Entrepreneurship

Financing A Business

The accounting equation, a fundamental identity of accounting, states that:

Assets = Liabilities + Owner’s Equity

A business converts debt (liabilities) and equity (owner’s equity) into assets that generate cash flows. Those on the right side of the equation make claims on this cash flow depending on the security they hold. Debt capital providers receive a coupon on their investment, while equity capital providers participate in the upside (and downside) as the owners of the business.

With that 20-second crash course in accounting and corporate finance out of the way, the question, both practical and philosophical, every entrepreneur has to answer is how the business should be funded.

Selecting the capital source for a business is one of the most important strategic choices an entrepreneur makes. Founders may not necessarily think through it in the way I have described above, but as Prime Minister PV Narasimha Rao said once, not taking a decision is also a decision.

Venture capital investors are equity participants, and expect higher returns compared to public equity investors. In recent years, the terms attached to equity investment by venture investors have turned equity into a quasi-debt instrument.

Debt financing is suitable for relatively predictable and regulated sectors, such as infrastructure and power, and it is unsuitable for riskier and innately unpredictable endeavours such as creative projects or technical innovation. Debt funding has an added advantage because interest payments are tax deductible, a provision introduced in the First World War.

Let’s examine what’s been happening in some sectors through the financing lens:

India e-commerce – Several e-commerce players raised very large sums of money at, it is now obvious with the benefit of hindsight, unjustifiably high valuations. These companies thought they were raising equity, but it was actually debt disguised as equity. This was not unique to Indian startups, and happened in other markets too. Venture capitalist Bill Gurley eloquently described the phenomenon as the “calcification of the cap table”. Onerous covenants on equity and the fund-raising arms race made the capital structure of many startups fragile, and the fragility has broken many companies. The calcification happened because founders chased higher and higher paper valuations. The price equity investors extracted for the high valuation was to take debt-like protections in case things went sideways. The transformation of equity into debt-like instruments was necessitated partly by the drive for higher headline valuation numbers. This is always irresponsible. Instead of fund-raising being a means to the end of building a business, fund-raising at ever-increasing valuations became an end in itself. While e-commerce startups have to do a capital raise to continue investing in the business, Amazon simply parks a chunk of the cash flows from its thriving marketplace and cloud businesses into India. Amazon is more conservatively financed than its Indian competitors and that is making a very big difference.

India telecom – Telecom spectrum is the essential “raw material” to run a telecom business. The corruption-mired allocation of this scarce and valuable resource by the Congress-led UPA government is one of the biggest scandals in India’s history. After the scandal, it became politically difficult to not maximize revenues on auctions of telecom spectrum. The legacy players borrowed huge sums of money from government-owned banks to license spectrum. Then Reliance Industries entered the business with Jio, funding spectrum acquisition and network buildout through very large equity-funded investments. Reliance can afford to invest on this scale because of its oil refining business. That business generates huge cash flows, and Reliance is investing some of this cash into its new telecom business. In a sense, Reliance Industries is doing to legacy telecom companies what Amazon is doing to e-commerce startups. Both Amazon and Reliance are investing equity, while the others are investing debt.

Global media and entertainment – A few months ago, Netflix issued corporate debt to fund new content. This is quite risky. Netflix’s low-rated and high-interest bonds were lapped up by investors starved of yield in the current low interest rate environment. It says something about the present environment that even though Netflix has told investors it will turn to bond markets to raise money frequently and invest the proceeds into a speculative assets like films and television shows, investors are handing over billions of dollars to the company knowing Netflix will keep burning cash. At the same time, digital music streaming startups in the US and India have raised enormous amounts of capital from private investors, probably with onerous terms attached – so these instruments may be labeled equity, but work more like debt. The problem the streaming services face is that the more money they make, the more content owners (typically large music labels and media companies) extract from them. As the intermediary, streaming services have limited bargaining power with the content owners. They are running the classic Red Queen race. The bet investors in such companies are taking is that the subscriber base can grow fast enough to a large enough scale so that eventually the economics of the model tilts in the favour of the licensee (i.e., the streaming service).

India agriculture – Indian agriculture is woefully over-regulated. Farmers have little control over both the price they can get for produce and where they are allowed to sell their output. For decades, India has simultaneously romanticized and infantilized the farmer. Farming is simply not viewed as a business, even though it is one. As if it wasn’t enough, farmers are left to the mercy of the weather too because India has a dearth of irrigation infrastructure. About 45% of employment is in the agriculture sector. Most people (we are talking tens of millions of people) just default to agricultural employment as there are limited opportunities to do anything else in rural India. There isn’t much equity capital entering farming, as farming tends to be largely subsistence-based. Deprived of equity funding sources, farmers turn to loans from formal and informal sources. They don’t have much of an incentive to invest in productivity tools for their farms either, because of pricing and other regulatory distortions. Given the high dependence of India’s population on farming and the inefficiencies built into Indian agriculture, every now and then there is a political clamour for farm loan waivers. This is a vicious cycle, and can only be broken by structural policy reforms for the sector.

When evaluating an investment, I find it very useful to think both backwards and forwards about how the business has been financed and how it will be financed. It reveals a lot about both the economics of the business and the management behind it.

Accelerating India’s Innovation Boom

Over the last three years, entrepreneurship has captured India’s imagination, and for good reasons. Never in our history has it been possible for first-generation entrepreneurs to start companies, raise seed capital and build a business in the way we have seen in recent times. The path available only to wealthy families and elite dynasties has been opened to every Indian today, thanks to the entrepreneurship boom.

Since taking office in May 2014, the Narendra Modi government has implemented a series of policy changes that have supported this unprecedented wave of entrepreneurship. The time taken for incorporation of companies has been brought down to a few days from several weeks. The Modi government has liberalised foreign direct investment across industries, and India is opening its doors to global capital even as the rest of the world becomes more protectionist.

In line with a commitment made in the 2015 Budget to gradually reduced the corporate tax rate, the government has cut the corporate tax rate to 25% for companies with revenues below Rs 50 crore, with the reduced rate now being considered for mid-size companies with revenues below Rs 500 crore. In a move to encourage startups to develop intellectual property-based businesses, the government implemented a concessional tax rate of 10% on income earned from licensing of patents, and India is now more aligned in this respect with global peers.

Small Industries Development Bank of India (SIDBI) has emerged as a significant domestic fund investor in India’s venture capital industry – with SIDBI’s support, several new early-stage funds have emerged to back Indian entrepreneurs, addressing a supply-side issue in the private capital market.

The public equity capital market, whose key function is to provide growth capital to businesses, has also seen substantive reforms. On the public markets side, the entry of Employees’ Provident Fund (EPF) is bringing depth and stability to the equity market while enabling organised sector workers to become beneficiaries of India’s long-term economic growth. The successful rollout of the Aadhaar program has reduced friction and identification costs associated with bank account and demat account opening by over 95% – it takes minutes rather than weeks now to open accounts with Aadhaar’s e-KYC facility. 

The stock market has played a critical role over the decades in supporting the growth of Indian business. When banks were not willing to provide capital to young companies in the 1970s and 1980s, intrepid entrepreneurs turned to the equity market. In the process, wealth creation was democratised and ordinary individuals were able to participate in the growth of companies like Reliance Industries and Infosys, which are today counted among India’s blue-chip corporates.

There are two ideas the government should consider to further streamline capital allocation in the economy and ensure that the wealth created by India’s entrepreneurs is shared widely across society. 

There is a big gap between the long-term capital gains (LTCG) tax rate on unlisted private equity investment and the LTCG rate for listed public equity investment. For unlisted equities, the holding period for LTCG is more than 2 years and the applicable rate is over 20%. For listed equities, the holding period is 1 year and the gains are tax free. This wide discrepancy in treatment makes early-stage startup investment far less compelling when compared to investment in the stock market, even though the positive spillover effects for job creation and innovation are substantial in startup investment. 

This issue already seems to be on the Prime Minister’s radar – in a speech to the capital markets community in Mumbai earlier this year, Prime Minister Modi had said that stock market participants should make a “fair contribution to nation-building through taxes”. It is also worth looking at the taxation of dividends. The current regime of dividend distribution tax (DDT) is an indirect tax on all shareholders, even though it comes out of the company’s pocket. Shareholders, who are collectively the owners of a company, already pay corporate income tax on profits at the company level. DDT is effectively a double tax inimical to the interest of minority, non-controlling shareholders, who is typically a small retail investor. Introducing LTCG for listed equities, eliminating all taxation of dividends and bringing balance between taxation of unlisted private equity and listed public equity investment would go a long way towards improving capital allocation.

Finally, capital markets regulations on new listings and initial public offerings need to be relaxed and adapted to accommodate new-age technology and knowledge-based startups that aren’t able to comply with criteria that would apply more to industrial businesses. For example, companies wanting to list on Indian exchanges are required to have a minimum average pre-tax operating profit of Rs 15 crore in at least 3 years out of the last 5 years. In older times, when investor awareness and knowledge was low, a rule of this type served to protect inexperienced small investors. 

The landscape today stands transformed, where over a crore Indians are participating in the stock market through systematic investment plans, parking in excess of Rs 4000 crore every month into listed stocks. This is number that has doubled in the last few years. Crores of Indians are becoming indirect equity owners by virtue of being EPF beneficiaries. New media platforms and digital connectivity are helping educate the masses on the challenges and opportunities of stock market investing.

The effect of having the profit requirement for listing in India is high-tech businesses which have achieved significant progress and built an asset base but are still loss-making are forced to look abroad for raising capital through an initial public offering. Relaxing this requirement will help keep Indian companies in India, and will give an opportunity to India’s burgeoning retail investor base to build wealth by investing in tomorrow’s corporate champions.

The government’s war against black money has severely undermined the attraction of gold and land as investment alternatives. The taxation and regulatory policy ideas highlighted above would further help shift savings into productive, cash flow generating assets that spur the economy forward. India is well on its way to becoming an innovation-driven economy, and these policy reforms would accelerate our country on that path.

(Originally Published: Reflections, Prime Minister Narendra Modi’s website)

India Can Emerge As An Innovation Leader

Has the Indian startup opportunity been wildly over-estimated? Mahesh Murthy’s article on this question has triggered a debate. Mahesh feels the “copy-paste” approach will not work in India — provided that most of India’s highly-valued startups are simply clones of successful US companies, “much of the growth assumed for our current unicorns is probably vastly overestimated”, he writes.

History is on Mahesh’s side. Desi Martini tried to be India’s Facebook — it was acquired by HT Media in 2007, but failed to scale and HT wrote off its investment. Guruji.com was a “search engine for India” backed by Sequoia Capital in 2006 — it was unable to compete with Google’s superior technology, failed to scale and eventually shut down. Seventymm, backed by substantial venture funding, tried to be India’s Netflix and also failed.

But it’s worth asking what’s different between the older crop of companies and the ones we see today. The obvious change is the rapid uptake of the mobile Internet and smartphones since 2008. Most Indians simply couldn’t afford to buy desktop or laptop computers, and pay for a monthly internet connection. Today, smartphones are available for a few thousand rupees and mobile data too is cheap enough, with telecom companies offering data packs and pay-as-you-go plans that allow even the lowest income groups to access the internet.

The broader story is about the rise of the Indian consumer — as I’ve written before, the US is the natural pioneer for consumer internet innovation because it is home to the world’s largest and most affluent consumer base, combined with an industrial commons in technology and engineering that is second to none. Russia and China don’t compete with the US because they are “walled gardens”, as Mahesh observed, and have very different cultural and language characteristics. In contrast, urban India is predominantly English-speaking and is also aligned with the US culturally. Whether its TV shows, Hollywood movies, English music, fashion or food, as India urbanizes, Indian consumer tastes are becoming more similar to the US, or loosely speaking, increasingly “westernized”.

The rise of the connected, aspirational Indian consumer who has a growing capacity to make discretionary spends is a robust and secular trend given India’s highly favourable demographics. In this sense, comparisons to the past are no longer relevant. This emerging consumer base will enable business opportunities in India over the next decade — including on the internet — that we cannot even imagine today.

One of the largest consumer markets in the economic history of the world is up for grabs, and the internet is a new distribution path to service that growing market. Venture funding is empowering first-generation entrepreneurs to create products and services for this new consumer. The global majors recognize the opportunity, and India-based internet companies are betting on it too. Just as Indian companies can’t cut-and-paste a model from abroad and succeed, even global internet companies cannot do a cut-paste job — the Indian market has its own quirks, and achieving success in India requires creativity and experimentation from all players, because everyone is in uncharted territory.

It can be debated whether valuations in certain cases are too rich, if private equity-funded startups can compete with well-established companies investing off their balance sheets, or whether some of India’s unicorns will be able to continue financing unprofitable growth — but debating such questions is very different from asserting that Indian internet ventures have no chance going up against global internet giants.

I think the opposite is true — the only country able to compete with the US on internet and technology innovation will be India, because only India has a large, growing consumer base and a comparable pool of technical talent. The challenge for India is to retain this talent at home, and attract talent from abroad. India’s open internet, compared to the “walled gardens” of Russia and China, will prove to be its strength in the longer run. The future won’t be like the past, as the expansion of the consumer base gives Indian startups the scale to build the next wave of the world’s great technology businesses.

Why Technology Matters For Sustainable Development

In his book Zero to One, Silicon Valley entrepreneur Peter Thiel addresses the distinction between globalization and technology. Globalization constitutes “horizontal progress”, he writes, or “taking things that work somewhere and making them work everywhere”; and China is the “paradigmatic example” of growth through globalization.

Technology, on the other hand, enables “vertical progress”, which Thiel argues is harder to imagine because it means “doing something nobody has ever done”. Moreover, while technology has for many come to mean information technology, there’s no reason to restrict its definition in this way, since “any new and better way of doing things” can be called technology.

Since the 2008 financial crisis, there has been an explosion of entrepreneurship around the world. Asian countries, particularly India and China, have demonstrated their ability to create high-growth start-ups. Around the world, there are 70 or so private enterprises valued at above $1 billion, and Asia is home to 15 of them.

But most of these ventures are products of horizontal progress (going “from one to n”, to use Thiel’s expression) and not vertical progress (“from zero to one”). Strictly speaking, even internet giants such as China’s Alibaba Group and India’s Flipkart are not technology pioneers: their well-earned success has been in deploying and scaling a proven business model in their home market.

So far, China, India and other emerging markets have grown by adopting and adapting technologies and business models from advanced economies. But can economic growth be sustained and delivered through the globalization model alone? Large populations in Asia and Africa aspire to join the ranks of the middle class; bringing sustainability to so many people will take innovation across a wide range of industries, which have so far remained relatively untouched by the rapid pace of change affecting information and communications technologies.

There is an enormous amount of latent consumer demand across the developing world that will be difficult to meet without innovation. Consider the challenges in energy, healthcare and financial services, for example. Energy and power requirements are so enormous that meeting them with fossil fuel-based technologies would result in serious environmental degradation, as China’s experience is proving.

In healthcare, large sections of the poor are being priced out of the market for life-saving drugs, and the industry requires a more cost-effective drug development model, as well as new government welfare mechanisms to deliver medicines to the bottom of the pyramid without violating the intellectual property rights of drug innovators.

In finance, tens of millions of people remain without bank accounts and are cut off from the formal financial system. Rapidly evolving crypto-currency technologies such as the Bitcoin (combined with internet-enabled smartphones) can help widen financial access.

The scale of need across these and other industries is such that the globalization approach alone is not sufficient: new technology is urgently required. Entrepreneurs have to deliver innovations in multiple sectors, not just ICT-related industries, to be able to make a large-scale impact.

Finally, it is more difficult for entrepreneurs and investors in advanced economies to deliver such innovations because they are not close to the customer. Increasingly, entrepreneurs in emerging markets will need to take the initiative and attempt to do what nobody has done, because the problems in these markets will be problems that nobody has really solved before. Additionally, these will be problems that advanced economies don’t really have a stake in solving.

In other words, emerging-market entrepreneurs will need to think of how to go “from zero to one” in myriad industries if they are to deliver sustainable and equitable growth for their large domestic populations. It poses a serious risk for global economic growth, but also presents the entrepreneurial opportunity of the century. Innovators who square the circle will not only create substantial wealth; they will also have done a tremendous service to human society by helping millions transition out of poverty.

Originally Published: World Economic Forum

Bitcoin and Emerging Markets

In my op-ed for Mint, I write about the potential applications bitcoin could have specifically for emerging markets like India:

India’s banking and financial services industry has incumbents that are inert, sloth-like and highly risk-averse. The banking industry in particular is heavily dominated by public sector undertakings (PSUs). PSU banks still control approximately 80% of all deposits. The industry is rife with corruption and mismanagement, for government banks know that their owner will always bail them out. But this was not always the case—before Indira Gandhi nationalized banks with the stroke of a pen, over 85% of deposits in India were held by private banks. Since the nationalization of banking, all innovation in the industry has come to a standstill.

For 2013-14, 63% of the total number and 35% of the total value of retail transactions was electronic. Average electronic transaction value has nearly tripled in four years, according to data from the Reserve Bank of India (RBI), India’s banking regulator. But Indian banks cartelize and lobby their regulator to punish consumers with outdated usage practices totally out of tune with the needs of mobile transactions and electronic commerce. Instead of prodding the banks to improve their fraud detection and redressal systems, RBI simply makes it harder for consumers to transact and introduces artificial friction by way of two-factor authentication requirements so that banks get away without having to improve themselves.

Besides enabling transactions with reduced friction and at lower cost, there are certain applications of the protocol that can enable altogether new use cases. Cryptocurrencies can be used to write “smart contracts”, or contracts that are digitally written and require no third party for enforcement. The value of this application is difficult to overstate in an environment like India, which the World Bank ranks 186 out of 189 countries globally on the enforceability of contracts. Given the slow, dysfunctional judicial system and the paucity of social capital, individuals have historically preferred to do business with people already known to them, or people who are from their own community.

An alternate approach, outside the present broken system, that offers “self-executing”, tamper-proof contracts and does away with the need for third-party intervention for mediation or dispute resolution, could be truly transformational for countries like India by collapsing business risks and transaction costs. Cryptocurrencies like bitcoin could help dramatically improve contract enforcement.

Consider a bank that gives a secured loan to a person wanting to buy a car, on the assumption that the person will pay for the asset in a fixed number of monthly instalments over a period of time. If the person fails to pay the monthly instalment in any month, the bank reserves the right to take back the car. When a person has reneged on such payments, Indian banks have been known to send strongmen and professional bullies as recovery agents to intimidate and threaten customers and even the relatives of such customers. With an integrated software solution built into the car that verifies whether the monthly instalment has been deposited, a self-executing contract could remotely brick the car, making it inoperable by the consumer should he fail to make the payment. The software “key” to activate the car again would lie with the bank, which can then take possession of the asset easily.

Another game-changing application for cryptocurrencies specific to the Indian context is in the area of remittances. In 2013-14, India received nearly $70 billion in remittances from abroad. The volume of intra-country remittances is estimated to be some Rs.75,000 crore annually. In this digital age, anachronistic and expensive modes of money transfer such as the money order persist. Not only would the cryptocurrency protocol applied to a large market such as remittances be lucrative, it would also be a tremendous service to millions of bottom-of-the-pyramid migrant workers, who have been able to get the latest smartphones for a low price, but are still deprived of cheap, efficient and user-friendly banking and money transfer services.

Besides enabling transactions with reduced friction and at lower cost, there are certain applications of the protocol that can enable altogether new use cases. Cryptocurrencies can be used to write “smart contracts”, or contracts that are digitally written and require no third party for enforcement. The value of this application is difficult to overstate in an environment like India, which the World Bank ranks 186 out of 189 countries globally on the enforceability of contracts. Given the slow, dysfunctional judicial system and the paucity of social capital, individuals have historically preferred to do business with people already known to them, or people who are from their own community. An alternate approach, outside the present broken system, that offers “self-executing”, tamper-proof contracts and does away with the need for third-party intervention for mediation or dispute resolution, could be truly transformational for countries like India by collapsing business risks and transaction costs. Cryptocurrencies like bitcoin could help dramatically improve contract enforcement. Consider a bank that gives a secured loan to a person wanting to buy a car, on the assumption that the person will pay for the asset in a fixed number of monthly instalments over a period of time. If the person fails to pay the monthly instalment in any month, the bank reserves the right to take back the car. When a person has reneged on such payments, Indian banks have been known to send strongmen and professional bullies as recovery agents to intimidate and threaten customers and even the relatives of such customers. With an integrated software solution built into the car that verifies whether the monthly instalment has been deposited, a self-executing contract could remotely brick the car, making it inoperable by the consumer should he fail to make the payment. The software “key” to activate the car again would lie with the bank, which can then take possession of the asset easily. Another game-changing application for cryptocurrencies specific to the Indian context is in the area of remittances. In 2013-14, India received nearly $70 billion in remittances from abroad. The volume of intra-country remittances is estimated to be some Rs.75,000 crore annually. In this digital age, anachronistic and expensive modes of money transfer such as the money order persist. Not only would the cryptocurrency protocol applied to a large market such as remittances be lucrative, it would also be a tremendous service to millions of bottom-of-the-pyramid migrant workers, who have been able to get the latest smartphones for a low price, but are still deprived of cheap, efficient and user-friendly banking and money transfer services.

Read more at: http://www.livemint.com/Opinion/lv9RU1qcTVEA3MKSCXQsUJ/Cryptocurrencies-can-transform-financial-services.html?utm_source=copy

Besides enabling transactions with reduced friction and at lower cost, there are certain applications of the protocol that can enable altogether new use cases. Cryptocurrencies can be used to write “smart contracts”, or contracts that are digitally written and require no third party for enforcement. The value of this application is difficult to overstate in an environment like India, which the World Bank ranks 186 out of 189 countries globally on the enforceability of contracts. Given the slow, dysfunctional judicial system and the paucity of social capital, individuals have historically preferred to do business with people already known to them, or people who are from their own community. An alternate approach, outside the present broken system, that offers “self-executing”, tamper-proof contracts and does away with the need for third-party intervention for mediation or dispute resolution, could be truly transformational for countries like India by collapsing business risks and transaction costs. Cryptocurrencies like bitcoin could help dramatically improve contract enforcement. Consider a bank that gives a secured loan to a person wanting to buy a car, on the assumption that the person will pay for the asset in a fixed number of monthly instalments over a period of time. If the person fails to pay the monthly instalment in any month, the bank reserves the right to take back the car. When a person has reneged on such payments, Indian banks have been known to send strongmen and professional bullies as recovery agents to intimidate and threaten customers and even the relatives of such customers. With an integrated software solution built into the car that verifies whether the monthly instalment has been deposited, a self-executing contract could remotely brick the car, making it inoperable by the consumer should he fail to make the payment. The software “key” to activate the car again would lie with the bank, which can then take possession of the asset easily. Another game-changing application for cryptocurrencies specific to the Indian context is in the area of remittances. In 2013-14, India received nearly $70 billion in remittances from abroad. The volume of intra-country remittances is estimated to be some Rs.75,000 crore annually. In this digital age, anachronistic and expensive modes of money transfer such as the money order persist. Not only would the cryptocurrency protocol applied to a large market such as remittances be lucrative, it would also be a tremendous service to millions of bottom-of-the-pyramid migrant workers, who have been able to get the latest smartphones for a low price, but are still deprived of cheap, efficient and user-friendly banking and money transfer services.

Read more at: http://www.livemint.com/Opinion/lv9RU1qcTVEA3MKSCXQsUJ/Cryptocurrencies-can-transform-financial-services.html?utm_source=copy

Besides enabling transactions with reduced friction and at lower cost, there are certain applications of the protocol that can enable altogether new use cases. Cryptocurrencies can be used to write “smart contracts”, or contracts that are digitally written and require no third party for enforcement. The value of this application is difficult to overstate in an environment like India, which the World Bank ranks 186 out of 189 countries globally on the enforceability of contracts. Given the slow, dysfunctional judicial system and the paucity of social capital, individuals have historically preferred to do business with people already known to them, or people who are from their own community. An alternate approach, outside the present broken system, that offers “self-executing”, tamper-proof contracts and does away with the need for third-party intervention for mediation or dispute resolution, could be truly transformational for countries like India by collapsing business risks and transaction costs. Cryptocurrencies like bitcoin could help dramatically improve contract enforcement. Consider a bank that gives a secured loan to a person wanting to buy a car, on the assumption that the person will pay for the asset in a fixed number of monthly instalments over a period of time. If the person fails to pay the monthly instalment in any month, the bank reserves the right to take back the car. When a person has reneged on such payments, Indian banks have been known to send strongmen and professional bullies as recovery agents to intimidate and threaten customers and even the relatives of such customers. With an integrated software solution built into the car that verifies whether the monthly instalment has been deposited, a self-executing contract could remotely brick the car, making it inoperable by the consumer should he fail to make the payment. The software “key” to activate the car again would lie with the bank, which can then take possession of the asset easily. Another game-changing application for cryptocurrencies specific to the Indian context is in the area of remittances. In 2013-14, India received nearly $70 billion in remittances from abroad. The volume of intra-country remittances is estimated to be some Rs.75,000 crore annually. In this digital age, anachronistic and expensive modes of money transfer such as the money order persist. Not only would the cryptocurrency protocol applied to a large market such as remittances be lucrative, it would also be a tremendous service to millions of bottom-of-the-pyramid migrant workers, who have been able to get the latest smartphones for a low price, but are still deprived of cheap, efficient and user-friendly banking and money transfer services.

Read more at: http://www.livemint.com/Opinion/lv9RU1qcTVEA3MKSCXQsUJ/Cryptocurrencies-can-transform-financial-services.html?utm_source=copy

Horizontal Progress vs Vertical Progress

In his new book Zero To One, entrepreneur and venture capitalist Peter Thiel writes:

At the macro level, the single word for horizontal progress is globalization – taking things that work somewhere and making them work everywhere. China is the paradigmatic example of globalization; its 20-year plan is to become like the United States is today.

The single word for vertical, 0 to 1 progress is technology . The rapid progress of information technology in recent decades has made Silicon Valley the capital of “technology” in general. But there is no reason why technology should be limited to computers. Properly understood, any new and better way of doing things is technology.

Elaborating on the theme of Globalization as “horizontal progress” versus Technology as “vertical progress”, Thiel writes:

This age of globalization has made it easy to imagine that the decades ahead will bring more convergence and more sameness. Even our everyday language suggests we believe in a kind of technological end of history: the division of the world into the so-called developed and developing nations implies that the “developed” world has already achieved the achievable, and that poorer nations just need to catch up.

But I don’t think that’s true…most people think the future of the world will be defined by globalization, but the truth is that technology matters more. Without technological change, if China doubles its energy production over the next two decades, it will also double its air pollution. If every one of India’s hundreds of millions of households were to live the way Americans already do— using only today’s tools— the result would be environmentally catastrophic. Spreading old ways to create wealth around the world will result in devastation, not riches. In a world of scarce resources, globalization without new technology is unsustainable.

As I’ve written earlier, this is a fundamental dichotomy: while advanced economies have the knowledge base and networks to deliver such innovation, the market for such innovation lies in emerging markets.

Achieving higher resource efficiency and developing lower-pollution energy sources presents a considerable innovation challenge – and commensurately, an entrepreneurship opportunity. So far, major startup successes that have emerged from India and China have been adept at “globalization” – they’ve taken proven business models from abroad, and executed those models well in their own markets.

The “technology” successes, especially in non-software or Internet areas, have been few and far between – and there are some very good reasons for why this is so. The question is whether emerging markets can become economically developed by globalization alone. As Thiel writes, this won’t be possible – “globalization without new technology is unsustainable”.

Something’s got to give – either we have technological breakthroughs that enable sustained economic growth, or growth itself will become constrained. China is already facing enormous pollution and environmental issues – sample these news reports:

Air Pollution, Birth Defects and the Risk in China (and Beyond)

The pollution constraint on China’s future growth

Environmentalism with Chinese characteristics

China Needs Industry to Enlist in “War on Pollution”

India is a fair distance away from China – and it’s already “choking on air pollution”. So the question is, where will the innovation come from, and which startups will deliver “vertical progress” to help sustain growth in emerging markets?

Four Ways To Liberate Indian Science

The economic liberalisation of 1991 was the second independence in Indian history. It represented a tectonic shift in policies, the start of the end of ‘licence raj’, and unshackled the growth of the country. Time has come for the third independence of India, the liberalisation of the academic, science and technology ecosystem in the country.

Historically, the growth of countries has been driven by continual advances in science and technology. According to Robert Solow, Nobel Prize winner in economics, capital and labour are not the only things that drive economic growth, half the economic growth in the US since World War II can be traced to advances in science and technology. Even China has realised this. At the current rates, China’s commitment to R&D is expected to surpass that of the US by 2022, when both countries are likely to reach about $600 billion in R&D. Unfortunately, successive governments in India have only provided lip service to the science and technology sector. Moreover, simply allocating money for science and technology is not in itself sufficient to drive economic growth. The new Government has the opportunity and the mandate to liberalise the Indian science and technology ecosystem, which is the transformative step required to take the Indian economy to the next level.

Academic and research institutions form the bedrock of the science and technology ecosystem, and are the fulcrum for creation of value. According to a 2011 report, sponsored by the venture capital firm Sequoia Capital, 39,900 active companies can trace their roots to Stanford University, creating an estimated 5.4 million jobs. If these companies collectively formed an independent nation, its estimated economy would be the world’s 10th largest. The reason that we do not have such institutions in our country is because our academic and research institutions are still stuck in the pre-1991 era. The new Government has the opportunity and the mandate to liberalise and transform this ecosystem so that our academic institutions move beyond producing skilled manpower to producing innovators and job creators for the nation.

Give autonomy to institutions

This will allow them to attract the best talents as researchers and faculty. This is critical as generation of new ideas require exceptional talent. New ideas can spawn industries that will generate employments for millions, creating a cascading effect on Indian economy. If institutions are given flexible grants rather than budgets under fixed heads, and allowed to compete for talent from all over the globe, we will see a resurgence of the sector.

Nobel physics laureate C.V Raman also founded the Travancore Chemical Company in 1943
Nobel physics laureate C.V Raman also founded the Travancore Chemical Company in 1943

Capitalise assets and resources

Most academic science and technology institutions and universities are endowed with significant land. These institutions should be encouraged and given the flexibility to build Innovation Clusters on unused land in partnership with the industry; academic institutions will own new infrastructure from where they get rent that can go towards building a corpus, while the industry gets access to knowledge capital. Such clusters will create jobs for graduating students and prevent brain drain, generate research partnerships and funding for faculty, and foster an ecosystem that supports innovation and entrepreneurship. Silicon Valley for example was seeded by Stanford University, while Massachusetts Institute of Technology owns the buildings in Tech Square at Cambridge, which house hundreds of companies.

It is obvious that such bold steps will create a lot of anxiety in the current ecosystem, where ‘profit’ has been seen as a dirty word. Similar anxieties were expressed when the Indian economy was liberalised. However, few people realise that our finest scientists did not restrict their work to the laboratory alone-C.V. Raman, who won the Nobel Prize in Physics, started the Travancore Chemical Company in 1943. This model, where faculty commercialise research, was a pioneering move, far ahead of its time.

Make policy friendly to R&D investment

Start-ups form the backbone of translating scientific ideas and technological advances from academia into products that drive economic growth, and the process requires significant capital. However, the toughest stage in the life of a start-up is the first few rounds of investment that leads to a product. Early investments in this sector have been dismal. Between 2007-2012, India saw 11 private equity deals totalling $43 million, and eight VC deals worth a combined $55 million in the life sciences/biotech sector. In comparison, the city of Boston saw an early stage investment of $869 million in 2012 alone. The new Government can put science and technology R&D sector on steroids by granting special tax exemption status to investments in science and technology start-up and innovation clusters for the initial 7-10 years of their operation.

Jagadish Chandra Bose was the first Indian to get a US patent

Jagadish Chandra Bose was the first Indian to get a US patent

Respect ownership of intellectual property

Without this we cannot create a true knowledge economy, as we will never attract investments. Not many people know that the first Indian to get a US patent was Jagadish Chandra Bose, one of India’s finest scientists, for an invention that improved detection of electrical disturbances. Interestingly, Swami Vivekananda not only saw the importance of protecting intellectual property, but also influenced Tata group founder Jamsetji Tata to found the Indian Institute of Science in Bangalore. Time has come to emulate the visions of Vivekananda, and to liberalise our science and technology institutions such that they can truly reclaim their glory and transform the Indian economy.

(Co-authored with Dr Shiladitya Sengupta.)

Originally Published: India Today

Challenging Silicon Valley’s Innovation Hegemony

For several decades, Silicon Valley has had a near-monopoly on innovation. The Valley emerged out of America’s deep commitment to higher education and scientific research, combined with the American will to maintain leadership in defence technology. Through the second half of the 20th century, China was disastrously experimenting with Maoism, India was embracing Socialism, a fragmented Europe was rebuilding after the Second World War and the other superpower, Soviet Russia, was persisting with its Communist economic model. The Americans invested public and private capital in fundamental research and development, allowing private enterprise to drive economic growth and entrepreneurial small businesses to commercialize publicly-funded scientific research. America invented the venture capital model to commercialize such research.

It stood out as an oasis in a world where central planning and a state control of the economy was the norm. Owing to a liberal immigration policy, it became a magnet for talent from around the world. Scores of scientists migrated from Europe to America in the throes of the Second World War, including titans like Enrico Fermi and Albert Einstein. Nobel laureates Hargobind Khorana and Subramanyan Chandrasekhar, both of whom completed their college education in India, also made America their home.

The migration of talent from other parts of the world to America continued through the 1960s and 1970s, with the best talent from China and India making the move, thanks to the economic havoc caused by the destructive ideas of Chairman Mao and Prime Minister Indira Gandhi.

In this way, America managed to consolidate the world’s best scientific talent. It then gave them a platform and funding to invent and create. The scientists and engineers who went to America might not all have founded technology companies, but through their work at private research labs, government research institutions, universities and startups, laid the foundations for America’s technological prowess that underpins its military and economic might to this day.

It is important to recognize that this was a historical aberration and cannot be sustained by design — America positioned itself to benefit from the poor choices that the rest of the world made. A reversion to the mean is underway, and the tide has started turning over the last two decades. Besides increased economic and financial integration worldwide permitting capital flows on a global scale, economic reforms catalyzing sustained growth in Asia and the creation of a common market in Europe have fostered economic blocks that can compete with America.

Sector after sector has become more globalized. Venture capital investing, long the exclusive preserve of a clutch of firms on Silicon Valley’s famed Sand Hill Road and till recently heavily concentrated in the United States, is now unmistakably global. Risk capital flows to places that have talented people pursuing breakthrough business ideas — and sustained global growth over the last two decades has set the stage for a need for technological innovation across economies and geographies. The rise of the Asian consumer is creating opportunities for innovation in all kinds of consumer products. Transplanting ideas from elsewhere doesn’t always cut it with the taste and sensibility of consumers in Asian countries. With increasing consumption, there is a glaring need for efficiency in resource utilization and energy use.

Challenging economic conditions combined with more stringent immigration policies in developed nations have made it appealing for accomplished scientists and engineers from developing nations to return home, where in many cases there is stronger economic growth alongside a new focus on nurturing and financing science and technology. This has set the stage for venture capital investing in emerging markets.

America has a long lead, but the rest of the world is catching up. It will continue to maintain primacy in Internet innovation in particular because of the spending capacity of the American consumer. The Internet is a platform for consumption, be it consuming information which allows for digital advertising to flourish or purchasing products through Internet-based retailers. America’s consumption power allows it be the breeding ground for global Internet giants such as Google, Amazon and Facebook, and it will dominate in web innovation as long as the American consumer has clout.

New York-based venture capitalist Fred Wilson recently wrote about how the Valley’s dominance could be upended if there was a new wave of technological disruption, far separated from the computing and Internet industry on which the Valley has been built. Wilson said that should Silicon Valley miss such a new wave, it could look like Detroit in a few decades.

Just as a consumer-centric economy allows it to dominate Internet innovation, it also creates an insulation from innovation in non-consumer industries. The world has become a dramatically different place in the last few decades, and such innovations that define the next wave of technological disruption can come from any nation that has a sufficiently large pool of talented people working to solve the big challenges in energy, health care, clean technology and other sectors. That would weaken Silicon Valley’s grip on driving innovation — and further undermine America’s standing as a global power.

Originally Published: http://navam.in/1omJBAj

The Global Innovation Challenge

Rising unemployment and income disparity has shaken democracies across the Western world in the last year. Unemployment among young people in particular has been persistent and pervasive — the United States saw the highest ever youth unemployment in 2011, and it has reached as high as 45 percent in Spain. Job creation has suffered not just because of excessive debt. Advanced economies have seen a massive erosion in manufacturing, and new enterprises have been too focused on driving consumption.

Internet companies have mushroomed in Silicon Valley thanks to the low cost and ease of building products for the Web. They’re able to scale globally while maintaining a relatively low employee headcount. The year 2011 was a landmark one for Internet companies, with several start-ups going public and raising over $3.5 billion in the best year for initial public offerings since 2000. Among the biggest ones to do so in the United States were LinkedIn, Zynga, Groupon and Renren, a Chinese social networking site. And Facebook’s recent filing for a $5 billion public offering could make 2012 the best year for Internet I.P.O.’s since the dot-com days of 1999.

But all these companies thrive on aiding consumption, whether it’s through gaming, social networking or group discount buying.

In contrast, production-oriented technology sectors in health care, advanced materials and energy have had limited success in America. Most ventures in clean technology have absorbed large amounts of capital and have yet to show returns for investors. Many that have managed to grow, like A123 Systems, which manufactures advanced lithium-ion batteries, and Tesla Motors, aren’t very profitable. The success of consumption-driven Internet start-ups has left production-oriented ventures behind.

It’s technology that ensures equitable growth. Think of how mobile phones are ubiquitous across the developing world: there are over five billion cellphone users worldwide. Would it have been possible for all of them to have landline telephones instead? Would there be enough copper in the world to draw wiring to even the poorest day-wage laborers in India and China who today use cellphones? Even if the world had enough copper, could it all be mined quickly enough with limited environmental impact, and could it be devoted to laying telephone lines for a customer of meager means? Almost every modern day convenience that the West takes for granted will have to be re-engineered to make it cheaper and better for large-scale use in the developing world.

There’s a dichotomy here. The advanced Western economies aren’t able to create jobs partly because of their inability to compete with Asia when it comes to large-scale manufacturing, and this has in turn limited their ability to scale production-oriented technology companies. In the East, the emergence of manufacturing — and in India’s case, I.T.-outsourcing — has created higher incomes, a stronger consumer culture and the need for energy and resource efficiency. Rapid urbanization and industrialization in the developing world are irreversible trends. There are suddenly billions of consumers in Asia who can now aspire to the standard of living in advanced economies, and meeting this demand will require a giant leap of innovation across sectors like energy, chemicals, health care, transportation, water and materials.

But emerging markets lag in innovation because their entrepreneurship ecosystem, higher education institutions and research infrastructure are far less robust. Above all, entrepreneurship is celebrated in American culture and business failures aren’t looked down upon. Silicon Valley is the product of this culture — like French cuisine and Indian classical music, it cannot be cloned. As the world’s innovation engine, Silicon Valley should lead the way in commercializing game-changing technologies that can ease constraints on the world’s resources and enhance production. Instead, it has found more success in ventures for the consumer market.

But start-ups must be close to their customers, and there’s a case to be made that industrial and clean-tech start-ups in Silicon Valley have been hard-pressed for success because their real customers are in emerging markets. From an economic standpoint, climate change and resource efficiency are more the problems of developing nations. Moreover, as the bankruptcy of American clean-energy start-ups like Solyndra has shown, innovation that needs to be propped up by governments is difficult to sustain.

Similarly, consumer Internet ventures in emerging markets are only able to clumsily copy ideas from abroad. Though there is a rapidly growing middle class with Internet access in India and China, the United States still has the world’s largest and most affluent consumer base, making it a natural pioneer for consumer Internet innovation.

The Internet is challenging the hegemony of nations. An Internet start-up in any country can reach consumers worldwide because of the platform’s openness. But the same isn’t true for production-focused start-ups. Greater economic integration and free trade will help them globalize more easily. To foster innovation in production-oriented sectors, nations need to champion the freer flow of technology, labor and capital and create institutions and laws that promote the same openness. There needs to be a symbiosis between entrepreneurial talent, investment capital and sectors that are in need of transformational innovation. Only then will global economic growth be truly inclusive and harmonious.

Originally Published: The New York Times International Weekly

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