How HNIs Can Benefit from Investing in Venture Capital Funds

28 Nov 2024 , 01:16 PM

Venture capital activity has greatly accelerated in India over the last decade, with record funding levels driven by large institutional investors. However, high-net-worth individuals (HNIs) still account for a major share of investors in Indian Venture Capital financing.

For Indian HNIs looking to diversify their portfolios beyond market-linked assets, venture funding presents an attractive opportunity given the high growth potential of India’s startup ecosystem. In this blog, we explore venture capital, the process VC firms follow to raise and invest funds, and the key advantages Indian HNIs can obtain by investing in the bright spots of India’s entrepreneurial landscape.

An Overview of Venture Capital Investing in India

Venture Capital refers to financing provided to early-stage companies that display innovative technologies, have scalable business models, and demonstrate high growth potential. Venture funds invest in such private companies in exchange for equity ownership. Some key traits of Indian venture capital are:

• High Growth Sectors: Indian VC investment is concentrated in high-technology sectors like IT/ITeS, consumer internet, fintech, edtech, health tech, and emerging areas like electric mobility.
• Key Startup Hubs: Bangalore, Mumbai-Pune corridor, NCR, and Hyderabad account for many VC deals in India, given the concentration of startups in these areas and the presence of innovation centres, talent pools, and supporting industries.
• Mixed Returns: Historically, Indian VC funds have shown mixed returns driven by evolving startup ecosystems. However, recent exits via IPOs and acquisitions have unlocked high returns across top funds.
• Concentration of Funds: The top VC funds account for nearly 50% of all investment activity, displaying the nascent stage the Indian market is in. However, new dedicated funds continue to emerge.

Types of Venture Capital Funds in India

There are various fund vehicles Indian HNIs can consider for startup investments:

• Conventional VCs: These are institutional funds from Limited Partners (LPs) like HNIs, family offices, endowments, etc., managed by professional teams.
• Angel Investing Platforms: These allow high-net-worth and ultra-HNIs to invest directly in multiple early-stage startups via managed angel networks.
• Corporate Venture Funds: Strategic investments made by large Indian corporations to nurture emerging startups.
• Government-sponsored Fund of Funds: Initiatives like the SIDBI Fund of Funds commit capital to daughter VC funds to boost the early-stage startup funding ecosystem.

Benefits of Investing in Indian VC Funds for HNIs

This section covers the benefits of investing in VC Funds for HNIs. Key benefits include the following:

1. Strong Growth Potential: India’s startup ecosystem has shown tremendous expansion with record funding levels year on year. Backing this growth via exposure to VC funds allows participation in India’s entrepreneurial rise.

2. Portfolio Diversification: VC funds provide access to balanced portfolios of startups across high-technology sectors with low correlation to mainstream equity markets.

3. Hedging Against Rupee Depreciation: Investing via India-dedicated VC funds provides attractive hedging against the depreciation of the Indian rupee (INR) compared to other international currencies.

4. Tax Benefits: Certain alternative Investment Funds allow tax exemptions under section 80C of the Income Tax Act. Moreover, long-term capital gains are taxed at 20% compared to 30% for short-term gains (assuming a 30% tax bracket for HNIs).

5. Co-Investment Opportunities: Several VC funds provide co-investment rights, allowing direct exposure to select portfolio startups. This allows outsized gains in case of specific breakout successes.

Overview of VC Fundraising and Investment Process

This section covers the key steps of the venture capital funding process. Key steps include the following:

1. Fund Raising: VC firms raise investment corpus from Limited Partners (HNIs, institutions, etc.) to create a fund vehicle that invests in an 8-10-year horizon for early-stage funds.

2. Deal Sourcing: During the 4-5 year investment period, VCs actively network with entrepreneurs, incubators, angel networks, etc., to source promising startups across sectors, stages, and geographies that match their fund strategy.

3. Investment Due Diligence: Shortlisted deals undergo a rigorous assessment of founding teams, business models, technologies, financials and projections before negotiating investment terms.

4. Portfolio Support: After the investment, VCs support their portfolios via follow-on funding, connections with corporate partners, hiring key executives, geographic expansion, and preparing for future exit events.

5. Exits: Target horizons for exits via IPO, secondary share sale, mergers, etc., typically 5-8 years. Top-tier funds demonstrate attractive realisations.

6. Distribution: Exits allow VC funds to unlock liquidity and distribute the proceeds to LPs after taking up to 30% of their carry fee of the gains. This completes the fund lifecycle.

Conclusion

India’s expanding economy presents a compelling case for exposure to venture capital funds for HNIs seeking diversification and growth. Maturing startup ecosystems, sizable returns from recent IPOs and exits, tax incentives and strong sectoral growth make India-focused VC funds an attractive asset class to consider. With a prudent selection of fund managers, HNIs can balance the risks and participate in India’s entrepreneurial and digital transformation.