As businesses, particularly startups and SMEs, in Nepal continue to struggle to secure financing facility, private equity and venture capital are now stepping in to fill the vacuum. Its not only the capital that these funds provide for any business to survive, but also managerial and operational expertise needed to thrive, spurring the development of the business ecosystem.
--BY NEWBIZ TEAM
Many business ideas conceived by aspiring or first-time entrepreneurs die even before they get translated into viable business cases.
While there might be many factors that kill any business idea, lack of financing opportunity to bankroll the business has been a major reason that compels many Nepali entrepreneurs to abandon their business ideas. For those who do not have their own capital or collateral to borrow from banks are forced to forego the business ideas.
But that may not be the case anymore. Specialized investment funds are now stepping in to inject equity in enterprises and startups that are looking for capital to either start or scale up businesses.
Realizing the importance of specialized investment funds in the capital market to support businesses and private enterprises, the Securities Board of Nepal (Sebon) has recently introduced the new rules that govern the alternative types of funds like private equity and venture capital (PE/VC).
By introducing the “Specialized Investment Fund Rules 2075”, Sebon—the securities market regulator—paved the legal way for setting up and operating funds like private equity and venture capital.
The concept and practice of private equity and venture capital is slightly new in Nepal. Although some of these funds were operating in Nepal for last few years, the capital market regulatory body recently started to issue approval or license for fund managers to establish and operate such funds.
Both the government and private sectors have been emphasizing the importance of increasing investments to accelerate the economic growth. Recognizing the role of PE/VC on alleviating some of the country's investment-related problems, the government has expressed its commitment to promote such funds which are also considered an alternative way for investment. In its budget speech for the current fiscal year 2022/23, the government has announced that it would promote entrepreneurship and innovation by facilitating the operation of private equity and venture capital. Earlier in the budget speech of fiscal year 2018/19 also, the government had said that new institutions like private equity, venture fund and hedge fund will be introduced into the capital market.
“Specialized Investment Fund Rules 2075 (2019)” has not only defined what alternative investment funds like private equity and venture capital funds are, but also laid down criteria and conditions for them.
As mentioned in the rule Private Equity Fund means a fund injecting initial equity, or other instruments related to equity, or making investments as per the desire of partners of a company.
Similarly, Venture Capital Fund means the funds whose securities are at the initial phase of operation and not listed with stock exchange market, or a fund making equity investments as a form of capital in the business related to innovative knowledge, skills, or competency or new goods services technology or intellectual property.
The Nepali government has given the Nepal Securities Board (SEBON) authority over managing and regulating venture capital firms as a means of boosting venture capital in the nation. The Specialized Investment Fund Rules 2075 (2019) has addressed such companies as a fund manager. The companies with 20 million rupees paid-up capital along with other required qualities are eligible to apply for fund manager.
Based on the rules the companies have to categorise the type of fund they wish to manage. The rules have cover private equity, venture capital fund, hedge fund and any other type of fund. Analysts say that these investment funds are vital to economies like Nepal that are struggling to meet a gap of financial resource shortage.
Though there is not any data on number of companies receiving the funding from private equity and venture capital or their portfolio size so far, it is estimated that 70 to 75 companies have received alternative type of investments. Some of the notable recipients of such alternative investments include Foodmandu, Red Mud Coffee, Smart Pani, Upaya City Cargo, Sastodeal, Swet Ganga Hydropower, Dalle Restaurant and Sajilo Sewa among others. Most of the investments from private equity and venture capital funds were made even before the Sebon introduced the rules on specialized investment funds.
Funds operating in Nepal are small compared to other emerging and developing economies as the industry is still in the early stage of the development. According to an estimate, these specialized investment funds total capacity currently stands around Rs 15 billion. The size is expected to grow further as new players are entering the market. Those who received the approval recently from the Sebon are also readying their funds for the deployment.
In some cases, business investors have already exited from the companies where they had made investments. Business Oxygen Pvt Ltd, a private-equity fund that has a climate focus, has sucessfully exited from Godawari International Pvt Ltd, a Churpi producing company; Le Sherpa, a restaurant; Shanti Engineering, a metal fabrication industry; The Lakeside Retreat, a hotel in Pokhara. Similarly, another fund manager True North Associates has also exited from three portfolio companies.
Analysts expect a boom on specialized funding deals in the near future with the recent decision of the Sebon to grant license for eight firms to work as specialized fund managers.
Immediately after issuing first such license to Global Equity Fund, the Sebon approved Nabil Investment Banking, NIC Asia Capital, Prabhu Capital, Lakshmi Capital, NIBA Ace Capital, NMB Capital, Global Equity Fund and Avasar Equity Limited as well. There are other fund managers who have also sought the approval to work as specialized fund managers in Nepal. Sebon officials say that it plans to issue approval to other fund managers in the pipeline if it is satisfied with their infrastructures and meet other conditions.
Their entry in the market is expected to accelerate investments in various startups and companies. Even though the foreign investors have been working on this field in Nepal, the Sebon’s decision to issue approvals has formalized this sector, said Dinesh Thakali, Managing Director of Prabhu Capital Limited.
“Although several companies were making investments under this model for a long time, the government has finally formalized this sector with Specialized Investment Fund Rules 2075 (2019),” he said, “This is going to benefit startup companies. They will not only receive investment but will also get financial and strategic mentorship for the business.”
Those companies who have received license from SEBON will need to submit their schemes for approval. The scheme covers the area on which the respective company wants to work on.
Once the Sebon approves the schemes of company, they will start hunting sponsor for funds and the company looking for such funds. On the part of companies looking for funding, they have to submit the business proposal along with the feasibility of study of the business idea. “Once businesses submit their proposals with their unique idea, we assess them for the investment viability or sometimes we take it to the sponsors as well. After the assessment, we will decide whether to fund or not,” Thakali said.
He also said that the company will not only get the fund but will also have guidance of the business management. Hence, this will establish a new practice of doing business. “This kind of fund management system has been highly appreciated worldwide. We have a limited time period for funding. This is a concept of in and out fund,” he added.
According to fund managers, SMEs, ecommerce, fintech, health and energy are some of the major sectors which have received the financing from existing private equity and venture capital in Nepal. They say that they are open for the investment in any sector or business that is viable, profitable and sustainable. The investment per company stands between Rs 10 million to Rs 700 million, taking an equity stake in (fully dilutive basis) between 10 percent and 60 percent, according to analysts’ estimates.
Fueling business innovation
In line with the global trend, start-ups have proliferated in Nepal in recent years as more and more youths choose entrepreneurship over employment. Some new businesses are, nevertheless, barely hanging on. Many of them find sustainability a key challenge. They fail within a year or two of their founding. And majority of them are failing due to a lack of funding or access to financing. While the founders or promoters do not have capital to start or expand their businesses, borrowing from banking institution becomes difficult as it requires them to present land or building as collateral. Though banking institutions are lately extending loans against project, they are still reluctant to bankroll such projects citing higher risks of loan losses in case the projects fail. In the lack of financing opportunity, many entrepreneurs end up abandoning their business ideas, according to entrepreneurs. Financing has been a constraint for all business sectors in Nepal. This problem is more pronounced among small and medium enterprises (SMEs).
As SMEs that account for nearly 98 percent of businesses identify access to finance as a major obstacle, these specialized funds could play a crucial role in driving growth. Karvika Thapa is among those entrepreneurs who had faced the similar challenges in her journey to the entrepreneurship. Thapa is now the CEO of Kimbu Tech, an international software company that provides IT solutions and outsourcing services.
Talking to New Business Age, she said there is still a lack of access to finance for many startups that wants to offer business solutions. Despite having innovative ideas, entrepreneurs are finding it difficult to launch their own businesses, she said.
"There are people who have wonderful business ideas on their mind. But not everyone has the means to invest on their own. They are compelled to rely on either banks or their relatives and family if they cannot manage investment on their own. When they turn to banks seeking credit or loans, they do not receive positive response from banks that are reluctant to go beyond traditional lending."
Recalling the difficulties, she faced to get a bank loan for her business, she said that securing funding has been a common challenge for most of the women entrepreneurs in Nepal. "The government has set up lending policies for female entrepreneurs, but each bank has its own rules, which upset the borrowers who are in desperate haunt for the financing,” she said.
In this situation, PE/VC’s financing not only become a lifeline for startups or growth stage companies but also benefits them from their management and other expertise or business development support. Sebon is also hopeful of more small and medium-sized enterprises (SMEs) benefitting from growing number of specialized fund managers and their fund schemes.
Ramesh Kumar Hamal, the Sebon Chairman, said that the increase in access to finance through private equity and venture capital funds in the country would encourage aspiring young entrepreneurs to start their own businesses.
"For startups or other small businesses, getting a loan without any collateral has always remained a major challenge. Those entrepreneurs who are facing such challenges will be extremely motivated if there are other alternative investment funds like private equity and venture capital,” he said. "It will be a huge relief for entrepreneurs who have so many innovative ideas but struggling to secure funding," he said.
Nepal is struggling to realize its economic potential due to various challenges. Among those challenges, shortage of resources has remained a critical constraint for the development. Nepal’s investment needs average 10-15% of GDP annually over the next decade as the country aspires to graduate from least developed country status by 2026 and towards middle-income country by 2030, according to some estimates.
The private sector participation is crucial to close the huge funding gap. Many analysts say that private equity and venture capital funds could become important sources to foster growth. However, the chronic underinvestment in Nepal has been inhibiting the country from realizing its growth potential.
At a time when banking institution are struggling with the financial resources, mobilization of capital by these specialized investment funds would also help to ease the pressure on the banking system. These specialized investment funds can also attract foreign direct investors who seek a return in the short span of investment. Given the limitation of the domestic resources, foreign investment is a must for Nepal to realize its economic potential.
“We have reached to a situation where the domestic resource alone cannot fulfill the demands for the capital. This is one of the reasons why there is a liquidity crunch in the banking system. To address this growing demand, we need foreign capital,” says Manish Thapa, Founding Managing Partner of Global Equity Fund, highlighting the role of private equity and venture capital to attract such investments.
There are already some specialized funds who have been mobilizing foreign investment. Dolma Impact Fund and Business Oxygen Pvt Ltd (BO2) are two major PEVC-type funds which have mobilized either foreign investors or development finance institutions (DFIs) like FMO and International Finance Corporation. Though these two funds are private equity, they make their investment through foreign direct investment approval routes and are governed by the FDI regulation.
Global Equity Fund’s Thapa says that the investment from DFIs has various advantages. “DFIs always look for impact on investment. They want to invest on such sectors that can not only gain financial profit but also can have some positive impact on society. DFIs are mostly focused on social impact, such as agriculture, climate change,” says Manish Thapa, Founding Managing Partner of Global Equity Fund. “The cost of such capital tends to remain low as they charge moderate interest rate. Other private investors may look for higher returns or the cost of foreign capital could go high for markets like Nepal which does not have any sovereign rating,” he says.
How much is any business worth? That’s a question that private equity or venture capital that want to invest on any business often find difficult during the deal making process, according to experts. As companies or businesses, particularly tech-based firms, seek higher valuation, fund managers identify it as a challenge while closing a deal. In some economies like India, the competition among fund managers have led to an unjustified and inflated valuation of companies and businesses.
Shabda Gyawali, Investment Director at Dolma Impact Fund, says that valuation remains a challenge while making investment decision in any business or company in Nepal. “Valuation has remained a challenge during the deal making process in Nepal. We take valuation of another company from the same sector in Nepal. If it’s a new company, we take reference from the similar type of companies in India,” says Gyawali.
Fund leaders call for the standardisation of metrics of valuation of any business or company for equity investment. “If we talk to companies, particularly in the tech sector, their valuation is insane. They would compare their companies with the similar companies in India, Singapore or the US and seek excessive value without any base,” says Global Equity Fund’s Thapa. “We have to develop certain standards for the valuation and the specialized fund industry should agree on that,” he adds.