hold portfolios diversified to reward them even if only one or two investments click. Almost every post-internet business breakthrough has had VC funding behind it. Though grumbles have arisen over the enterprise value often lost in the process of opening ownership to investors at large, this Silicon Valley model does a fine job of financial intermediation.

To be sure, the Narendra Modi administration has also worked hard to catalyse the country’s start-up scene, most prominently through its incentive-laden “Startup India" scheme of 2016. Last week, the Reserve Bank of India (RBI) issued revised guidelines to banks for priority sector lending that included special credit for start-ups. On the face of it, this is laudable. But is it? Banks are ill-equipped to assess and price off-the-chart risks of the sort that most new businesses bear. Nor can they salvage much by way of collateral in case of defaults, given the intangibility of their assets. This could mean that these priority quota loans go the same way as other forms of state-directed lending—into an abyss. At any other time, this could be greeted with sighs of acceptance. The inefficiency of state-dominated banking needs no reminder. Alas, right now, our banks seem at threat of being crushed by bad loans. We face a crunch that ought to reinforce a cardinal principle. When risks run high, they should be shared by willing partners. If earnings are stable, debt works well. The overuse of credit as a hand-out in times of crisis is asking for trouble later

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