The government is preparing a framework to help minimise the risk for local pension funds and insurance companies from investment in the startup sector, which has become a major employment generator and contributor to the economy but where business failures are fairly common, officials aware of the matter said.
“This is a part of the government’s broader intention to enhance the proportion of domestic capital invested into Indian startups,” one of the officials said.
Indian pension funds and insurers are not allowed to directly back startups, but can invest 3-5% of their investable surplus into alternative investment funds (AIFs) or fund of funds that support local startups. Having a safety net in place may allow for easing regulations to increase this limit and permit direct investment by these institutions, which managed close to Rs 100 lakh crore of public money at the end of fiscal 2023, into a sector where new funding has dried up in recent years.
The Department of Financial Services under the Ministry of Finance is working on preparing the risk framework for direct investments by pension funds and insurance companies in local startups, the people said.
“Risk cannot be completely wiped away. Even public market investments carry risks. However, once there is a mechanism that minimises it to the farthest extent possible … regulators will be able to issue amendments that allow higher investments,” a second official said.
“The biggest concern is that eight out of 10 startups end up failing… and to have public money being invested in a risky asset class would need a safety net,” he added.
The finance ministry did not respond to email queries.
The issue of enhancing domestic capital in Indian startups has come up in meetings between the government and the Indian Venture and Alternate Capital Association (IVCA), the official said. The National Startup Advisory Council formed under the commerce ministry too has discussed this, he added.
According to industry sources, 15% of the capital invested in Indian startups is from domestic sources. While this has grown over the years, investments in the technology ecosystem in the past few years have fallen significantly.
A venture investor involved in discussions with the government said they have been conducting workshops with fund managers at insurance companies and pension funds to educate them about various mechanics of startup investing.
The proposed framework is expected to capture issues such as the definition of a startup, including whether the scope could be expanded beyond how the Department for Promotion of Industry and Internal Trade defines it.
“There are global financial institutions who are taking different risks such as currency risks and credit risks to invest into Indian startups but Indian financial institutions are unable to do so primarily due to regulations. There is a general cap for insurance companies to invest into loss-making assets. The fair value norms of unlisted securities are based on book value, which means a good chunk of the investment may be underwater from the date of investment. This becomes a hurdle for them as it’ll be a hit to their profits,” said Siddarth Pai, founding partner at 3one4 Capital.
“They (domestic insurers and pension funds) also need to be given specialised information on a regular basis and there are certain reporting requirements that startups need to make. For this to happen, the (pension and insurance sector) regulations and guidelines need to be amended,” he added.
“It could also cover aspects such as stricter reporting norms should government pension funds, or public or private insurers, choose to invest in startups directly,” one of the government officials cited earlier said.
Need for domestic capital
In addition to preparing a framework for pension funds and insurers to invest, the Centre is also considering expanding the Sidbi Fund of Funds and the Startup India seed funding schemes, another official said.
The Sidbi Fund of Funds has so far committed investments of more than Rs 10,000 crore in Indian startups. Through the scheme, the government sponsors AIFs or venture firms, including Chiratae Ventures, Blume Ventures, Stellaris Venture Partners, Fireside Ventures and India Quotient.
Conversations over enhancing domestic capital in startups have come at a time when the Indian investment ecosystem is witnessing a significant slowdown. According to a recent Bain & Company and IVCA report, investments in 2023 in Indian startups fell to $9.6 billion from $25.7 billion in 2022.
In an interaction with ET reporters last month, commerce and industry minister Piyush Goyal said one of the biggest concerns of the government in the context of India’s startup ecosystem was the need for higher domestic capital.
“I wish to see more private sector investments from domestic funds and domestic industry…that’s my biggest area of concern in the startup ecosystem. Otherwise, our young boys and girls, and men and women come up with brilliant ideas, and foreign investors, which are super savvy, pick up that idea and start owning our brilliant startups,” he said.
On a question over whether the government could look at setting up a sovereign wealth fund for investments into startups, Goyal said that it’s a subject on which the new government would decide upon.
At the Startup Mahakumbh in New Delhi last month, Prime Minister Narendra Modi also said that the country was making efforts to create a better mechanism for funding.
IVCA president Rajat Tandon told ET that the industry body has been requesting the government to open up domestic pools of capital. “We are now seeing a new momentum towards enhancing domestic investment in innovative startups and IPs (intellectual properties) which pique the interest of investors and require Atmanirbhar capital,” he said.
