Ensconced in his cozy office in South Mumbai, a fund manager at a venture capital fund is trying his best to offer a cerebral rationale for the recent spate of exits by large institutional investors from India's fledgling venture capital industry. In a matter of minutes, however, the façade drops. The monologue turns vitriolic, with the fund manager breathing fire on a range of issues that has led to the VC industry in India hitting its lowest ebb in recent times. Topping his hate-list is the government for its dubious take on private equity-regulations make no distinction between private equity and foreign direct investment. The Indian banks and financial institutions aren't spared either for steering clear of private venture capital funds. "They are willing to sink hundreds of crores into non-performing industries but will not back performance-driven teams; we just don't figure as an asset class" he fumes.

Mr VC's ire is understandable. He is one of the many Indian venture fund managers who has become a victim of the blow-hot-blow-cold approach of overseas investors. Stung by the poor performance of private equity the world over, several large investors have walked out of the Indian market in recent times. Among them has been Australian insurance major AMP, which last month called off its joint venture with IndAsia Fund Advisors, an advisory firm headed by well known finance and corporate consultant Pradip Shah. The JV was managing an India-specific fund with a corpus of about $55 million (Rs 262.6 crore), where amp was the anchor investor with a commitment of about $25 million (Rs 119.4 crore).

If you think Shah can still cobble together a smaller fund with one of his other partners, Canadian investment firm CDPQ, well he can't. For CDPQ too has rethought its Asia strategy, and one element of that game plan is to stay away from India. CDPQ had also appointed another independent team to scout for deals in India. The Canadian firm's rethink on investing in Asia puts a question mark on the fate of that team as well. These are not isolated cases. India is also disappearing from the radar screen of another major private equity player, GE Capital.

Blame it on the rough global climes. As Girish Kulkarni, Managing Director, TDA Capital Partners, points out: "When the market sours and there is pressure on investors, they prefer to concentrate on those geographies that command a major portion of their portfolio. They'd rather not waste time managing emerging market allocations, which sometimes account for as low as one per cent of their portfolios." To be sure, such behaviour isn't unusual amongst global investors who make investments that reflect on the balance sheet rather than create specific investment vehicles like funds. Large entities in the corporate, insurance or pension fund sectors get attracted to private equity investments when the going is good and that's when they tend to make direct investments that are reflected on their balance sheets. When these investments don't pay off, they stick out on the balance sheet, thereby resulting in these companies veering towards caution and withdrawing from private equity.

That's exactly what's happening. Between 1995 and 2000 global insurance companies and pension funds over-allocated to the private equity business on the expectation of a 20 per cent return over a five-year period. But with these expectations proving unreal, they are starting to pull back. Capital commitments are made only to established VC firms with a track record, of which there are very few in India.

Fund raising in India is likely to get tougher than ever. The year 2001 saw a sharp decline in the number of funds raised to 14, from 45 in 2000. The amount of monies raised has also dipped from $825.6 million (Rs 3,962.9 crore) in 2000 to $395 million (Rs 1,886.5 crore) in 2001. While official figures for 2002 are not yet available, market players are unable to think of a single fund that was raised last year, barring the amp-IndAsia fund, which has now collapsed. At least five funds that have been frantically trying to raise money for the past year have had little luck. Overseas capital accounts for roughly 60 per cent of the monies in the Indian VC industry. So with foreign money drying up, the sector is looking to the domestic banks and FIs for succour-which isn't coming.

"It's individuals in the Indian VC industry who have gone out and attracted overseas money from the international markets. There has been very little support from the government or government bodies for this sector. There should be some simple changes in policy to start with. For instance, we should be given a separate status under FDI regulations," suggests Prakash Karnik, who is part of the team that had been appointed by CDPQ to spot investment opportunities in India.

There Are Gripes Galore

If the VC community feels that making private equity conform with FDI norms isn't fair, that's not their only gripe. What also gets their goat is the recent proposal stipulating that a private equity investor would have to make an open offer to shareholders if it takes a 15 per cent stake in a listed entity. As for the reluctance of banks and FIs to invest in VC funds, one venture capitalist resignedly attributes it to a "resistance towards parting with the fund management fee (1.5-2 per cent of the fund size) or an aversion to profit sharing".

The institutions for their part could have their own reasons for staying away from VC funds. As Rakesh Rewari, CEO, SIDBI Venture (the asset management company for the national venture fund for software and it), is quick to point out. "Some of the critical issues here are that when a fund is set up with allocations from a government body, the money often has to go to designated sectors. Most private VCs would not want to invest in these sectors. What's more, the VCs expect returns in two to three years. Which company in the SME (small and medium enterprises) sector for instance is going to give you returns in that time frame?"

Interestingly SIDBI Venture, as anchor investor, has just committed $5 million (Rs 23.8 crore) in a $20-40 million (Rs 95.5 crore-Rs 191.04 crore) India-specific fund being raised by the Washington-based Small Entrepreneurs Assistance Fund (SEAF), which will be dedicated to the Indian SME segment.

That's one indicator that the VC industry isn't yet dead. It's only getting more focused. Sections of the vc tribe maintain it is unfair to write off this industry purely on the basis of a tough fund-raising environment. They point to the capital waiting in the wings. After all, it's not as if funds haven't been raised. And the large private equity players like General Atlantic Partners, Newbridge Capital, Warburg Pincus and Walden International continue to scout for deals in India. Says Raj Dugar, co-founder of Westbridge Capital, which is currently managing a $140 million (Rs 668.5 crore) corpus: "I anticipate fewer deals this year but certainly much larger ones than last year. Investors are spending a lot more time looking at the kind of deals they want to do. We for one continue to be very bullish on India."

As of last year, over a billion dollars is estimated to have been sunk into Indian venture capital and private equity. Yet, barely a handful of funds has actually struck deals last year. Ranu Vohra, CEO of investment bank Avendus Advisors, estimates that less than 10 firms (of the 50-odd VC firms in India) have actually concluded more than one deal last year. And of those few deals, most would be private equity transactions in established or listed companies, rather than early-stage funding, which is what venture capitalists should ideally be looking at.

There's of course a sound reason for that. Investments in entrenched firms are fairly derisked, as most of them would already be high up on the growth curve and ripe candidates for acquisitions or strategic sales. And that means the VC/private equity investor won't spend too many sleepless nights worrying about his exit options. "The boom and bust in the technology and telecom sectors worldwide has taken its toll on the investment climate. It's been a domino effect which has taken its toll on the risk appetite of funds," sums up Karnik.

A Flicker Of Hope

Still it may be a wee bit early to write an epitaph for early-stage funding. There may be hope yet for start-ups looking for risk capital, if two angel investors who've got together to rekindle the spirit of early-stage investing have their way. "In all this churn investors have forgotten the small entrepreneur," shrugs Pravin Gandhi, co-founder, Infinity Ventures. Gandhi for sure hasn't.

He and another angel investor Mahesh Murthy have teamed up to set up "Seed," which will foster small businesses.

Ventures like Seed and the SEAF fund for India may be modest attempts, but the message is clear: It may not be fair to write off the venture capital sector in India just yet. As Rahul Bhasin, Managing Partner, Barings Private Equity Partners, concludes: "Excesses had been committed in this market worldwide and India was no exception. We are just achieving more normal levels of commitment." For now, commitment of any kind will do just fine.