The user’s guide to early-stage fundraising

The user’s guide to early-stage fundraising

Over the last decade, the early-stage funding environment has dramatically changed. There are now myriad financing options that founders can consider as they look to build their companies. Nearly 70,000 companies received funding through angel networks and 3,000 through venture capital firms annually, according to CB Insights.

On the most recent episode of Ventured, we spoke with Qasar Younis, Chief Operating Officer of Y Combinator (YC), about the early-stage funding landscape and how entrepreneurs can best navigate the waters of raising capital today. Here are some takeaways from our discussion

Benefit from more accessible investors

The startup ecosystem is more sophisticated than ever before because of global availability to startup resources and new types of funding sources. With platforms like AngelList and Indiegogo, access to early capital has dramatically improved. Investors like Y Combinator (YC) and KPCB have continued to increase funding accessibility for founders regardless of location. Programs such as KPCB Fellows or KPCB Edge target entrepreneurs earlier in their careers while the YC Fellows Program and the YC College Tour seek to educate new entrepreneurs on how they can begin their journeys as founders.

Consider all funding options before tapping VCs

There are roughly four ways to get funding for your startup. Understanding your funding options and thinking critically about each path is crucial to your success — and is often overlooked.

Bootstrapping: This is how the majority of companies are funded today. The benefits here are that you retain maximum ownership of your company. However, this may not be sustainable as your capital requirements grow.

Incubators & Accelerators: If you are a first-time entrepreneur, it can oftentimes be helpful to join an incubator or accelerator to get your business going. While there’s a variety of these that exist today, most usually provide mentoring, content and a small amount of capital.

Online Platforms: There are a number of funding platforms available online. As a founder you can utilize these to get a sense of demand for your product, find angel investors from across the globe and get feedback on your company.

Venture Capital: While some founders may jump straight to venture capitalists, most usually reach this step later in the life of their companies. By utilizing the options, or a combination of options outlined above, you can prove more out as a founder prior to meeting investors.

Don’t worry too much about today’s macro environment

While the current economic environment has been fluctuating over concerns of global growth and European solidarity, early-stage founders should not panic. The macro-funding environment does not necessarily constitute a barrier to achieving success. Oftentimes, downturns provide unique opportunities for entrepreneurs to succeed because it’s harder for competitors to raise capital, and talent is usually cheaper to hire. For instance, more than half of the companies on the Fortune 500 list in 2009 were started during recessions or bear markets, as well as almost half of the firms on the Inc. list of America’s fastest-growing companies in 2008. In the most recent economic turmoil of 2009, both WhatsApp and Square were started.

Great companies are founded irrespective of a boom or bust. Startups are a test of will and determination and as a result are often on a seven- to 10-year time horizon, if not longer.

Stay focused on customers and users

While many entrepreneurs don’t realize it, they may be going through the motions and simply doing things that look and feel like work but aren’t actually creating value that will ensure long-term success. Two areas that highlight this gap are customers and product fit, or making stuff that people really want. Not enough entrepreneurs truly understand their customers, especially in the early days, even though that understanding will help dictate product and roadmap decisions. Similarly, founders need to be able to explain why customers actually want the product they are creating, since that insight will help drive almost any business forward.

Know that VCs invest in people, not pitch decks

Although we evaluate certain metrics that help us gain conviction about a particular company, we often invest in the intangibles — the things that are hard to get across on paper. We find ourselves asking questions like how do the founders work with each other, how do they communicate, what do they know that no one else knows and how are they uniquely positioned to solve this unique problem? Having conviction about the team beyond quantifiable growth or user metrics is a major driver for how we decide to invest in companies.

Global Investment Banking Review H1 16 - some big losers

Global Investment Banking Fees Total US$37.1 billion; Slowest First Half for IB Fees since 2009; Americas and Europe Decline 26%

Fees for global Investment Banking services, from M&A advisory to capital markets underwriting, totaled US$37.1 billion during the first half of 2016, a 23% decrease over last year at this time and the slowest first six months for fees since 2012. Fees in the Americas totaled US$19.9 billion, down 26% compared to the first half of 2015 while fees in Europe also decreased 26% and Asia Pacific fees decreased 10%. Fees in Japan decreased 19% compared to a year ago, while fees in Middle East/Africa also decreased 19% compared to first half 2015 levels.

JP Morgan Takes Top Spot for Global Investment Banking Fees; Top 10 Firms Register Combined Wallet Share Loss of 2.2 Points

JP Morgan topped the global investment banking league table during the first half of 2016 with US$2.6 billion in fees, or 7.0% of overall wallet-share. Goldman Sachs booked US$2.4 billion in fees during the first half of 2016 for second place, while Bank of America Merrill Lynch moved into third place from fourth a year ago. The composition of the top ten banks remained unchanged, with seven firms moving rank position compared to a year ago. Within the top 10, Goldman Sachs and Deutsche Bank saw the steepest wallet share declines with losses of 0.7 and 0.6 wallet share points, respectively.

Consumer Staples IB Fees Register 23% Increase; Healthcare and Telecom Fees Post Steepest Declines

Investment banking activity in the financials, energy & power, industrials and technology sectors accounted for 58% of the global fee pool during first half 2016. JP Morgan topped the fee rankings in six sectors during the half, with double-digit wallet-share in the technology and telecom sectors. Fees from deal making in the consumer staples sector increased 23% compared to a year ago with Bank of America Merrill Lynch commanding 9.0% of all fees booked in the sector during the first half. Healthcare and telecom fees registered the steepest percentage declines this half, down 49% and 42%, respectively.

Financial Sponsor-related Fees Down 40%; Carlyle Group, Barclays Tops Financial Sponsor Fee Rankings

Investment banking fees generated by financial sponsors and their portfolio companies reached $3.9 billion during the first half of 2016, a decrease of 40% compared to 2015. Fees generated from leveraged buyouts accounted for 29% of financial sponsor-related fees during the half, while ECM exits accounted for 10% and M&A exits comprised 23% of overall fees. The Carlyle Group and related entities generated $222 million in investment banking fees this year, down 1% compared to the first half of 2015, while Barclays collected an industry-leading 7.0% of financial sponsor-related fees during the first half.

IPOs Pull Equity Capital Markets Fees Down 43%; Debt Capital Markets Fees Down 11%, while M&A Fees Decline 15%

Dragged down by a 57% decrease in fees from IPOs, equity capital markets underwriting fees totaled US$7.3 billion during first half 2016, down 43% from a year ago. Fees from debt capital markets underwriting totaled US$11.4 billion, down 11% compared to last year's tally and accounted for 31% of overall IB fees during the first half of 2016. M&A advisory fees totaled US$11.5 billion during first half 2016, a decline of 15% compared to the same period last year, and accounted for 31% of the global fee pool, while fees from syndicated loans decreased 24% compared to the first half of 2015.

Turn of the screw

Ultra-low interest rates are slowly squeezing Germany’s banks

BANKS the world over are groaning under the burden of low, even negative, interest rates. The gripes from Germany are among the loudest. In March, when the European Central Bank cut its main lending rate to zero and its deposit rate to -0.4%, the head of the savings banks’ association called the policy “dangerous”. At the co-operative banks’ annual conference this month, a Bundesbank official earned loud applause just for not being from the ECB.

Germany’s banking system comprises three “pillars”. In the private-sector column, Deutsche Bank, the country’s biggest, expects no profit this year. That is mainly because of its investment-banking woes, but low interest rates have also weighed it down: it wants to sell Postbank, a retail operation it took over in 2010. Commerzbank, ranked second, specialises in serving the Mittelstand, Germany’s battalion of family-owned firms. It has felt the interest-rate squeeze even more. Analysts at Morgan Stanley place it among the worst-hit of Europe’s listed lenders.

Most Germans, however, entrust their savings to the other two pillars. One includes 409 savings banks (Sparkassen), mostly municipally owned; the other, 1,021 co-operatives. These conservative, mainly small, local banks are the most vocal complainers—even though at first blush they have little to moan about. Savings banks’ combined earnings declined only slightly last year, to €4.6 billion ($5.1 billion) from €4.8 billion in 2014. Deposits and loans grew; mortgages soared by 23.3%. Capital cushions are reassuringly plump: their tier-1 ratio rose from 14.5% in 2014 to 14.8%. Co-ops had a similar story to tell. But trouble is brewing.

The ECB has flattened long-term rates as well as short ones, by buying public-sector bonds and, starting this month, corporate debt. Ten-year German government-bond yields are near zero—and recently dipped below, thanks in part to markets’ fears about this week’s Brexit referendum. For banks, this means ever thinner margins from taking in short-term deposits and making longer-term loans—from which, says McKinsey, a consulting firm, German banks earn 70% of their revenue.

Lenders have been well insulated so far, because most loans on their books were made when interest rates were higher: 80% of loans last longer than five years. Rising bond prices (the corollary of falling rates) have provided further padding as banks’ portfolios gain in value: that effect alone has brought the savings banks €19.4 billion over the past five years. But as old loans mature, they are being replaced by new ones at today’s ultra-low rates. The mortgage boom is thus a mixed blessing: rates are typically fixed for ten years or more.

With no increase in ECB rates in sight, the screw is tightening. Half of the 1,500 banks surveyed by the Bundesbank last year—before the latest rate cuts—expected net interest income to fall by at least 20% by 2019. Although banks would prefer higher rates, too sudden an increase would also be awkward, pressuring them to pay more for deposits while locked into loans at rock-bottom rates.

Banks are seeking ways to alleviate the pain. Commerzbank is charging big companies for deposits, above thresholds negotiated case by case. (It is also reported to be pondering stashing cash in vaults rather than be charged by the ECB.) Bankers warn of an end to free personal current accounts. But with so many banks to choose from, scope for raising fees is limited.

Selling investment products and advice seems more promising; and commission income has risen, as some savers seek out higher returns. Yet low rates have made many Germans, already a cautious lot, even less adventurous. They are stuffing more, not less, into the bank—but into instant-access accounts: with rates so low they may as well keep cash on hand.

Low rates are not banks’ only worry. Both bankers and politicians vehemently oppose a proposed deposit-insurance scheme for the euro zone: the savings banks and co-ops have always looked out for each other, and don’t see why they should insure Greeks and Italians, too. Smaller institutions complain about an increase in regulation since the financial crisis—even though they weathered the storm far better than many larger ones. The savings banks’ association claims that red tape costs its members 10% of earnings—and some as much as 20%.

Another concern is the march of technology. Germans have been slow to take up digital banking, but their banks—reliant on simple deposits and loans, and still carrying the costs of dense branch networks—are vulnerable to digital competition nonetheless. Number26, a Berlin startup, has signed up over 200,000 customers across Europe for its smartphone-based current account within months. The savings banks plan to hit back this year with Yomo, a smartphone app aimed at young adults.

McKinsey reckons that low rates, regulation and digitisation together could cut German banks’ return on equity from an already wretched 4% in 2013 to -2% within a few years if they do nothing in response. The pressure is starting to tell. This month the Sparkasse Köln-Bonn, one of the biggest savings banks, said it would close 22 of its 106 branches. Some rural banks have replaced branches with buses.

All this is likely to thin the crowded ranks of Germany’s lenders. Consolidation has been under way for decades: since 1999 the number of co-ops has fallen by half; on August 1st their two remaining “central” banks, DZ Bank and WGZ Bank, which provide co-ops with wholesale and investment-banking services, are to join forces. The pace of mergers has steadied in recent years. Negative rates may speed it up again.

‘Food business is a sunrise industry with head space for everyone’

VL RAJESH, Divisional Chief Executive, ITC Foods

ITC Foods is perhaps one of the youngest multi-brand food companies in the domestic FMCG space. ITC as a group expects a major chunk of its 1 lakh crore target from its non-tobacco business to come from its foods’ business by 2030. In an interview with BusinessLine, VL Rajesh, Divisional Chief Executive, shares his growth strategy as well as his views on the controversies surrounding the industry and about Patanjali.

Which products in your portfolio will see maximum growth?

Our growth will come from two places: the bulk of the growth will come from the core. We have 13 different product verticals and 10 brands. We have about 200 products which we plan to increase it to 300 by 2020. The rest will come from the new variants, new products which we are launching now. The last 14 months have seen three new launches. We also have region- specific brands which we will nationalise. Last financial year, we crossed $1-billion-mark though we would have liked to grow at a faster clip. Right now, we are growing at low double digit rate which for us is not good, but for most others in the industry it will be quite acceptable.

Will at some point of time, ITC Foods get into milk and bread categories?

Well, you see we are not going to say no to anything but not in the immediate future. We can get into every food product. We have a responsibility towards our stakeholders. We will get into large categories which has the potential to grow at a later stage.

Patanjali has been making quite a splash in the industry. How big a threat is it for players like you?

See, the impact is not much. We are not present in certain categories they are in like toothpaste and they have a range of ayurvedic products. So, their positioning is different. But like ours, it is a home-grown brand and we will be happy if they grow too. The foods space is a sunrise industry for a long time to come. Everything is getting branded. There is enormous head space for everyone.

It is over a year now since the Maggi Noodles controversy broke out. As a competitor, how have you fared since then?

The controversy hit the industry very hard. The industry actually collapsed. As per certain industry reports, a ₹320-crore per month market fell to ₹56 crore per month. But since then, we have come back fast because of the unique campaign we ran which allowed any consumer to ask any questions regarding the issue and we answered each one of them. Our share, which was at about 15 per cent, is now growing at 25 per cent. But the industry is still to recover. It is as per independent industry reports now at ₹240 crore per month.

Looking back what exactly went wrong?

The interpretation changed but the law did not change. But, since then, there has been a great clarity from the regulatory side and lot of work has been done to streamline the process. We kept ourselves completely open to scrutiny. One must understand that MSG (monosodium glutamate) is there even in mother’s milk. This is what makes the child drink milk. Most do not add MSG. When you do lab tests, it cannot differentiate between naturally occurring MSG and what has been added. It is important to verify the tests and you have to do it repeatedly to get the right results.

If you look at the controversies surrounding the foods business, right from noodles to bread, you wonder whether branding has really helped.

In the food business, unlike any other businesses, we can do all the right stuff, but the moment you put it in your mouth, you get to know whether you want to have another helping or not. It is a very harsh business. As far as our quality is concerned, our research centre is perhaps the best kept secret. We have over 80 PhDs working in the centre, which is over 2.5 lakh sq ft. They deliver cutting edge products as well as test our products. So, what we claim is what you get. We must realise that when a consumer buys a food product, there is implicit assumption that it is safe and that should not be violated because of the unregulated industry. If the branded industry grows, it is good for the consumer and for the government as well as more of them to get into the tax net.

Soumya Rajan: ‘I look at family offices as patient capital’

SOUMYA RAJAN, MD & CEO, Waterfield Advisors

Family office capital, unlike a fund, has an investment horizon stretching to 15 years

As the number of high-net-worth and ultra-high-net-worth families grows, many advisors are now involved with setting up family offices to cater to the complex needs of these families. Globally, it is estimated that there are around 4,000-5,000 family offices, of which only 3-5 per cent are housed in Asia-Pacific, suggesting a significant growth potential over the next five to 10 years. Soumya Rajan, MD & CEO, Waterfield Advisors, an India-focused boutique multi-family office, shares her views on how family offices are making a difference to the way UHNIs manage their wealth.

Can you give a brief on how family offices operate?

The family office space is for ultra high net worth family segments. They look at the needs of families in a holistic manner. Unlike banks and other financial institutions that provide only investment guidance, family offices also advice on business succession, investing the liquidity generated by them and on legacy and philanthropy.

Banks do not typically cater to these areas, neither do they look at the sensitivities around company structures, shareholding pattern, differentiating between ownership and management, when it comes to succession.

So, what is the profile of your clients? Are they all from business families?

The profile is mainly family-owned businesses in the ultra high networth space, typically with investible surplus of over $60 million.

They would have operating companies that could be holding a stake in other businesses or could be interested in buying ancillary businesses. We manage around ₹9,000 crore of assets under advisory and this covers roughly 20 families.

We have two lines of business; one is the family-office business and the other is the corporate advisory business. Corporate advisory is also important because for many clients; liquidity is created because of what happens on the corporate side.

Many of them don’t want to go to investment banks right at the outset as the information is sometimes quite sensitive.

So, we hold discussions with the families in terms of the structuring or the restructuring they want to do and the investment bank comes in at a later stage.

Because once the deal enters the investment bank territory, it is information in public domain. The families we deal with are also in the listed space, so sensitive information needs to be dealt with care.

How are the investments managed? Is it on discretionary or non-discretionary terms?

It is completely non-discretionary. We are registered with SEBI as investment advisors because we believe that this is the only way you can avoid a conflict of interest with the client.

Our business model is predicated on the fee that we receive from the client. That’s the way things are expected to move forward too.

Many regulations that have come out from SEBI recently are aiming to make investors adapt to the fee-based advisory model rather than the commission-based one. They have stated that investment advisors will be a separate category.

Then they introduced the concept of two different NAVs for mutual funds; in the direct one, distributors are not involved. Recently SEBI has asked for disclosures on the commissions that are being paid to distributors.

All this is to move towards greater transparency and the advisory model is in tandem with this drive. Ultimately, what it does is to lower the cost of investment for the family; particularly if you are dealing with large corpuses, even 50 basis points can make a large difference to the returns. Ultimately, the distribution cost comes from the returns.

What are the asset classes that you recommend as investments to your clients?

We advise across assets classes that include equity, fixed income, real estate and alternative asset class. We see a growing interest of family offices in the alternative assets space due to the evolving eco-system in the venture capital and private equity side.

Many families are already looking at angel investment, seed investment, and so on, to participate in the start-up ecosystem. Allocation to this asset class has grown from 2-3 per cent to around 15 per cent now.

This is a very long-term and illiquid asset class. I look at family offices as patient capital because unlike a fund that has to exit an investment in five or seven years, family office capital is more long-term oriented, with investment horizon stretching to 15 years or even longer.

Since there is no re-investment risk in this space, family offices are allocating more to start-ups.

They use two routes to invest in this space; one, through fund managers with good track record, or by directly investing in unlisted companies. A group of families could come together to invest in these companies or it could be a single family making the investment.

So, do you help them with valuing an unlisted company?

We do. We help them do the due diligence and value the company. That is covered by our corporate advisory team.

Do you advise the families to churn their portfolios often based on your perception regarding the prospects of various asset classes?

The family office segment generally follows a ‘buy and hold’ strategy. They do not move their portfolios around much. They review their asset allocation strategy once a year, typically in April, taking the macro economic conditions into consideration. This is typically not changed unless there is a significant economic event that warrants a change. They are quite disciplined with their investments and the portfolios are tailored keeping in mind exposure risk and concentration risk as well.

What is the view on real estate investments among UHNIs now, given that price appreciation is hard to come by?

We are seeing a little bit of unwinding of real estate positions of many families. They have made big money over a certain period of time. They are not making any fresh investments in real estate. Most new investments are going into equities or five-year debt. My sense is that once there is a real estate regulator in place, money could flow into real estate again.

India Weekly Market Updates from 25th June to 1st July 2016

India Market Weekly

Economy

·      RBI Governor on Thursday called on Finance Minister as the central bank and the government seek to quickly put in place a broad-based 6-member panel — the Monetary Policy Committee (MPC) which is being set up to decide on lending rates instead of the present practice of RBI Governor taking a call in this regard. MPC will set interest rates by a majority, with a casting vote for the governor in the case of a tie. Out of the six members of MPC, three will be from RBI — the Governor, who will be the ex-officio chairman, a deputy Governor and an executive director. The other three members will be appointed by the government on recommendations of a search-cum-selection committee, which will be headed by the Cabinet Secretary. http://goo.gl/mx94xc

·        Large part of banks' bad loans result of fraud: CAG  http://goo.gl/3Le7UM

·     The World Bank Thursday committed USD 1 billion to support solar energy programme in India, which is reducing dependence on conventional energy sources to reduce greenhouse gas emissions. http://goo.gl/VxLKdR

·         The tax department Thursday notified rules for calculating fair market value of assets located in India in case of indirect transfer by multi-national companies for the purpose of levying tax. http://goo.gl/2Oz7jH

·         The central government on Thursday asked the Odisha government to expedite the process for mines auction, an official said. http://goo.gl/KG5L1B

·         The stressed assets problem affecting the banking sector is still not over and the menace will continue for some more time, SBI chief Arundhati Bhattacharya said today.  "In terms of asset quality, I did not say 2016-17 will be a lot better. In fact, I said there could be pains as well because the numbers we have taken are basically on the fund- based part but the non-fund based part also gets converted subsequent to classification," SBI Chairman Bhattacharya told reporters after the AGM of the bank. http://goo.gl/hRdw6g

·         Owing to policy measures taken by the government, India has improved in global rankings in terms of transparency in real estate sector in Asia Pacific, says a report. http://goo.gl/KgAi6E

·         India telecom market to face ‘massive’ tariff erosion post Jio entry: Sunil Mittal http://goo.gl/LwrVXu

·         The government is mulling an additional Rs 25,000 crore allocation to roads, railways and power sectors over and above the allocation made to them in the Union Budget, potentially providing a mid-year boost to public spending. http://goo.gl/xiujOM

·         Cabinet approves rise in salaries, pension for government employees http://goo.gl/NfRULL

·         Centre clears a move that makes 24x7 malls, movie theatres, eating joints a reality http://goo.gl/H0sjrn

·         Government asks LIC to fund road expansion projects http://goo.gl/j8A7k5

·         World Bank chief Jim Yong Kim said that Reserve Bank of India Governor Raghuram Rajan's decision to not take a second term at the bank will not affect the Indian economy http://goo.gl/LFaSB9

·         Output of India's core industries declined in May after five consecutive months of rise, official data showed on Thursday http://goo.gl/rx55Pu

Corporates

·         DLF promoters to make the company debt-free by infusing Rs 10,000 crore http://goo.gl/LcPXiR

·         Hit by a fire incident at one of its key vendors, Maruti Suzuki India reported 13.9 per cent in total sales in June at 98,840 units as against 1,14,756 in June 2015.  Hyundai Motor India Ltd (HMIL) on Friday said its domestic sales in the month of June grew 9.7 per cent to 39,806 units.  Ashok Leyland Ltd closed last month with a volume growth of seven per cent, the company said on Friday. Eicher Motors Ltd. closed last month with 36 per cent growth in sales volumes
Equitas Holdings Ltd. on Friday said it had got the final licence from the Reserve Bank of India to start operations as small finance bank. http://goo.gl/GfdPeS
Indian Oil Corp (IOC) has cut the price of transport fuel effective on Friday by under a rupee each, of petrol by 89 paise a litre and of diesel by 49 paise

·         Reliance Defence gets Reserve Bank nod to exit CDR http://goo.gl/7snjB3

·        Dairy major GCMMF, which markets milk and dairy products under Amul brand , will invest Rs 3,000 crore over the next four years on its expansion plans.     http://goo.gl/P6bCQI

 
Global events

·         China bank PSBC files for 2016's biggest IPO http://goo.gl/6CFBQs

·        EU decides to block itself as a single market to UK: Europe had made it "crystal clear" that access to the European single market remained contingent on accepting its four principles of free movement - applying to goods, services, capital, and people. "There will be no single market access 'a la carte'," European Council President Donald Tusk Angela Merkel, meanwhile, rejected the idea of treaty change or reform in light of the UK's referendum, saying voters would rather see results - not debate - from Brussels. http://goo.gl/tFRcgq

Politics

·         Modi cabinet reshuffle likely in first week of July, poll-bound UP may get more say http://goo.gl/4vA8Or

·         Government feels it has got numbers in Rajya Sabha to move GST Bill http://goo.gl/Yg26Dv

·         Amid a fresh controversy over its legal validity, the one-man Justice S.N. Dhingra Commission of Inquiry set up by the Haryana government to probe controversial land deals in Gurgaon district has sought extension of time for six weeks to submit its report, state government sources said on Thursday. 

·         Three-year tenure for RBI governor is short, says Raghuram Rajan. On Thursday he pitched for a longer tenure for the central bank head, saying the global practice has to be emulated in India as well. http://goo.gl/9ekNft

LIC-led NBFC may offer up to Rs1 trillion credit guarantee

State-run insurer Life Insurance Corp. of India or LIC will structure its credit guarantee company in a manner that will allow it to guarantee infrastructure projects worth Rs.50,000 crore to Rs.1 trillion, said two people familiar with the development.

The credit guarantee firm, which will be set up as a non-banking financial company (NBFC), is part of the government’s plan to aid infrastructure projects by speeding up the flow of funds to the sector. In his Union budget speech in February, finance minister Arun Jaitley said that LIC will set up a dedicated fund to provide credit enhancement to infrastructure projects. The proposal is now starting to get fleshed out.

LIC will hold a 15-20% promoter stake in the proposed NBFC while the rest of the equity in the company would be offered to large foreign funds, domestic insurers and institutional investors, said the two people cited above.

“LIC will hold 15-20% stake or more if allowed by the insurance regulator and the government. Rest of the stake may be held by other public sector insurance companies, domestic financial institutions and global investors,” said one of the people cited above. “Discussions are on and the company should start by September this year,” this person added while requesting anonymity as talks are confidential.

An email sent to LIC on Monday seeking details remained unanswered.

The NBFC will provide credit guarantees to large infrastructure projects, especially those launched by the central and state governments in the road and power sectors.

A well-capitalized credit guarantor would be a good initiative, said Ananda Bhoumik, managing director and chief analytical officer, India Ratings and Research Pvt. Ltd.

“LIC itself is a large investor in the infrastructure space so it will be well-acquainted with the business. Once the product offerings from LIC’s credit guarantee fund start coming in, all credit rating agencies will have to evaluate the risks and help the market understand them in the context of credit guarantee and the structure of the model,” Bhoumik said.

A credit guarantee from an LIC sponsored firm will help bump up the rating of a infrastructure project in return for a fee. This could be particularly helpful for infrastructure projects in the post-completion phase when they can use an enhanced credit rating to raise cheaper funds from the market. These funds can then replace more expensive bank loans taken during construction.

“Throughout the construction period the entire funding is typically from banks, but post the construction if there is a credit enhancement their bonds will be upgraded to AA and it will be easier for them to get funding from the market so that they can free up the bank capital channel again and bring in more lending to develop their other projects,” Bhoumik said.

While bond investors typically want to invest in instruments rated AA and above, most infrastructure projects have ratings no better than BBB.

The LIC-led NBFC, which is likely to be headed by a finance ministry official, will begin with a seed capital of Rs.500-1,000 crore. If the amount of seed capital is high, the company will be in a position to provide a larger quantum of guarantees. Typically, the amount of guarantee offered by a credit guarantee fund or company is linked to the capital base of the entity and pre-determined number of times that the equity capital can be leveraged.

LIC will be the first contributor to the NBFC’s initial seed capital for its new unit, said the first person.

According to Pawan Agrawal, chief analytical officer, Crisil Ratings, the launch of credit enhancement fund will be an important step.

“Usually, the infrastructure projects even after completion are rated in the A or BBB category, primarily due to their highly leveraged nature, and low liquidity cushion. The credit enhancement fund can act as a bridge to enhance the ratings of these infrastructure projects, and enable their access to the bond markets,” Agrawal said.

“This also addresses an important identified need in the Indian market to increase the variety of credit enhancement providers, which can take the first loss risk, thereby providing credit enhancement. This credit enhancement fund, once operationalized, will address this need,” Agrawal added.

The talks between the government and LIC to set up the NBFC are in advanced stages. The government is likely to approach the Reserve Bank of India (RBI) for an NBFC licence in the next few weeks so that the company starts operations latest by September.

The proposed entity will not only provide credit guarantees but also may raise funds for infrastructure projects by issuing bonds at a later stage, the second person said.

To be sure, this is not the first time the government is attempting to use a credit guarantee model to help ease funding constraints faced by infrastructure firms.

At present, the government, through its wholly owned company India Infrastructure Finance Co. Ltd (IIFCL), provides partial credit guarantee facilities to infrastructure companies.

A partial credit guarantee is one which supports only a part of the project cost.

LIC will now join IIFCL in the credit guarantee business.

“It is a good business for LIC. We will prefer to fund only large, viable government-backed infrastructure projects. On a seed capital of Rs.500-1000 crore, the NBFC will be able to provide guarantees to projects costing up to Rs.50,000 crore-Rs.1 trillion,” said the first person cited above.

“LIC will charge fees for providing credit guarantee and unless the project fails in some rare event due to any unforeseen circumstances, the fees earned through credit guarantee will remain as a profit for the NBFC,” this person added.

With assets of around Rs.20 trillion, LIC is the largest and the only state-run life insurer in India. LIC Housing Finance Ltd and LIC Mutual Fund currently its two main subsidiaries.