Exploring the relationship between venture capital funding flows and macroeconomic factors in an emerging economy

Abstract

Startups constitute an important driver of innovation and growth in economies. India, in particular has been experiencing a burgeoning of startups in its economy. Startups, however, experience tough phases of financial shortages at the time of inception and are solely dependent on raising capital through equity. In this context, venture capitalists (VCs) or venture capital firms constitute an important entity that not only provide funding to startups, but through their expertise also provide immense business guidance to them. It is in this backdrop that this report seeks to understand the drivers of VC investments in the context of the Indian economy. Through our research, we aim to understand the sensitivity of VC investments to macroeconomic and macro-financial indicators. In the process, this report focuses on 8 major VC firms. Over and above analyzing sensitivity to macroeconomic variables, this report also provides descriptive statistics on the trends in investments as a whole and the kind of startups they invest in (based on their maturity), and the sectors most VCs flock to. Our results suggest that between the macroeconomic variables (GDP and forward looking consumer sentiment) and macro-financial variables (Nifty50 index, Corporate Tax rate, Repo Rate, and the Fed Funds Rate), macro-financial variables on a broad level seem to drive VC investments more. In this report, we sought to analyze how VC investments position themselves with respect to FDI and FPI, and we find that arrangements between VCs and startups and VCs and their investors, in turn, allow for longer-term arrangements. Given that VC investments are directly impacted by business sentiment, it is imperative that policy decisions are implemented in order to ensure a vibrant startup ecosystem in the economy. This report suggests four policy interventions. Of these, three focus on individual investor-level transactions while one focuses on helping improve the overall ecosystem for startups. It is important for the state to facilitate relations between startups and investors through investment promotion agencies, and possibly also co-invest. Additionally, the government must focus on providing tax breaks to startups. This is likely to help late stage startups who are already profitable. Finally, an ecosystem must be built through incubators to ensure lower incidence of startup failure through effective guidance. This effectively, reduces the risk of VC investments, bringing down their expected rate of return for each investment and allowing for funding to be much more diversified.