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Venture Capital
Environment in India
Independent Study
By
Kumar Gounder
OHSU/OGI
Fall 2005
With
Kumar Gounder - MST502D - Venture Capital and Entrepreneurship environment in India Page 1 of 19
TABLE OF CONTENTS
1 ABSTACT .....................................................................................................3
2 PRE-LIBERALIZATION - BETWEEN 1947 AND 1990.................................3
2.1 Venture Capital in India during Pre-liberalization period .........................4
3 POST ECONOMIC LIBERALIZATION - AFTER 1990 .................................4
3.1 India Venture Capital History ..................................................................5
3.2 Visibility of Indian entrepreneurs’ Success in Silicon Valley (SV) ...........5
3.3 Drivers of Venture Investing in India .......................................................7
3.4 BSE Sensex Journey from 1000 to 9000................................................7
3.5 State of Venture Capital in India .............................................................7
3.6 Highlights & Trends of the Indian VC environment in Recent Years.......8
3.7 VC Activity in Asian Region – 2003 ......................................................10
3.8 Analysis of Investments in 2002 and 2003 ...........................................11
3.9 Deals in 2003 (by stage).......................................................................11
3.10 Fund Raising Position...........................................................................11
3.11 Supportive regulatory Environment ......................................................11
3.12 Entrepreneurship in India......................................................................12
3.13 Trends influencing high-tech entrepreneurship in India ........................12
3.14 The VC “Hotbeds”.................................................................................12
3.15 Issues and challenges ..........................................................................13
4 CONCLUSION ............................................................................................13
5 APPENDICES .............................................................................................14
5.1 Appendix - A: Amount invested in India (Source: NASSCOMM) ..........14
5.2 Appendix - B: Private Equity Investments in Asia: 2001 .......................14
5.3 Appendix – C: Indian Scenario as of 2001 - A Statistical Snapshot.....15
5.4 Appendix – D: List of some VC/PE Companies ....................................17
5.5 Appendix – E - Interview with Ganapathy Subramanian.......................18
5.6 Appendix – F: References ....................................................................19
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1 ABSTACT
India is the largest democracy on the planet and second most populous country in the world. Its
extraordinary history is intimately tied to its geography. A meeting ground between the East and
the West, it has been invader’s paradise. Persians, Greeks, Chinese nomads, Arabs, French,
Portuguese and British invaded India between 1500 BC and 1947. India’s most ancient
civilization, Indus, is one of the world’s oldest and goes as far back as 5000 years. British ruled
India for more than 150 years. India fought for its independence for long and gained it in 1947
from the British.
After the independence, India decided to have a planned economy, where all the aspects of the
economy were controlled by the government and licenses were given to select few. This resulted
in ‘License Raj’. The term ‘License Raj’ refers to elaborate licenses, regulations and the
accompanying red tape, that were required to set up businesses between 1947 and 1990. In
1991, Mr. Narashimha Rao, the then Finance Minister of India, facing macroeconomic crisis
introduced economic reforms by dismantling licensing regulations in order to attract Foreign
Direct Investment (FDI) and private businesses. License Raj was believed to be dismantled in
that year.
We can witness the outcome of the economic liberalization in the journey of Bombay Stock
Exchange (BSE)’s 30 stock index known as Sensex from 1000 in 1990 to 9000 in 2005. Close to
7,000 stocks trade on the 130-year old SBE, the oldest bourse in Asia.
In the last one and half decades, India has proved itself as a destination for Information
Technology (IT) and Business Process Outsourcing (BPO). India is also fast emerging as a major
center for cutting-edge research and development (R&D) projects for global multinational
companies.
Lot of activities are happening in India in various sectors such as IT, BPO, Knowledge Process
Outsourcing (KPO), Semiconductors, Biotechnology, Textiles, Manufacturing, and Engineering
recently. In this paper, I will analyze the entrepreneurship and venture capital environment in
India. I will divide the post independence periods between 1947 and 2005 as pre-liberalization
period (1947-1990) and post liberalization period (1990 onwards) and analyze the venture capital
and entrepreneurship environment during these periods. I talked with Mr. Ganapathy
Subramanian of Jumpstartup, an early stage India-US venture capital firm. He is a founding
partner of Jumpstartp-I. I will present his views of the Indian Venture Capital industry.
He was absolutely correct. India’s share in the world trade declined from 2% in 1950-51 to 1% in
1965-66, and 0.5% in 1973-74. It continued to hover around this figure until 1990-91. There were
widespread corruption in India during these periods especially when one had to deal with
government entities. Even today, corruption exists. However, the level has come down because
the government started implementing economic reforms by liberalizing, de-regulating, and moving
towards e-governance.
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The leaders of the independence movement were the supporters of small and medium
businesses as an alternative to “exploitation” by the multinational firms. These small and medium
businesses were in traditional industries. Despite the emphasis on small and medium businesses,
the Indian economy was dominated by a few massive private sector conglomerates such as Tata
and Birla groups, and some nationalized firms. Large conglomerates did not need venture capital
fund as they had access to fund from national commercial banks. It was very difficult for small
and medium firms to venture into a new business because of the license raj system. This
situation was not relevant for the emergence of venture capital.
The earliest discussion of venture capital in India came in 1973 when the government appointed
a commission to examine strategies for fostering small and medium-sized enterprises (Nasscom
2000). In 1983, a book titled “Risk Capital for Industry” was written and published in India with
the support of the Economic and Scientific Research Foundation of India. This book showed how
difficult to raise “risk capital” for new ventures in the Indian financial system’s operation that
existed during that time and proposed various measures to liberalize and deregulate the financial
market. Later, it led to political discussions on the difficulties India had in encouraging
entrepreneurship and the general malfunctioning of the Indian financial system.
India did not have any policies toward venture capital prior to 1988. In fact, there was no formal
venture capital before 1988. The Indian government issued its first guidelines to legalize venture
capital operations in 1988 (Ministry of Finance 1988). These guidelines were aimed at the state-
controlled banks to establish venture capital subsidiaries. It was also possible for other investors
to create venture capital firm. When the Indian government realized the potential of venture
capital, World Bank was also interested in encouraging economic liberalization in India. So, the
government announced an institutional structure for venture capital (Ministry of Finance 1988).
Thus, the first venture capital company, Technology Development & Information Company of
India Ltd. (TDICI) was established in August 1988 and was run by Mr. Kiran Nadkarni. TDICI was
formed by Industrial Credit and Investment Corporation of India (ICICI) and Unit Trust of India
(UTI) to primarily focus on technologies. Both ICICI and UTI were state-controlled institutions. It
was the World Bank funded experimental project. Since the government controlled every aspect
of the economy, it was not surprising that the first formal venture capital organization began in the
public sector.
Several established software firms received funds from TDICI, including Wipro for developing a
“ruggedized” computer for army use. There were several successes, including several firms
which went public, such as VXL, Mastek Software Systems, Microland, and Sun
Pharmaceuticals.
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In 1990, another venture capital company Gujarat Venture Finance Limited (GVFL) started
operations with a 240 million rupee fund with investments from the World Bank and other state
and central banks and private institutions. Since that fund was sufficiently successful, GVFL
started another fund in 1995 and raised 600 million rupees. In 1997, it raised a third fund to target
the IT sector.
The other two venture funds were formed by Andhra Pradesh Industrial Development Corporation
(APDIC) and CanBank (the only bank-operated venture capital subsidiary) formed by a
nationalized bank Canara Bank. The performance was marginal.
By 1995, even though some fund performance was disappointing, there came a realization that
there actually were viable investment opportunities in India, and a number of venture capitalists
had received training.
Although the venture capital environment in India is recent and new, there are four phases in the
Indian venture capital history. They are:
The success of Indian entrepreneurs in Silicon Valley that began in 1980s became more visible in
the 1990s. This created a notion in the United States that India might have more possible
entrepreneurs. This notion brought the Foreign Investors’ attention toward India. Following are
some of the venture capital firms started operations in India after this realization:
In 1993, the Indian Venture Capital Association (IVCA) was formed to create conducive
environment in India for venture capital and entrepreneurship. It consisted of nine members:
1. TDICI
2. GVFL
3. IDBI’s venture division
4. RCTC
5. APIDC
6. CanBank
7. Credit Capital Corporation
8. Grindlays (acquired by Standard Charted Bank)
9. British venture 3i Corporation
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Between 1988 and 1996, the government relaxed the regulations further on venture capital
operations. So, only in 1996, overseas and truly private domestic venture capitalists began
investing.
Indian government realized the potential benefits of healthy venture capital sector in the late
1990s. In 1999, the government announced a number of new regulations. This included a
significant regulation liberalizing the ability of various financial institutions to invest in venture
capital. As a result, the number of venture capital firms has radically increased as shown in the
following table:
Year # of VC firms
Before 1994 11
1998 18
2001 40
2005 More than 100
The bureaucratic obstacles to the free operation of venture capital remained significant. There
continued to be a confusing array of newly created statutes. The following statutes govern
venture capital in India:
In early 2000, domestic venture capitalists were regulated by three government bodies:
For foreign venture capital firms there was even greater regulation in the form of:
• The Foreign Investment Promotion Board (FIPB), which approves every investment
• The Reserve Bank of India (RBI), which approves every disinvestment.
The following regulations did not create an inviting environment for investors.
• Income tax rules provided that venture capital funds may invest only up to 40 percent of
the paid-up capital of a recipient firm, and also not beyond 25 percent of their own funds.
• All investors in the venture capital fund had limited liability, and there was no flexibility in
risk sharing arrangements.
• There were no standard control arrangements, so they had to be determined by
negotiation between management and investors in the fund.
• Limited life funds were not recognized. So, it was relatively easy to terminate a trust, but
this meant that the entire firm was closed rather than a specific fund within the firm.
Therefore, each fund had to be created as a separate trust or company. This process is
administratively and legally time-consuming. Terminating a fund is even more
cumbersome, as it requires court approval on a case-by-case basis.
• For firms with more than 50 non-employee shareholders, India’s corporate law does not
provide flexibility in using equity to reward employees. While this may be satisfactory for
early-stage venture capital investors, it could discourage later-stage investors who invest
as parts of a consortium.
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• Tax restrictions on corporations require that corporations paying dividends must pay a 10
percent dividend–distribution tax on the aggregate dividend. On the other hand, trusts
granting dividends are exempt from dividend tax.
• The tax code in 2001 was disadvantageous from the viewpoint of the international
venture capital investor. Earnings from an international venture capital investor are taxed
even if it is a tax exempt institution in its country of origin.
• Knowledge based industries growing fast and mostly global and are less affected by
domestic issues
• World class engineers, professionals, entrepreneurs - success evident in the US as well
• 2nd largest English speaking population with emphasis on science and mathematics
among Indian students
• India has advanced rapidly in the 90’s, catching up with global markets in many sectors.
Evidence of this in the US as well
• 25% of small IT companies in the US have Indian founders
• Disproportionately large presence of Indians (1 million+) in the US Software Sector
• 50% of all H1 visas issued to Indians
Bombay Stock Exchange (BSE), the oldest stock exchange of India was established in 1875. The
BSE Sensex comprises 30 stocks. BSE crossed 9000 mark for the first time in its history on Nov
28, 2005. Following is the timeline:
Businesses and consumers are very bullish on Indian Economy. Economic liberalization and
Regulation of Venture Capital Operations paved the way for Mergers and Acquisitions (M&A).
Associated Chambers of Commerce and Industry of India (Assocham) estimates M&A activities in
India will touch $17B in 2005. The hot sectors in M&A are banking, pharmaceutical, IT, media and
telecom.
Despite there was no venture capital firm in India until 1988, India jumped to 15th position world
wide in 2001 and 12th position in 2002 based on investment. India ranked #1 when it was based
on Compound Annual Growth Rate (CAGR). India’s CAGR was 82% for the period 1998-2002.
The following table illustrates the fact along with other countries’ positions.
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State of Venture Capital – Top 20 Countries in 2002 – Based on Investment
(Source: IVCA and Infinity Ventures)
Year 2001
• Nearly all VCs were hesitant to invest in startups with inexperienced management
team, or a clear, scalable business model. Consequently, the seed funding share in
total disbursements was only 15 per cent.
• VCs preferred to continue funding the late stage or expansion ventures. This venture
grew to 41% of the total. The typical deal sizes were:
o Series A - $1 to $1.5 million
o Series B - $3 to $5 million
o Series C - $4 to $8 million
o Series D - $5 to $15 million
• Nearly 70 VC funds were operating in India with total assets under management of
nearly $ 5.6 billion. The amount had grown nearly twenty fold between 1996 and 2001.
o Most VCs were not keen to fund small companies. They were interested in a
minimum deal size of $1M. They wanted to invest in listed companies.
o VCs turned their attention to IT enabled services, wireless applications and
biotechnology sectors as small software service companies were not able to
offer a differentiated value proposition and internet centric ventures faced the
difficulty of sustaining and scaling up of revenues.
• IP software development companies slowly came into the limelight. This was especially
true in the areas of embedded software, digital signal processing, and system on chip
(SOC) among other applications. A number of VCs expressed tentative interest, of
course, the caveat of domain knowledge, and management capability continue to rule
strong.
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• Internet investments declined and non-Internet related investments increased from 28
per cent of VC investments in 2000 to 68 per cent in 2001.
Year 2002
• India ranked as second most active VC market in the Asian region, outside of Japan, in
attracting capital
• $590M Venture capital fund and private equity was invested
• There were 41 exits that included Spectramind, Customer Asset, Exl and iFlex
• 76 deals received investment
• Indian VC funds received $241M in new commitments, up 11.7% from 2001
• The digital signature regime implemented in April 2002 offered a big boost to the e-
commerce sectors especially e-banking and online trading.
Year 2003
• $774M in venture capital and private equity funds invested in 2003, up 40% year-over-
year.
• Increased M&A and attractive IPO market led to big ticket exits that included UTI Bank,
TV Today, Indraprastha Gas, Worldzen and VisionSource
• Majority of the investments in Late Stage & Private Investment in Public Equity (PIPE)
transactions with bank and media as hot sectors
• Average deal size was much larger though the number of deals decreased to 42
• Indian VC funds received approximately $360M in new commitments
Year 2004
Year 2005
• Private equity funds are likely to invest more than $2 billion this year, said Arun
Natarajan, founder of TSJ Media, which tracks Indian private equity deals
• In the first nine months, they invested $1.2B surpassing last year’s $1.1B
• Though venture capital is inherently risk capital, the funds are increasingly tilting
toward sure returns," said Natarajan, who says the inflow may very well increase in
2006.
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• In the first nine months of 2005, private equity funds invested in 98 companies,
compared to 66 companies in all of 2004. Of the 98 companies, 29 were either already
listed or readying for an IPO. In 2004, there were only 21 such investments out of the
total of 66.
• "Lots of bigger funds who are traditionally late-stage investors are now moving into
India," said Vijay Angadi, managing director at the $50 million ICF Venture Novastar
Fund.
• Warburg Pincus sold two-thirds of its 18% stake in Bharti Tele-ventures Ltd.
(532454.BY) for close to $1.1B during Bharti's IPO in 2003. The private equity firm had
invested $300 million in the company in several stages from 1999 to 2001.
• "Historically, venture capital flowed into export-led industries like software, biotech and
textiles. Now it is also going to domestic-demand driven companies," said Puneet
Bhatia, managing director at Newbridge Capital, which manages a $1.7 billion private-
equity fund.
• In October, Newbridge invested $100 million for a 49% stake in Shriram Holdings,
which finances truck purchases by fleet operators.
• U.S. private-equity firm Blackstone announced in September that it plans to set up a
$1 billion fund to invest in Indian companies. The fund plans to invest $23 million on
average in each company across various industry segments.
• Several sector-specific funds, led by retail and real-estate focused investments, are
setting up operations.
• SEBI cleared 10 proposals in October from real-estate dedicated venture capital funds
like Solitaire Capital, while U.S. venture capital fund Oak Ventures has announced a
plan to set up a $200 million fund aimed at the local retail sector
• "There is an emergence of a clear stratification within the industry, on who specializes
in what, in terms of stage and size of financing," Natarajan of TSJ Media said. "At
every stage of a company's growth, we now have a private equity player ready to
invest."
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3.8 Analysis of Investments in 2002 and 2003
Even though the number of deals in 2003 was less than number of deals in 2002, the total
amount invested in 2003 was much higher than the amount invested in 2002.
• Indian Government irrespective of the party that ruled India since 1990 is highly
supportive of growth in technology and knowledge based sectors
• Strong and supportive legal framework
Information Technology Act
VC norms
ESOPs
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Copyright, etc
• Government controlled telecom being fully deregulated
• Capital Market system amongst most advanced in Asia
• Electronic trading – through National Stock Exchange (NSE) and Bombay Stock
Exchange (BSE)
Global entrepreneurship monitor (GEM), a joint research by Babson College and London
Business School, quantifies various factors that determine entrepreneurial activity globally. Its
findings are:
o India fares fairly well on the entrepreneurship scale:
o Small entrepreneurial new firms created 33 million new jobs in 2003
A global study says India is an enterprising nation. Global Entrepreneurship Monitor (GEM)
findings show that in India, there are more than 107 million people seeking actively to establish
85 million new businesses. In the period 2000-2004, an average of 15 out of every 100 Indians
was aiming to be an entrepreneur.
o The rapid pace of globalization and the fast growth of Asian economies present
tremendous opportunities and challenges for India
o Increasing outsourcing to India not just for services but also for core businesses,
engineering activities & cutting edge R&D work
o IT off-shoring industry has spawned market for number of ancillary industries like
entertainment, media, transportation, hospitality, infrastructure, etc
o “Micro-Multinational” model gaining popularity providing globalization of talent, markets,
business models & capital
o Migration of number of Business Unit functions
o World class knowledge of technology, markets, systems; adhering to global quality
standards
o Strong US linkages especially with Silicon Valley (SV), known for its entrepreneurial
culture
o More than 50% of SV VC portfolio leverages India connectivity, in some cases being a
pre-requisite for investment
The VC Hotbeds are Bangalore, Delhi and Bombay. Other cities such as Chennai, Hydrabad,
Pune, Calcutta and Trivandram are also emerging. All IP-led companies, IT and IT enabled
service companies are in Bangalore. Delhi has Software and IT enabled services and
Telecom. Software and IT enabled services, Media, Computer Graphics, Animation and
Banking sectors are strong in Bombay.
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Apart from the above mentioned sectors, VCs invest in the following hot sectors:
4 CONCLUSION
India has advanced very rapidly since economic liberalization in 1990 and is catching up with
other developed markets quickly. The environment for venture capital has improved many folds
since 1990. This is evident from the fact that while the amount invested in India in 1996-97 was
just $20M, the amount invested is estimated to be $2B in 2005. This has resulted in Indian
companies acquiring foreign companies and become true global companies and allowed foreign
companies to invest in Indian companies directly. Assocham estimates that the total M&A
activities in India will touch $17B in 2005. Indian venture capital industry has entered into its
fourth phase now, i.e. US firms are investing directly in companies headquartered in India.
Despite there are some issues and challenges in the Indian VC industry compared to other
developed markets such as the US, India is catching up with other markets very quickly. VC
operations in India will be regulated further in the future to create even more conducive
environment for venture capital operations and entrepreneurship. Global Enterprise Monitor
research showed that India is an enterprising nation and 15% of the Indians were aiming to be
entrepreneurs in 2003-2004. Small entrepreneurial firms created 33 million jobs in 2003. The
overall environment for venture capitalists and entrepreneurs in India is very good. It can only get
better in the coming years.
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5 APPENDICES
5.1 Appendix - A: Amount invested in India (Source: NASSCOMM)
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5.3 Appendix – C: Indian Scenario as of 2001 - A Statistical Snapshot
(Courtesy: Indiainfoline.com and data source: IVCA)
Contributors of Funds
Contributors Rs mn %
Foreign Institutional Investors 13,426.47 52.46
All India Financial Institutions 6,252.90 24.43
Multilateral Development Agencies 2,133.64 8.34
Other Banks 1,541.00 6.02
Foreign Investors 570 2.23
Private Sector 412.53 1.61
Public Sector 324.44 1.27
Nationalized Banks 278.67 1.09%
Non Resident Indians 235.5 0.92%
State Financial Institutions 215 0.84%
Other Public 115.52 0.45%
Insurance Companies 85 0.33%
Mutual Funds 4.5 0.02%
Total 25,595.17 100.00%
Methods Of Financing
Instruments Rs million %
Equity Shares 6,318.12 63.18
Redeemable Preference Shares 2,154.46 21.54
Non Convertible Debt 873.01 8.73
Convertible Instruments 580.02 5.8
Other Instruments 75.85 0.75
Total 10,000.46 100
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Financing By Industry
Financing By States
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5.4 Appendix – D: List of some VC/PE Companies
List of Some VC/PE Companies preferring to invest in Start-ups out of around 100 active
Venture capital firms
Minimum
Investment
(INR
Company million)
Aavishkaar India Micro Venture Capital Fund 0.44
West Bengal Asset Management Company Ltd. 1.20
Pitango Ventures 2.22
Gujarat Venture Finance Limited 2.50
Kerela Venture Capital Fund Private Ltd. 2.50
Austin Ventures 4.43
Highland Capital Patners 4.43
INC3 4.43
Infinity Technology Investments 5.00
KITVEN 5.00
SIDBI 5.00
New Enterprise Associates 8.86
Marigold Capital Service Ltd. 20.00
Acer Technology Venture 22.15
Jafco Investments (Asia Pacific) Ltd. 22.15
Jumpstartup 22.15
Mohr Davidow Ventures 22.15
Andhra Pradesh Ind Devp Corp Venture Capital Ltd. 25.00
Mitsuri Ventures 44.30
New Media Spark 44.30
Alta Partners 88.60
Norwest Venture Partners 132.90
Pequot Venture 132.90
Battery Ventures 221.50
Sofinnova Ventures Inc. 221.50
IDFC 300.00
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5.5 Appendix – E - Interview with Ganapathy Subramanian
Ganapathy has over 15 years industry experience including 11 years of life cycle experience in
Venture Capital investing in India and US. His area of focus has been investments in young and
high growth companies in the software and services industries. Ganapathy has held active board
member in several technology companies and has assisted the companies successfully execute
strategic initiatives like spin-offs, acquisitions, sale, IPO and additional financings. Over his 11
years as a VC, Ganapathy has been directly involved in over 30 investments and 12 exits.
Prior to founding JumpStartUp in 2000, Ganapathy served as Group Manager of Private Equity
Investments (Information Technology) at ICICI Venture, India's leading venture capital firm.
Ganapathy played a lead role in the formulation and implementation of the Software Fund, one of
the most successful funds in India (4.6X, IRR: 180%). Ganapathy also made significant
contributions to the formulation and execution of the investment plan of ICICI Venture's first
offshore fund in partnership with US based Trust Company of West (TCW). Prior to ICICI
Venture, he worked for Marico Industries Limited and Southern Petrochemical Industries
Corporation Limited.
Ganapathy is well networked in the VC and financial community in the Indian markets and leads
efforts in catalysing the development of an ecosystem through various industry associations.
Ganapathy graduated with Honours in Chemical Engineering from Regional Engineering College,
Tiruchirapalli and has an MBA from XLRI, Jamshedpur, India.
“India is 13 years old as far as VC is concerned.” True VC investment started around 2000 even
though the first company TDICI was established in 1988. However, it is growing very fast. In the
early 1990s, there were handful of VC firms were there. Today, there are around 100 VC firms
are operating in India.
Even tough India has started regulating VC operations in the last few years there exist some
restrictions unlike in the US.
What are some of the problems entrepreneurs face today in India as far as VC is
concerned?
Since most of the VCs invest in late stage companies, it is very difficult for entrepreneurs even
today to raise less than $5M.
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5.6 Appendix – F: References
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