In January 1978, a venture capital (or VC) firm bought shares in a newly formed company at nine cents per share. It sold its shares shortly within eighteen months, in August 1979, to another investor for nearly $1 per share, 11 times the price it had paid. Within another eighteen months, the company's shares were trading at $22 per share, 22 times the previous price. The company is Apple Computers, and the VC firm Sequoia Capital. More than 35 years later, the world of venture capital and their investment valuations still follow these dizzying patterns. Such stratospheric valuations in short bursts in the early days of a VC-backed company are par for the course and in themselves do not signal any market manipulation. This does not immediately imply collusion among investors. More importantly, this in itself cannot be an excuse to unleash the might of the state on a private investor.
The offices of Sequoia Capital India were recently raided by the Enforcement Directorate (or ED). According to media reports, the ED's primary suspicion is that there was malafide intent behind Sequoia'spurchase of shares of in a start-up, Vasan Healthcare, at Rs 7,500 per share in 2010 while the same company's shares were valued at only Rs 200 in 2008. The ED is apparently questioning the basis for the valuation and is insinuating that its shares were deliberately and artificially valued so high. Understandably, this much-publicised raid has set the alarm bells ringing among the VC fraternity in India. The fear is not one of being held accountable for their transactions. The trepidation is that venture capitalists can become collateral damage in the power games of the mighty, and the flimsy excuse of valuations can be used to exercise undue powers by government authorities.
In the modern "Panama Papers" world, there are many legitimate reasons for suspicion about financial transactions among private parties, but valuation of private companies for transactions among private investors is not one of them. Ironically, in 2012, the Government of Singapore Investment Corporation (GIC) invested in Vasan Healthcare at a much higher price than what Sequoia Capital had paid. GIC is a sovereign fund of the government of Singapore. If investors, foreign or domestic, are seen to be aiding a company in violating the laws of the land or even turning a blind eye to it, the government should rightly take action against them. But what the government perceives as the benchmark value of a private company cannot be grounds for harassment.
While this incident may have caught the media's fancy owing to the protagonists in this story, such harassment of VC-backed companies over valuations are plentiful. There are innumerable such incidents of tax authorities issuing random notices to small, private companies over valuations at which they have received investment from a private investor. The very notion that there is one right valuation for a company is absurd. To pretend that the government is the best judge of this valuation and to use that as basis for persecution is tyrannical.
Venture capital investors have invested over $50 billion in India over the last decade. This has helped create over 3,000 new companies. These companies are an important jobs engine for the economy, especially in the absence of private investment by traditional industry. Ola Cabs, another Sequoia-funded company, alone employs over 200,000 drivers across 200 cities and towns of India. This is an important asset class that spurs innovation and jobs.
All this is not even to remotely suggest that the VC fraternity has to be beyond scrutiny. It is merely to imply that venture capital is a well-established industry in India, not a group of buccaneering investors gambling money in new companies in collusion with dubious people or entities, as portrayed. The ED has the right to question these investors' source of funds, taxes paid on gains on investments, the bureaucratic legitimacy of the companies they invest in, and so on. But preaching techniques of valuing new companies to established VC investors and using it as an alibi for raids, causing reputational and operational damage to these investors, is entirely unwarranted. This unfortunate incident has triggered panic among both global and domestic VCs. This creates the risk of diminishing investor appetite for innovative, risky start-ups in India.
Lest this is construed as holding a brief for either the venture capitalist or the company in question or the personalities involved, this is not a plea on behalf of anyone. Neither is this a judgment of innocence on the company or its investors. This is merely to highlight the consternation among VC investors and entrepreneurs over the recent raids by the ED and their potential ramifications.
Venture capital investment in new companies had been the untold glory of the Indian economy over the past decade. Prime Minister Modi should be lauded for sounding the bugle on this, through his "Start Up India" programme, launched in characteristic splendour in January. However, these whimsical, sudden raids on VCs on fragile grounds are a travesty of the promises of Start Up India. Before yet another important initiative of this government is dismissed as just another slogan, it will serve the government well to end this needless harassment of private businesses and truly live up to its oft-repeated goal of ensuring ease of doing business.
Chakravarty is a Fellow in Political Economy at IDFC Institute and co-founder of Mumbai Angels. Pai is Chairman, Manipal Global and former CFO and board member, Infosys Technologies
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