+ innovation & entrepreneurship FINANCING TECHNOLOGY ENTREPRENEURS & SMES IN DEVELOPING COUNTRIES: CHALLENGES AND OPPORTUNITIES FINANCING TECHNOLOGY ENTREPRENEURS & SMES IN DEVELOPING COUNTRIES: CHALLENGES AND INDIA OPPORTUNITIES Country Study AN infoDev PUBLICATION PREPARED BY Roberto Zavatta Economisti Associati SRL in collaboration with Zernike Group BV Meta Group SRL June 2008 Information for Development Program www.infoDev.org www.infoDev.org FINANCING TECHNOLOGY ENTREPRENEURS & SMES IN DEVELOPING COUNTRIES: CHALLENGES AND OPPORTUNITIES INDIA Country Study AN infoDev PUBLICATION PREPARED BY Roberto Zavatta Economisti Associati SRL in collaboration with Zernike Group BV Meta Group SRL June 2008 Information for Development Program www.infoDev.org ICT-enabled INNOVATION AND ENTREPRENEURSHIP SERIES ©2008 The International Bank for Reconstruction and Development/ The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: [email protected] All rights reserved The findings, interpretations and conclusions expressed herein are entirely those of the author(s) and do not necessarily reflect the view of infoDev, the Donors of infoDev, the International Bank for Reconstruction and Development/The World Bank and its affiliated organizations, the Board of Executive Directors of the World Bank or the governments they represent. 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For permission to photocopy or reprint any part of this work, please send a request with complete information to infoDev Communications & Publications Department, 2121 Pennsylvania Avenue NW; Mailstop F 5P-503, Washington, D.C. 20433, USA; telephone: 202-458-4070; Internet: www.infodev.org; Email: [email protected]. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: [email protected]. Cover design by Patricia Hord Graphic Design, Inc. Typesetting by The Word Express, Inc. TabLE of Contents Abbreviations and Acronyms v Executive Summary 1 I. Introduction 5 II. The Country Background 7 II.1 ICT/ICTE Industry 7 II.2 Policy and Institutional Framework 8 II.3 The Financial Sector 9 III. Issues in the Financing of Ict/icte Small Businesses 13 III.1 SME Financing Needs – The Demand Side 13 III.2 Issues in Accessing Financing – The Supply Side 13 III.3 The Financing Gap – Nature and Severity 18 IV. Conclusions and Recommendations 21 IV.1 Introduction 21 IV.2 Measures Aimed at Facilitating Access to Equity Financing 21 IV.3 Measures Aimed at Facilitating Access to Bank Financing 23 AnneXes Annex A – The Ict/icte Sector 27 Annex B – Policy and Institutional Framework 35 Annex C – The Financial Sector 41 Annex D – List of Entities Interviewed 53 Annex E – Profiles of Sme Financing Organizations 55 Annex F – Profiles of Ict/icte Sme 65 iv Financing Technology Entrepreneurs & SMEs in Developing Countries: Challenges and Opportunities ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank NASSCOM National Association of Software BA Business Angels and Services Company BoA Band of Angels NEGAP National E-Governance Action BPO Business process outsourcing Plan CGF Credit Guarantee Fund PIPE Private Investment in Public EC European Commission Equity EDP Electronic Data Processing R&D Research and Development ERP Enterprise Resource Planning RBI Reserve Bank of India EU European Union SEBI Security and Exchange Board of IC Integrated Circuit India ICT Information and Communication SEZ Special Economic Zones Technology SIDBI Small Industries Development ICTE ICT Enabled Bank of India IFC International Finance Corporation SME Small and Medium Enterprise IFI International Financial Institutions STPI Software Technology Parks of India IPO Initial Public Offering TDB Technology Development Board ISP Internet Service Provider TBI Technology Business Incubators IP Intellectual Property TOR Terms of Reference IT Information Technology VAS Value-Added Services ITES IT-enabled services VC Venture Capital IVCA Indian Venture Capital VCF Venture Capital Fund Association. VoIP Voice over Internet Protocol MNC Multinational Corporation Exchange Rates US$ 1 = INR 45.3134 (average 2006) EUR 1 = INR 56.9098 (average 2006) Abbreviations and Acronyms v vi Financing Technology Entrepreneurs & SMEs in Developing Countries: Challenges and Opportunities the main lines of business. By contrast with the EXECUTIVE highly advanced software and IT services industry, the Indian domestic hardware industry is still SUMMARY relatively underdeveloped. Most of the MNC investment in manufacturing and assembling tends The Indian IT industry is among the world’s largest. to concentrate on other countries in the region. The It is the most important outsourcing destination for bulk of the domestic production is destined for the software, IT and IT-enabled services. The key driver growing internal market. In addition, the Indian of the Indian ICT industry has been to a large ICT industry encompasses 150 Internet service extent the technology transfer induced by big providers and 100,000 public Internet points Multinational Corporations (MNCs), which started (cybercafés). becoming established in India in the early 1990s. Initially, the largest operations were MNC captives. In advance of many other developing countries, The types of services performed has little complexity. India has had a liberal policy in the telecom and The ICT sector quickly scaled–up, and as important ICT sector since the early 1990s. The main changes domestic firms emerged, such as Infosys and Wipro, occurred in the period of 1994–2001, when various the variety of activities increased and gained more initiatives were undertaken in order to: (i) define depth. Today, the Indian ICT industry can compete medium and long-term policies; (ii) attract private with the world giants. Indian IT clusters are home investment; (iii) create an adequate institutional to advanced R&D centers serving several global IT landscape; and (iv) adopt concrete measures to leaders. In 2006, this industry posted an aggregated support the growth of the ICT industry. In 2000, revenue of US$37.4 billion, growing by 31% over the parliament passed the “Information Technology the previous year, with an overall contribution to the Act”, which contained various provisions aimed at GDP of 4.8%. Software and IT services account for enhancing e-commerce and e-governance. In 2004, the most, with 61% of share; hardware follows with a specific policy to support the diffusion of broad- another 21%; the remaining 18% is represented by band technology was issued. In addition to the ICT-enabled activities. Direct employment is well interventions in the legal and institutional frame- above 1,300,000 units. The MNC’s direct invest- work, several other measures have been undertaken ments in this sector for the current year are expected by the Indian Government to support the develop- to hit an unprecedented US$10 billion. The total ment of private IT entrepreneurship. These measures number of Indian ICT/ICTE firms is not known, fall principally into three categories: (i) fiscal but it may be around 4,000–5,000 (excluding policies; (ii) custom facilitations; and (iii) infrastruc- micro-enterprises, small retail businesses and ture. The first category includes income tax holidays Internet points). SMEs account for 80–85% of the and excise exemptions, particularly for software and total. However, the Indian ICT/ICTE industry also IT services firms. The second group encompasses includes a handful of giant players with revenues in custom duty reductions or exemptions in imports excess of US$1 billion, and about 200 medium to and exports of ICT/ICTE services and components large foreign-owned facilities. The software and IT and other facilitations. What is arguably the most services industry is articulated in various segments, important measure in the area of infrastructures such as software development, customized applica- involves the establishment of technology parks and tions, value-added services, and IT engineering. The processing areas that enjoying special treatments. software sector focuses on exports, which amount to US$17 billion. Similarly, the ICT-enabled sector is The Indian financial sector encompasses a variety of skewed toward exports. India is by far the world players. As of Q1 2006, there were 88 commercial leader in this segment, with an impressive growth banks, 133 regional rural banks, 1,864 urban rate, and a workforce of nearly half a million cooperative banks (UCBs), and several others non- employees. Contact centers and financial services are banking financial companies. In addition more than Executive Summary 1 90 venture capital funds (VCFs) and private equity less than 20. In parallel, the average size of all VC firms are