Yesterday the Committee on Technology Innovation and Venture Capital presented its report to the Planning Commission.  The Committee was chaired by yours truly and included  major names from hi-tech industry, the finance world and academia.  Read the short report.  It is important because honing the edge of innovation is now a necessity as Indian producers approach the cutting edges of global competition.

Growth accounting exercises have consistently shown that the main explanation for economic growth is what we call technical progress. Its pace and direction depends on how, where and when innovations are taken up by producers.  In Indian industry much of this change in techniques and business models has come from the absorption of innovations that have already been proven abroad.

We cannot rely forever on this catch-up option.  When Indian companies start becoming global players they will be seen as competitors by the foreign companies from which they have been buying know-how. They will have to rely more and more on local R & D, in-house and independent, if they are to remain major players even in the domestic market.

In certain areas our requirements are very specific and few foreigners are working on developing new products or processes for our needs.  We have to do this ourselves.  This has been the case in agriculture for a long time.  But we now see this in other areas like pharmaceuticals and even engineering.  Tata’s cannot develop their Rs. 1 lakh car by reverse engineering.  They will have to innovate in terms of materials and product design.

There are other reasons for encouraging and rewarding indigenous innovation.  Strategic imperatives require competences not just in defence industries narrowly defined but in a broader range of activities.

Consider also the other end – the sources of new technologies in public sector programmes for space, atomic energy and defence, in the CSIR labs, the IITs and engineering colleges.  The link between the talented individuals here and industry is weak.  Some complain about the lack of truly new ideas from these research establishments.  But a part of the explanation is the lack of support for risky ventures from the capital market and from the entrepreneurial class.

This is where venture capital comes in.  It involves an off-market acquisition of an equity stake in a company and can be seen as a part of private equity financing directed at early stage ventures. 

A potted history of the development of private equity finance in India is presented in the table.  Before 1997 the industry was small and based almost entirely on official funding from the government and institutions like the World Bank.  The change comes after that when foreign institutional investors step in smelling money in the IT sector.  In the halcyon years of the dot-com boom some 23 percent of the money went to early stage ventures where new products, processes or business models are tried out.  But with the collapse of the dot-com boom the proportion going to early stage ventures dropped to less than 5 percent.

A part of the explanation for the shift to late stage private equity financing is the ease with which huge profits could be made in an exuberant capital market.  But a bigger part of the explanation is the low deal flow.  The real challenge is to nurture ideas and talent and develop them to the point at which they can become bankable propositions. 

This cannot be done simply by exhorting technologists to become entrepreneurs.  We have done this in the past and it has not worked.  What we need is an ecosystem that connects technologists with entrepreneurs and investment managers who are ready to take risks in return for high rewards.  Now that the share market is less exuberant those hunting for high returns may well be tempted to take risks with new innovative ventures.

The report of the Planning Commission Committee focuses its attention on what needs to be done to cover this gap in early stage financing.  Its recommendations aim at connecting the sources of technology, the entrepreneurial community and investment managers.  At the technology end public assistance is required to set up Enterprise Units that can channel sponsored research by industry, provide consultancy services, forge partnerships with entrepreneurs and nurture in-house aspirants who want to commercialise their research ideas.   

But public assistance is not enough.  The real break through can come only if we can stimulate risk taking by private firms and high net worth individuals.  The Committee’s recommendations include some proposals, including tax incentives, which could help to do this.  Tax breaks are not very popular with the Finance Ministry these days.  But combined with the other proposals they could lead to a better use of the public money that is already being spent on technology promotion by helping to leverage much larger amounts of private resources.

A new enterprise may start in a small way with funds from friends and family.  But to grow the enterprise needs a financing system that takes it further with angel investors providing seed money, venture funds coming in at the stage of commercialization, private equity at the early expansion stage and the IPO in the capital market or an M & A when the enterprise has matured. 

The policy frame at the capital market end is reasonably well set though the Committee has some recommendations to smoothen some rough edges.  The real challenge is to stimulate a deal flow by making it easier to commercialise new ideas and to get Indian industry and high net worth individuals interested in the whole business of technology and venture funding.

The Committee has focused on technology ventures in the classical sense.  But some of the concepts of venture capital funding are applicable in activities aimed at promoting rural development by developing and promoting new technologies for agriculture and artisan industries.  There is room for the micro-credit equivalent of venture funding where money is provided to prove concepts and commercialise them and the funding comes along with strong management support.