Note: The views & opinions expressed in these essays are strictly my own, and not those of any entity I may be associated with as an employee, consultant, promoter, investor, etc.ARCHIVES
Technology Entrepreneurship in India - Teams
Technology Entrepreneurship in India - Generating Revenue
Technology Entrepreneurship in India - Raising Capital
Equities, ETFs, F&O
Oct 2011: Equity Risk Premium for India
Jun 2011: Investing in Indian equities
Technology Enterprises in India
Nov 2010: Technology investment in India - WATER
Aug 2010: Technology enterprises in India - 3 avatars
Risk Capital for MSMEs
Mar 2010: Risk mitigation for investors in MSMEs
Mar 2010: Why don't (Indian) MSMEs get risk capital?
Feb 2010: Angel investing - Will it work for Indian MSMEs?
Feb 2010: What's so special about innovative MSMEs?
Feb 2010: Where do Indian/NRI (V)HNIs invest?
Feb 2010: Funding options for innovative MSMEs in India
Jan 2010: Innovative MSMEs in India
Risk mitigation for investors in MSMEs
(Last revised 16-Mar-2010, Send comments to email@example.com)
Given the numerous issues w.r.t. risk funding of MSMEs, people across the world have come up with innovative solutions. Many of them are driven by non-profits / not-for-profits such as Jacqueline Novogratz's Acumen Fund. There are many ideas we can borrow while considering risk capital for (innovative, high-growth) MSMEs in India. Here are a few.
Investment business model
There has been ample research on the negative effects of management fees on investment returns. Obviously, this is true for mutual funds, hedge funds, VCs as well as private equity firms. A 2-and-20 model automatically raises the bar on expected IRR from each investment in the portfolio. A low-cost model to venture funding lowers the IRR needed from each investment, thus lowering the risk that needs to be taken by the investment manager.
A recent example is Right Side Capital, which is a US VC firm. But this low-cost approach is especially relevant for emerging / developing countries; an example is Equity for Africa (EFA). Here is what they have to say:
"Transaction costs are reduced by sourcing local, reliable staff, and using a few skilled people to design, develop and oversee the process at charity salaries rather than MBA salaries. No frills: no business class flights, no US$ 10,000 memberships of development networks, no international networking conferences, no Western-style hotels."
This is not new in the sense that VCs tend to stick to domains where they have an 'edge'. But it is interesting how angels/VCs differ in how they define their focus areas.
Investing risk capital into MSMEs, especially in developing countries, must address the prevalence of fraud. While evaluation and due diligence prior to investment can help filter out most cases, it is important to design the investment such that it deters fraudulent behavior.
Seed-stage investors in the US - for example: Y Combinator - are leading this shift towards simpler investment process, standardized term sheets, transparent agreements, etc. There are now in fact four excellent sources of publicly available documents for seed-stage investments:
While most Indian MSMEs may not be tech-savvy, an MSME-oriented venture fund can certainly use technology wisely throughout the investment process. For example, Angelsoft provides "simple, powerful, deal-flow and portfolio management tools for accepting, tracking and collaborating on early-stage investments". I think there are even opportunities to use data-driven algorithms to sort out investment candidates, much like 'quant' investment strategies. This, of course, runs counter to the 'expert' method of VC investing.
Again, see how EFA uses technology to streamline risk funding for MSMEs:
"Well-designed software also improves efficiency, and appropriate SMS technology can enhance this further. It is important to emphasize that this is not a question of the more innovative the better: this is about consistent, single-minded delivery."
A combination of the above - plus a few inventive modifications - ought to result in a viable business model for risk funding of innovative, high-growth MSMEs in India.