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BW Businessworld

Social Capital

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Vineet Rai grimaces when he is described as a social venture capitalist. He doesn't like the sound of it and considers it too faddish a term used indiscriminately in recent times. Rai can be allowed to have such radical views. Ten years ago, he founded Aavishkaar, India's first for-profit social venture capital (VC) firm. It took him seven years to scrape together a paltry $14.3 million for his first fund. The money has gone into 17 companies in off-beat areas of business such as village handicrafts, energy-efficient stove burners, organic cotton farming and affordable healthcare. The common aim of all these businesses is to improve the lives of low-income citizens in rural India.

Jayant Sinha (top), partner, Omidyar Network India Sriram Raghavan, founder, Comat Tech (BW Pics by Satheesh Nair and Gopal K.)Rai is now raising his fourth fund, the $100- million AIMVCF II (Aavishkaar India Micro Venture Capital Fund II). This time, he does not have to scrounge around for funds. Blue chip foreign investors such as Washington-based International Finance Corporation and UK's CDC Group are already queuing up to invest in the fund. Recently, Rai was in Seoul for the G 20 Summit where, as the winner of the G 20 SME Finance Challenge, Aavishkaar was pledged funding from member countries. The firm has also just raised $30 million of a targeted $80 million for its second microfinance-dedicated fund Aavishkaar Goodwell (the first fund was $18 million).

Tipping Point
Social VC, still a new idea even globally, has had a good outing in India the past couple of years. Seven-odd pureplay social VC funds, including Aavishkaar, are active here (see All For A Cause, And More). So far, they have invested an estimated $140 million in social startups, according to media and industry reports.

Social startups seek to address the needs of the poor, chiefly healthcare, education, housing, water and energy. Unlike NGOs, these firms target commercial gains. This is vital, they hold, for sustainable impact. Therefore, they need commercial capital. Social VC provides that capital.

The early success of some of their investments has given social VC funds the firepower to emerge from the shadow of mainstream VC. Startups such as Vaatsalya, which runs 10 affordable hospitals for rural and semi-urban citizens, d.light design, which has sold 220,000 solar lamps benefiting 1.1 million people, and Comat Technologies, which has enabled 10 million rural people to digitise land and other records, are worthy examples of profitable firms that address rural markets. They have played a critical role in attracting high-profile investors such as Indian-American billionaire venture capitalist Vinod Khosla and eBay founder Pierre Omidyar to the folds of social VC.

More importantly, mainstream VC funds such as Draper Fisher Jurvetson (DFJ), Nexus Venture Partners, IndoUS Ventures and Seedfund are now betting on such businesses. About $1 billion, according to broad estimates, is in the pipeline to be invested in Indian social startups over the next five years. This will come both from pureplay social VC funds and mainstream investors. Social VC is at a tipping point in India.

So why is Vineet Rai grimacing? It has to do with the ties between social VC funds and microfinance. Recent events involving Hyderabad-based SKS Microfinance have made the relationship somewhat uneasy. Microfinance is the business of giving high-interest loans to the rural poor. SKS is the poster boy of this business. In August, it became India's first microfinance institution (MFI) to go public. The listing on the Bombay Stock Exchange at Rs 1,040 per share (about $23) validated the commercial viability of such businesses. But the dizzying success of the IPO has also opened up a can of worms.

Aavishkaar & Utkarsh Micro Finance
Aavishkaar invested in Chennai-based Utkarsh, which offers financial and non-financial services to the underprivileged and the poor in March, along with IFC
Omidayar Network & Comat Technologies
Omidyar invested $9.36 million in e-governance service startup Comat in 2008 — its first forprofit investment in India
Bamboo Finance & Husk Power Systems
Bamboo Financemanaged Oasis Fund invested $375,000 in HPS in 2009. HPS burns rice husk to make power for off-grid villages in Bihar

Last month, the Society for Elimination of Rural Poverty (SERP), an affiliate of the Andhra Pradesh government, released a report alleging 54 cases of suicide in the state as borrowers were unable to repay microfinance loans; 17 of these, reportedly, were SKS borrowers. Allegations have since followed on loans given by different MFIs leading borrowers into debt trap.

The high annual interest rates charged by MFIs, 24-36 per cent, are currently under scrutiny by the Reserve Bank of India. It has also not gone unnoticed that the listing earned SKS's VC investors huge profits. Vinod Khosla, who had invested $2.5 million in 2006 with other investors, has made a reported $117 million on selling part of his 6.6 per cent stake.

Eric Berkowitz (top), founder & investment executive, Bamboo Finance; Gyanesh Pandey, founder & CEO, Husk Power Systems (BW Pics By Tribhuwan Sharma)Sequoia Capital, the Palo Alto-based VC fund that is the largest shareholder in SKS, has reportedly multiplied its $32 million investment 13 times. MFIs across the country are now being questioned on loan collection tactics, corporate governance and their business motives.

Unfortunately, this has cast a shadow over social VC funds. Out of the $140 million invested by social VC funds in India till date, an estimated $50 million has gone into MFIs. Take for instance US-based Elevar Equity. Out of its eight investments in India, four are in microfinance, including SKS. It has recently launched a $70-million fund that will be more focused on social startups. Omidyar's India portfolio of five firms has one microfinance related enterprise, though a non-profit. Aavishkaar's microfinance fund has investments in five MFIs, of which Chennai-based Equitas Microfinance earned it an IRR (internal rate of return) of 160 per cent on exit this September. This has led to the misplaced notion that microfinance is a social business.

"Microfinance does not create social impact. It only creates outreach. You need to build services such as healthcare and education and leverage that outreach to create social impact," says Rai. While Equitas has brought him stellar gains, he points out two other exits in September as more significant — Servals Automation and Shree Kamdhenu Electronics, earning IRRs of 65 per cent and 45 per cent respectively. "This proves non-financial businesses that address the bottom-of-the-pyramid can also be profitable," he says. Chennai-based Servals, founded by 68-year-old P. Mukundan, makes stove burners that use 30 per cent less kerosene. Shree Kamdhenu, located at Vallabh Vidhyanagar in Gujarat and founded by seven entrepreneurs, has created an automated milk collection system that helps dairy cooperatives operate more efficiently.

The Social Factor
Part of the problem lies in the similarities between microfinance and social businesses. Both address the poor and are largely funded by VC funds. In microfinance, however, the bulk of the money has come from mainstream VC funds. However, there are big differences in their investing styles and intents. Social VC funds such as Aavishkaar, Gray Matters Capital and Oasis Fund look to make commercial gains by investing in businesses that address the needs of the underprivileged.

(L-R) Pierre Omidyar (Bloomberg), Sumir Chadha (BW Pic Subhabrata Das), Vinod Khosla (BW Pic Tribhuwan Sharma)
However, unlike mainstream VC funds, they only invest in companies they think will have a widespread and beneficial impact on the poor. Mainstream VC funds such as Sumir Chadha's Sequoia or DFJ are driven solely by commercial gains. So, while a Sequoia promises its limited partners (institutions investing in VC funds) returns of 10 times or more, social VC funds promise significantly less. "We do expect market or neo-market returns. But social impact is an equally important measure," says Eric Berkowitz, founding member and investment executive of Bamboo Finance, which manages the $50-million Oasis Fund.

The emphasis on social impact also makes such investments much more risky as they are less likely to succeed. Social VC funds invest in a firm when it is barely at the idea stage, while mainstream VCs tend to come in at the post-revenue stage. Their investments are also smaller. Gray Matters, for instance, starts with $250,000 per firm; it could go up to $2 million. There is no real industry information to help with pre-investment due diligence, no peers to benchmark against, and no foreseeable exit plans.

Though a new idea globally, social venture capital has had a good outing in India in the past few years

1982: Ashoka Foundation, a USbased non-profit, sows the seeds of social VC in India. Selects social entrepreneurs as Ashoka Fellows and backs each with a small grant
1997:Grassroots Innovations Augmentation Network (GIAN) sets up the first Indian non-profit social VC fund, backed by the Gujarat government and IIM Ahmedabad. Vineet Rai takes charge of GIAN
1999: Ramanan Raghavendran, partner at VC firm ConnectCapital, sets up Impact Partners, the first non-profit social VC fund backed by private capital. Donors: Ratan Tata Trust and Ford Foundation
2001: Rai quits GIAN to set up Aavishkaar India Micro Venture Capital Fund, India's first for-profit social VC fund. Target corpus: $14 million. New York-based Acumen Fund begins to invest in India
2002: Aavishkaar marks its first investment with Servals Automation, even as it continues to raise its maiden fund
2006: Omidyar Network starts investing in India. It adopts a strategy of investing as a for-profit social VC and giving grants. Vinod Khosla leads a $2.5-million investment in SKS Microfinance
2007: Aavishkaar raises second fund: the $18 million Aavishkaar Goodwell devoted to microfinance. Mainstream VC funds such as Nexus Ventures begin sporadic investments in social enterprises
2008: Aavishkaar raises second fund: the $18 million Aavishkaar Goodwell devoted to microfinance. Mainstream VC funds such as Nexus Ventures begin sporadic investments in social enterprises
2009: Omidyar Network sets up Mumbai office. Social VC investments hit $100 million
2010: SKS becomes India's first social enterprise to go public. Vinod Khosla announces a new social VC fund for India and Africa. Aavishkaar starts raising $180 million for two new funds

A good example is Aavishkaar's investment in Vortex Engineering, a Chennai startup that came up with the idea of ATMs for villages. Its solar ‘Gramatellers' consume less power (just 100 MW per day). Neither do they need ACs. "We invested in it when Gramatellers were at the concept stage," says Rai, of the $2-million investment in 2006. Vortex, says CEO V. Vijay Babu, will do Rs 100 crore revenues in two years. Vortex's big break came this March when SBI contracted it to set up 545 rural ATMs (300 solar). "The advantage of having a social VC fund on board is that they stay invested longer," says Babu. Vortex's other investors include Oasis Fund and Hyderabad-based Ventureast, which forayed into social investing this year with the launch of the $5-million BYST Growth Fund.

Husk Power Systems is also almost entirely backed by social VC funds. This year, Oasis Fund, along with New York-based non-profit Acumen Fund and others invested $1.25 million. Husk, founded by Gyanesh Pandey, Ratnesh Yadav, Charles Ransler and Manoj Sinha, runs and operates 35-100 KW mini power plants, based on rice husk. It electrifies 50,000 off-grid rural homes. "Our investors have been instrumental in helping us streamline proce-sses and plan ahead. We will look at overseas markets such as Africa," says Pandey.

Source: VC Funds, Media Reports and VCCEdge
Neither Rai nor Berkowitz denies the importance of giving financial access to the poor through microfinance. "But it can't be done in isolation," says Rai. Aavishkaar's five MFI investments cover Tamil Nadu (Equitas), Karnataka (Grameen Koota), Maharashtra (Suryoday) and Andhra Pradesh (Basix and Share Microfinance). The strategy is to create access and follow-up with other basic-need businesses. For instance, it invested Rs 50 lakh in Bangalore- based Vaatsalya in 2006 to test scalability of affordable hospitals in semi-urban and rural markets. Vaatsalya, in which Oasis is also an investor, now runs 10 hospitals, each with 60-70 beds, and is profitable. Out of Aavishkaar's portfolio of 22 companies, 17 are social businesses.

The good news for Rai and his ilk is, despite the cloud over microfinance, there is a surge in interest in social businesses. Not just in India. US and European pension trusts, family offices and financial firms such as JP Morgan who traditionally back mainstream VCs now look at social VC funds as viable assets. "Institutional investors are already sold on microfinance. It's a matter of time before they enter the social VC space in a big way," says Berkowitz, who has raised fresh funds for Oasis from such investors.

Impact Investing
India, with its vast rural and under-privileged population, stands to be one of the biggest beneficiaries of this trend. Take a cue from Omidyar Network's activities here. Born in 2004, it has already invested $400 million globally, of which $60 million is in India. Its investments include Comat and d.light design. "Capital follows opportunity. People now realise entrepreneurship at the bottom-of-the-pyramid can impact a lot of people and create wealth," says Jayant Sinha, partner at Omidyar Network India. It intends to deploy $200 million here within five years.

There is no dearth of capital. A recent report released by US-based Social Investment Forum finds the US alone has 117 alternative social investment vehicles, including social VC funds, which manage $37.8 billion in total assets, a 613 per cent increase from 2007.

The latest to jump on to the social VC bandwagon is Vinod Khosla. He says he will use the $117 million earned from SKS to set up a social VC fund for Africa and Asia. Mainstream VC funds are also likely to follow with their brand of ‘impact investing'. But Nexus, which has investments in d.light design and Suminter Organic Farming, which contracts organic farming to small farmers, says these are not social investments. "The intent is to build scalable businesses with a social impact while generating adequate returns," says Sandeep Singhal, managing director of Nexus.

But he says while most of the due diligence is the same as with other companies, such investments are difficult to gauge for their ability to scale. "In Suminter, we met the farmers in Gujarat and Maharashtra," he says. Seedfund's investment in Vaatsalya was also driven by similar interest. "The only difference in investing in such businesses is you are likely to earn returns in seven years, rather than 3-4," says Anand Lunia, Seedfund's CFO.

By March 2011, social VC investments in India, both by pureplay social VC funds and others, are expected to cross $300 million. It will be a trifle compared to overall VC investments of about $1 billion. But it will be significant enough for social VC funds to fight off their demons and establish a distinct identity.

snigdha dot sengupta at abp dot in