Grail Research, on a regular basis, will partner with thought leaders, clients and other individuals to support their

research needs on special projects that we find particularly interesting. Recently, we aided Rob LeBlanc, a Harvard Business School student, with primary research for his MBA report. This paper is an overview of his final report and its findings

The Indian Start-up Ecosystem: On the Cusp?

By Rob LeBlanc

India has already experienced two major surges in early-stage venture capital (VC) money, yet still remains a relatively nascent and underdeveloped market. Indeed, in 2008 (before any distortion from the global economic downturn), VC investment per capita in India was more than 4 times smaller than in China, more than 10 times smaller than in Europe, nearly 120 times smaller than in the US, and 350 times smaller than in Israel. Obviously, these comparisons are difficult to make. Global VC hubs like Silicon Valley, Cambridge, and Tel Aviv take decades to develop. But the question I address here is how can this evolution be accelerated in India? How can the Indian start-up ecosystem leapfrog those in other leading markets? What barriers stand in its way? What, despite already promising efforts, can be done to overcome these barriers and catalyze a start-up boom? I attempt to answer these questions by identifying a general failure of the early-stage investment market, driven by three major barriers: 1) a lack of bankable entrepreneurs; 2) a shortage of real early-stage capital; and 3) a debilitating business environment. In addition to enumerating positive trends that should continue, I conclude by offering certain recommendations that may help overcome these barriers. For government, I suggest outsourcing the selection and allocation of seed funding schemes to private players to accelerate disbursements and improve investment decisions. For private incubators, I

Copyright 2012 by Grail Research, a division of Integreon

recommend developing a new form of mass incubation, distinctly tailored to the Indian context. And, for private investors, I argue for migrating back down-market by funding incubators in a fund-of-funds model.

Methodology
My findings rely on a combination of primary and secondary research efforts. On the primary side, I conducted nearly 30 personal interviews from February to April 2012 with various ecosystem participants, including entrepreneurs, incubators, early-stage investors and government officials. I also commissioned a survey, completed by Grail Research in April 2012, of hundreds of American and Indian entrepreneurs to compare their primary uses of time. My secondary research focused on two major tasks. The first was a consolidation of various disparate lists of ecosystem participants to get a relatively exhaustive sense of ecosystem participants and who is doing what. The second was a scan of other countries to identify private and public innovations that could be useful in accelerating the Indian start-up ecosystem. Drawing upon these sources of information, I begin by identifying what I see as a general failure of the early-stage investment market.

Context: A Market Failure

The Indian start-up ecosystem appears paradoxical. On the one hand, there seems to be a surplus of investment capital; yet, on the other hand, there are many entrepreneurs struggling to raise funds. How can there be both a surplus and scarcity of capital? How can there be a seemingly hot market, with lots of capital and big valuations, and yet, at the same time, an apparently cold market, with struggling entrepreneurs and few transactions? What explains this paradox? I contend that it is a function of a fundamental dislocation in the start-up ecosystem an early-stage investment market failure created by three major barriers: 1. A lack of bankable entrepreneurs. Due to a cultural aversion to risk taking, a social stigma associated with failure, an inaccessible educational system, and a lack of precedents, there are relatively few quality founders (and founding teams) in India that can attract and effectively deploy early-stage investment capital. 2. A lack of real seed capital. Taken as a whole, the funding environment is deficient. Banks require non-existent collateral. Government schemes and public incubators are too small and slow. VCs have migrated up-market and have herded around the technology sector. And, although private incubators and dedicated seed funds are focusing on the right space, they are too few and far between to fund the type of start-up revolution optimists envision. As a result, on average, Indian entrepreneurs expend 4-5 times as much effort raising funds as their American counterparts.

Copyright 2012 by Grail Research, a division of Integreon

3. A debilitating business environment. Despite great leaps forward, India still has terrible physical infrastructure and sclerotic bureaucracy, crippled by endemic corruption. Indeed, in 2012, The World Bank ranked India 132nd out of 185 countries for ease of doing business, the lowest of any BRICS market.

Recommendations
To overcome these barriers, my research points to several incremental initiatives. 1. Outsource Public Funding Schemes. To partially address the shortage of real seedstage capital, the Government of India (as well as progressive State governments) should outsource the selection and allocation of funding schemes to private players like the Chilean Government with its program, StartUp Chile. Doing so will dramatically accelerate disbursements, improve investment allocations, increase transparency and reduce corruption. The Governments recently announced earlystage social innovation fund, the India Inclusive Innovation Fund, could offer an ideal platform to experiment with such a public-private disbursement model. 2. Develop Mass Incubators. Drawing on the tenets of Y Combinator and 500startups in the United States, private incubators (or new entrants) should develop an Indian mass incubator. Beyond the standard provision of small seed-stage investments on reasonable terms that allow for quick experimentation (and failure), design principles for an Indian mass incubator should include the following: start to co-create business ideas (not wait for them); look at basic, small scale opportunities (rather than for the next Google); explore outside Tier I cities (to unlock under-resourced talent); provide sector-specific mentorship; 3. Migrate Capital Back Down-Market. VCs should migrate back down-market by funding incubators in a fund-of-funds model. They should even consider funding the experimentation and launch of the mass incubators discussed above. Doing so would add significant amounts of capital to the under-scale seed-stage space and allow for VCs to expand their currently narrow investment pipelines.

Copyright 2012 by Grail Research, a division of Integreon

Conclusion
While these recommendations are not simple or easy to implement, I believe they can begin to address the underlying problems holding the Indian start-up ecosystem back. Unlocking public funds and pushing VC funding back down-market can increase the amount of real seed capital available to early-stage entrepreneurs; whereas developing mass incubators can dramatically increase the number of bankable Indian entrepreneurs. While they cannot address government policy and regulation, or directly improve Indias challenging business environment, taken together, these actions can help address the ecosystems current market failure. With this dislocation reduced, there will be more and more immediate opportunities for success and large exits, which in turn, will change attitudes and attract more capital in a virtuous cycle that should, sooner rather than later, push the Indian start-up ecosystem over the cusp.

This report summarizes a more comprehensive research report prepared by Rob LeBlanc as part of his MBA studies at Harvard Business School. Grail Research assisted integrally with some of the reports primary data collection and analysis. To receive a copy of the original report, supporting research, pose questions or provide commentary, please contact the author directly at rleblanc@mba2012.hbs.edu .

For more information about Grail Research and our services please contact info@grailresearch.com.

Copyright 2012 by Grail Research, a division of Integreon