Sorry chief, wasn’t my fault – the FM sucked !

“Your liberty ends where my nose begins” – P.Chidambaram, Finance Minister (FM) in the Government of India seemed to declare to VCs in India investing in sectors other than select categories like IT, Biotech etc. After all these years of kid-glove treatment and patronage, the FM said enough is enough.

The Finance Bill, 2007 seeks to restrict the `pass through’ status for Venture Capital Funds (‘VCFs’)/ Venture Capital Companies (‘VCCs’) to income from investment in domestic unlisted companies only, engaged in certain specified businesses such as IT, bio-tech etc (‘VCU’). 

Currently, VCFs/ VCCs enjoy complete pass-through status under Section 10(23FB) of the Indian Income Tax Act, 1961, irrespective of nature of income.  Instead, the income is taxed in the hands of its investors at the time of distribution under Section 115U of the Act, on a pass-through basis.  VC firms normally get themselves registered as a company in tax havens such as Mauritius, Cyprus etc., with which India has a double taxation avoidance agreement ( DTAA ) and since these countries have little or no taxes on either business profits or capital gains, it has been a case of tax freedom all the way for the VC funds so long as they have registered themselves with the Securities and Exchange Board of India (SEBI). 

But now in the Budget 2007 tabled before the Indian Parliament yesterday, the FM has restricted its application to select sectors only.  The FM’s proposal with regards to the tax “pass-through” provision for venture capital funds will cause irreparable harm to innovation and entrepreneurship in India and seriously discourage the growth of venture capital in India, says Indian Venture Capital Association (IVCA) in a statement.

But is it really why they cry or is there more to it ? 

The truth is that VC firms, realizing the risks involved in startups and the longer exit duration, have quietly transformed themselves into pure Private Equity players, even as they were lapping up the tax incentives offered to minimise the venture investment risk.  This hole has now been plugged and naturally it throws a monkey wrench in their covert designs. 

The ground reality has been that VC funds primarily trooped into India for investing in the over hyped IT / ITES sectors only.  Since the startup ecosystem in India was just evolving, there were fewer investible opportunities.  The VC funds were also not very proactive and were making do with posting one or two greenhorns ( just out of Harvard / Stanford, two years with Mckinsey / Goldman Sachs, spent preparing a few vertical Excel worksheets first, then horizontalizing them before running to the copier howling `Eureka’ ) as Associates / Principals in India even as their general partners preferred to chew gum in the US.  And, how were they selected ?  On their ability to speak just one or two out of 18 official Indian languages and for their world beating `ability’ to convert lakhs of Indian rupees into millions of US $$ in their reports to the VC partners in US. 

Getting back home, this wet-behind-the-ears twig realized it commanded too much of respect locally since entrepreneurs and Investment Bankers filled its inbox with Business Plans and Executive Summaries.  Soon it became ego-laden Asshole (ELAH) inaccessible to startup founders who became snarky worms in a pile of shit and deserved to be deftly shooed away citing a flaw or two in their business model.  Startups meant sweat, no glitz or glare – ELAH wanted none of it.  

Looking at the developing situation, the local charlatans like stock brokers and construction / real estate tycoons took advantage of the naivete of the ELAH.  As a result of such serenading, most of the VC funds soon had one or more stock broking outfit or a construction company in their portfolio, stakes acquired at obscene valuations by the ELAH, besides the oh-so-great travel portals and online marriage bureaus it had patronised – in a country where PC / broadband penetration continues to be less than 2% of total population and where 95% of the marriages are traditionally arranged between known families by parents who do not trust online-buddies to marry their son / daughter.  

By now the ELAH had already lost touch with its widely touted strategic prowess in IT / ITES skills ( by taking up an I-Banking career right after a heavily state-subsidised Engineering / computer science education ) for which its IIT / Stanford / MIT stints have presumably trained it for and using which it was expected to guide and mentor the IT startups.  The ELAH had little or no clue over the problems ailing the Indian property scene which was plagued by defective titles and benami transactions ( illegal surrogate ownership) and the flagrant violation of estate and construction laws by the Construction mafia.  By any reckoning, it takes none short of a real estate wizard to be a VC in that space, which these suits-in-tropics ( ELAH swears by western “legacy systems” and wears it even as it’s 42 degree celsius outside – he tracks New York weather ! ) could hardly be. What ELAH and its employers failed to realize was while education is acquisitive, practical commercial sense is intuitive.  Let me bring Tom Perkins here – Versatility has its limits too.

If this has been the case with construction,  the other unfamiliar segment where the ELAH had forayed was stock broking. Indian stock brokers were as a breed notorious for their scheming (and scamming ) ways,  sought VC investments while the SENSEX was at its historic peak and while they were riding the peak cycle.  Naturally valuations will be stratospheric.  Warren Buffet would’ve surely cringed, but ELAH plunged right in, made several million $$ investment at > 100x P/E, came out and proudly blogged about it the next day.  Ah, it had its 15 seconds of wide-grinned fame too over the tube, got a few col inches in print,  took copies ( ah, there he goes – I’d told you, he got `trained’ at Mckinsey / Goldman Sachs ) for marking to its employers at Menlo Park / Sandhill Road – all part of elaborate pre-arranged PR initiative by the charitable (beneficiary) brokerage at ELAH’s special request.  The only pre-investment due diligence ELAH insisted was- “get me in the limelight”.  The brokerages were more than happy to provide it ! 

All this probably couldn’t have gone unnoticed at the North Block.  The Ministry of Finance had actually expected these guys to build and nurture the entrepreneurial startup ecosystem in India – and precisely the reason why these incentives were doled out in the first place.  Now that the real game was up and it promptly pulled the rug from under their feet.  It’ll take a while before the General Partners in the US smell the rot, realize their mistake and revisit their hiring practices to fire the ELAH and appoint local people who have their skin in the game as VCs.

Hopefully by then ELAH would quietly have rolled out its plan B for survival and may be fumbling with its execution too.   When asked about those investments, ELAH has a ready excuse now – “the third world sucks, Chief..wasn’t my fault…!”  

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One Response to “Sorry chief, wasn’t my fault – the FM sucked !”

  1. Vish Says:

    Wow!

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