India Needs a Retail-Funded Deep-Tech Revolution

Last week, governments around the world took note as a state-backed Chinese firm began building its own advanced chip-printing machine—a deep ultraviolet, or DUV, lithography system. Effectively, the market for these incredibly complex machines is monopolised by ASML of the Netherlands. The US doesn't make such machines, and neither does Germany. Japan's Nikon and Canon make DUV machines, but not the high-end version. As one can imagine, the technology is fiendishly hard to master. But now a Chinese company has done it.

But this column is not about China's chipmaking breakthrough. Rather, it is about the strategic need for countries to develop their own capabilities in technologies that will shape the world in the years ahead.

For instance, China's DUV machine, made with some Japanese parts, is inefficient compared with ASML's. But China doesn't care about efficiency; it cares about capability. With the US and Europe barring its access to high-tech chips and equipment, China needs to become self-reliant. It will now work on perfecting the DUV machine and then make headway with the next-generation extreme ultraviolet, or EUV, machine that ASML already makes, but which China is unlikely to master for the next 10 years.

India also needs to become self-reliant in critical technologies. But to achieve that, the country needs, apart from a pioneering spirit, oodles of capital. China, for instance, has had a budget, by some estimates, of $150 billion to spend on semiconductor technologies between 2014 and 2029.

In comparison, India's most ambitious catch-all technology investment fund—the Research, Development, and Innovation Scheme—is worth $12 billion.

Clearly, there are limits to India's ability to make such investments. Nor is the banking system a viable source of capital for most startups, whose cash flows and risk profiles are fundamentally unsuited to conventional lending.

Therefore, to accelerate investment in deep tech, India needs to look beyond the government and even institutional investors such as alternative investment funds and venture funds. At present, venture capital in India is still largely funded by foreign limited partners, that is, institutional investors. These are investors who want India exposure in their portfolios but can change their minds at any time for economic or political reasons. The solution, then, is to broaden critical deep-tech investment to a new class of believers—the Indian retail investor.

A Decade of Experimentation

To be sure, this idea is neither unique nor new. The US has Nasdaq, China built the STAR Market, and the UK added a new market for intermittent liquidity (PISCES) alongside AIM. India has also tried to channel retail capital, but with limited success. The novelty, then, must lie in designing such a structure specifically to overcome the old hurdles. Allow me to elaborate.

In 2013, an Institutional Trading Platform, or ITP, was launched to allow SMEs and startups to access capital and to allow angel investors and VCs to buy and sell their shares. But the rules required the startup to have received at least ₹5 million in professional investment, while the minimum trading lot was ₹1 million. The ITP failed to take off.

In 2019, the ITP was rebranded as the Innovators Growth Platform, allowing any individual with an annual income of ₹5 million and a net worth of ₹50 million, and companies with at least ₹250 million, to become accredited investors. While the ITP required investors to hold the pre-issue capital for at least two years, the IGP, following a later amendment, reduced this to one year and lowered both the minimum IPO application size and the minimum trading lot to ₹200,000. It didn't work then and still doesn't. The reason is simple: SEBI kept tweaking supply-side issues without addressing the demand-side problem.

The government, for its part, has attempted different funding mechanisms to accelerate startup innovation. And contrary to what many people may think, it has been rather successful. A ₹100 billion Fund of Funds for Startups under SIDBI was launched in 2016 to anchor alternative investment funds, which then invest at least twice SIDBI's commitment into startups. Many of India's unicorns were once beneficiaries of this fund.

Then, in 2021, the Startup India Seed Fund Scheme was introduced with a corpus of nearly ₹10 billion to provide grants and debt that help innovative ideas reach the proof-of-concept and prototype stage. At last count, some 2,600 startups had received nearly ₹4.70 billion.

The government has done even better with its sector-specific seed and grant schemes. The Department of Biotechnology's Ignition Grant, for instance, gives startups up to ₹5 million to turn an idea into something tangible. At one partner incubator alone, more than 50 grantees secured follow-on funding worth ₹5 billion and filed more than 75 patents. Similarly, the Innovation for Defence Excellence, which offers grants of as much as ₹15 million, has funded more than 200 startups in partnership with DRDO and defence PSUs.

These successful schemes have a few things in common. First, they partnered with agencies and institutions possessing domain expertise to identify the most deserving startups rather than leaving the government to do so itself. Second, they paired capital with mentoring and demand linkages, especially for defence startups. Third, the grants and investments worked as force multipliers. My argument in this column is that a much larger pool of capital can be unlocked by allowing retail investors into this mix. Doing so would enable many of these startups to cross the valley of death between seed and growth funding.

A Fund of Partnerships

Thus far, the government has deliberately kept small investors out of small and untested companies to protect them from investment risk. The structure I propose is designed to continue minimising that risk—though not eliminating it—while offering a capped capital gains benefit per PAN number.

Here's the proposal:

• India should launch a closed-end, listed and tranched fund of funds with a capped capital gains exemption on exit for investors, along with a modest upfront tax concession to nudge participation.

• The government would provide seed capital and invest it across a select group of AIFs, which would then match the government's corpus.

• Retail investors would be allowed to invest an amount equal to twice the combined capital contributed by the government and the AIFs.

• The AIFs would decide which deep-tech companies to back.

• If the fund delivers handsome returns at the end of its life—say, seven years—everyone benefits. But if it incurs losses, they are first absorbed by the sovereign and the AIFs, in proportion to their contributions. This feature is central to the design.

• To provide liquidity in the event of unforeseen emergencies, the fund would be listed. However, the capital gains exemption would apply only after completion of three years. Thereafter, the capped exemption would increase progressively: four completed years—25%; five years—50%; six years—75%; and seven years (the end of the fund's life)—100%. The US QSBS regime offers a broadly comparable incentive, though in a different form.

• The secondary market would exist primarily to facilitate emergency exits, while leaving some upside for buyers willing to hold the investment to maturity.

Such a fund structure would allow a government seed commitment of, say, $2 billion to scale into a $12 billion investment pool, while giving retail investors access to a diversified, professionally managed slice of India's deep-tech upside with a sovereign cushion. If successful, the model could set in motion a virtuous cycle that finances India's deep-tech ambitions for years to come.