The world of alternative financing is a dynamic landscape where investment strategies and opportunities continually evolve. Two prominent pillars within this domain are Private Equity (PE) and Venture Capital (VC), each characterised by distinct attributes and roles.
In the context of Nepal, where traditional banking systems often limit the growth of innovative startups and small and medium-sized enterprises (SMEs), PE and VC firms have emerged as catalysts for positive change. These firms inject vital capital, mentorship, and expertise into the business ecosystem, spurring economic growth, job creation, and private investment. Recent regulatory frameworks like the Specialised Investment Fund (SIF) regulation introduced by the Securities Board of Nepal (Sebon) have created a favourable environment for PE and VC investments, paving the way for a transformative impact.
This article delves into the changing investment landscape in Nepal and explores the growth and impact of PE and VC investments in the country. It will also shed light on the regulatory developments that have shaped this sector, the key players driving its expansion, and the challenges and recommendations that could further unlock the potential of PE and VC in Nepal. Ultimately, PE and VC are not just investment strategies; they are forces that are reshaping Nepal's economic future.
Private Equity: Exploiting Mature Potential
Private Equity constitutes a form of investment that primarily concentrates on established companies with a track record of consistent operations and revenue generation. By channelling their investments into mature enterprises seeking expansion, restructuring, or operational enhancement, these firms acquire a substantial stake in a target company and actively participate in its management. The capacity to actively influence the course of target companies through PE investments offers avenues for sustainable growth and value generation.
Venture Capital: Fostering Innovation
In contrast, Venture Capital is a form of investment that specialises in early-stage startups and high-growth firms. VC firms extend funding to businesses in their nascent stages or those requiring capital infusions for scaling operations, product development, or market entry. VC investors typically refrain from active involvement in day-to-day management but offer valuable guidance and networking opportunities.
Private Equity and Venture Capital both provide essential capital to businesses, but they diverge in terms of strategies, risk profiles, and target companies. PE firms unlock the potential of mature enterprises, while VC firms nurture innovation and propel the growth of startups. Knowledge of these differences is critical for entrepreneurs seeking investment and investors aiming to diversify their portfolios. By recognizing the distinctive roles played by PE and VC in the business domain, stakeholders can make well-informed decisions within the ever-evolving landscape of alternative finance.
Current State of PE/VC
Private Equity and Venture Capital firms are critical to helping transform any country's economy. Their contribution is crucial particularly in creating the job opportunity, promoting the startup ecosystem, fuelling the technological transformation, building capacity of the entrepreneurs, and driving innovation and knowledge transfer in the economy. India in particular is benefited by PE and VC ecosystem through cross-border collaboration whereby majority of the FDI is routed through PE and VC platform. Nepal has struggled to provide alternative financing options, especially for innovative startups and SMEs, due to traditional banking systems that provide debt by collecting deposits from people and, in exchange, demand collateral and personal guarantees, hindering business growth. In contrast, PE and VC firms collect a pool of funds from investors, complete a rigorous due diligence process for potential companies, and finally proceed to provide crucial support by injecting capital, mentorship, and expertise into suitable companies that have high future prospects. This infusion of funds has already spurred success in Nepal, boosting economic growth, job creation, and private investment.
The introduction of regulatory frameworks like the Specialised Investment Fund (SIF) by the Securities Board of Nepal (Sebon) has opened up avenues for PE and VC investments, creating a favourable environment for investors and entrepreneurs. Furthermore, PE and VC firms provide capital and nurture innovation and growth by funding startups and high-potential firms, contributing significantly to the country's economic transformation. As Nepal's PE and VC sectors evolve, they will play a pivotal role in shaping the country's financial landscape and advancing economic prosperity.
Changing the Investment Landscape
Nepal's investment landscape is experiencing a transformation with the emergence of PE and VC firms. Since 2012, developments, such as the funding of logistics services provider Upaya by Nepal Infrastructures Investment Fund Limited (NIIF) and the $10 million investment agreement between Japan International Cooperation Agency (JICA) and Dolma Impact Fund II, have highlighted the growing interest in alternative and specialised investment opportunities in Nepal.
The growth of PE and VC investments in Nepal has expanded the horizons for entrepreneurs, especially small and medium-sized enterprises (SMEs) and startups. These forms of investment have become a lifeline for businesses seeking to scale up and innovate. Over the past decade, the PE/VC landscape in Nepal has enabled promising projects with seed capital to attract investors and fuel their growth. For example, Foodmandu, a local food delivery company, secured its first round of institutional funding (known as Series A funding) from local fund True North Associates, and Series B funding from Team Ventures and most recently secured Series C funding of $4 million from Dolma Impact Fund II. Foodmandu currently employs over 400 people and has partnerships with around 1,000 restaurants with rapid expansion plans into new geographies, adding new business verticals and enhancing its technology.
A study released by the Nepal Private Equity Association in 2023 highlighted that between 2012 and 2022, $66 million was invested in 15 sectors. According to the study, 46% of these funds were channelled into renewable energy and 23.6% into information technology (IT). This influx of capital has played a crucial role in the success of hydroelectric sector and various mid-level companies in Nepal, such as Foodmandu, SastoDeal, Incessant Rain, Sajilo Sewa, Dalle Restaurant, Fusemachines, CloudFactory, and Upaya City Cargo.
The growth of the PE/VC industry in Nepal received a significant boost in 2019 when Sebon introduced the Specialized Investment Fund Regulation. This regulation allows investment companies to mobilise funds for private equity and venture capital activities. Firms acting as fund managers and maintaining a minimum paid-up capital of Rs 20 million are eligible to mobilise funds in the domestic market. Under these rules, firms with a minimum fund size of Rs 150 million can obtain permission to mobilise alternative investments. Fund managers are required to hold a minimum of 2% stake in the fund with the anchor investment of 10% as a contribution capital from the fund sponsor.
Players in the PE/VC Scene
Nepal has more than a dozen institutional investment firms actively operating in the PE/VC sector. These firms can be categorised into three groups:
Local funds registered under the Company Act: Team Ventures, Kriti Venture Fund, Safal Ventures, Seed Investments, Tele Venture, True North Associates and many such companies are operating as investment companies to provide alternative finance. They operate under the Company Act and have been actively contributing towards the growth of the PE/VC ecosystem.
Local funds Registered at the Sebon: A total of 12 fund managers, including merchant banks, have received fund managers licence from the Sebon to start their operations following the introduction of the Specialized Investment Fund (SIF) Regulation. This regulation has facilitated the mobilisation of alternative investments in the domestic market.
Funds backed by Development Finance Institution (DFI): Institutions such as Business Oxygen (BO2) and Dolma Impact Fund receive backing from DFIs. BO2 is part of the Global SME Ventures initiative of the International Finance Corporation (IFC) and has attracted investments from the IFC, Climate Investment Funds (PPCR), and UK Aid's Department for International Development (DFID). Dolma Impact Fund II stands out with the largest investment portfolio in Nepal's PE/VC scene, investing in emerging companies across various sectors, including energy, healthcare, and technology. They have secured investments from international organisations like IFC, FMO, Finnfund and DFC. These DFIs prioritise investments that generate profit and have a positive societal impact.
Significant Challenges and Barriers
Despite the promising growth observed in Nepal's PE/VC sector, there are several hurdles and issues that need to be addressed effectively to unlock the industry's full potential such as refining regulations, reducing fees, improving taxation policies, and aligning with international best practices. These measures are critical steps towards overcoming these obstacles and realising the complete potential of private equity and venture capital investments in Nepal.
The Specialized Investment Fund (SIF) Regulation, although it has opened many avenues, has introduced significant challenges to the PE/VC sector. The regulations need to be refined to align with international standards and address potential conflicts with the Foreign Investment and Technology Transfer Act (FITTA) and the Income Tax Act. Regulatory costs imposed on fund managers by Sebon are considered excessive. Lower fees can encourage greater participation and attract new players.
Section 57 of the Income Tax Act is a potential obstacle for companies seeking PE/VC investments, as it states that a change in ownership exceeding 50% may result in loss carrying forward. Addressing these taxation issues is crucial for improving the investment climate. The minimum capital threshold for establishing onshore and local funds may discourage investment firms, and encouraging smaller funds could be vital for directing capital towards SMEs.
PE/VCs in Nepal have not only made new investments but have also successfully exited from companies in which they invested, such as Godawari International Pvt Ltd, Le Sherpa, Shanti Engineering, Dalle Restaurant, and The Lakeside Retreat and most recently Team Ventures partial exit from Foodmandu resulting in 2x returns in merely two years.
Fund managers emphasise that Nepal's financial resources are insufficient to meet capital demands, making specialised funds crucial for bridging the financing gap. However, they highlight the need for the government to make amendments to the number of acts to improve the investment climate and encourage additional alternative investments in startups and SME sectors.
The dynamic world of alternative finance is witnessing a transformative shift in Nepal, thanks to the pivotal role played by Private Equity (PE) and Venture Capital (VC) firms. These financial catalysts have emerged as beacons of hope for a country grappling with traditional banking systems that often impede the growth of startups and small and medium sized businesses. As we have explored the key characteristics of PE and VC, the regulatory developments, the major players, and the challenges faced by this sector in Nepal, it is clear that these investment strategies are not just about allocating funds; they are about shaping the future of Nepal's economy.
Private Equity, with its focus on mature companies and long-term value creation, has unlocked the potential of established enterprises, while Venture Capital has nurtured innovation and propelled the growth of early-stage startups. These two distinct yet complementary pillars have diversified investment opportunities in Nepal, creating a favourable environment for economic growth, job creation, and private investment. These firms are not only injecting capital but also actively supporting local startups, driving economic growth, and creating jobs.
The regulatory landscape, including the introduction of the Specialised Investment Fund (SIF) Regulation, has provided a significant boost to the PE/VC sector. However, challenges like regulatory refinement, taxation issues, and capital thresholds need to be addressed to fully harness the potential of this sector.
As Nepal continues on its journey of economic transformation, PE/VC will undoubtedly play pivotal roles in strengthening SMEs, attracting local private and international investment, and fostering innovation. This transformation is about providing financial support and simultaneously shaping Nepal's future prosperity and economic landscape.
(TEAM Ventures, is an industry-agnostic alternative investment firm with a diverse portfolio spanning the energy, technology, real-estate, manufacturing, financial institutions, agro-infrastructure, and electric-vehicles sectors.)