While The World Bets, India Loans: Why India Has Built a Startup Culture Without a Venture Capital Culture

India undoubtedly has one of the fastest-growing startup ecosystems in the world. However, one must stop and start asking the question of why almost 9 out of 10 startups fail in India. The answer would provide you with a typical checklist of bad unit economics, copied business models, and businesses that scaled and invested capital before finding adequate product-market fit. 

Illustration by The Geostrata

Every single reason is true, but it is not the primary reason. All these reasons are secondary. Beyond the mistakes of the founder lies the problem of how risk capital moves in the Indian economy. The way this capital moves is not even close to how it moves and develops the culture of successful startups in global benchmark models like the United States and Israel. 

INDIA INSTINCTIVELY DE-RISKS THE LENDER, NOT THE FOUNDER

Taking a look at what the Indian state has built over the past decade subscribes to the notion that the Indian capital system prioritises a lender and not a founder. MUDRA (Micro Units Development and Refinance Agency) loans, the Credit Guarantee Fund Trust for Micro and Small Enterprises, the Credit Guarantee scheme for Startups, Stand-up India, and PMEGP (Prime Minister's Employment Generation Programme) all point towards a singular reality.

These initiatives provide banks with government-backed guarantees so that they can lend without collateral or at least subsidise the interest rates on lending. This lending pattern is consistent across almost every government scheme.

The government continues to absorb downside risks for the lender, and the founder owes the principal amount regardless of how the business itself ends up performing.   

The policy is not bad across the board. It is a sensible structure if you have a small, cash-flow-positive business that cannot get credit from banks without collateral, mainly in the Micro, Small and Medium Enterprises (MSME) sector. However, it is nearly useless for a startup. A startup culture operates under the assumption that most startups will fail, but the culture will result in an ultimate net benefit, which is paid for by the minority of successful startups and not the failed startups in the sector.

A startup founder relies on equity-based funding from angel investment, venture capital, crowdfunding, etc because the obligation to repay does not exist even if the company dies. On the contrary, a debt scheme like the MUDRA scheme assumes the traditional financing logic of internal accruals and predictable and positive cash flow. India took the MSME toolkit in procurement quotas, guaranteed loans, and subsidised interest rates and imprinted it onto high-variance technology ventures.

Startup India was launched in 2016 as a positive move by the government with genuine ambition, and the number of startups registered in India increased from a few hundred to tens of thousands.

However, registration scale was never the real constraint in the Indian ecosystem; it was the scale of risk-absorbing capital. And after 10 years of Startup India, India has not been able to fix the latter. 

The evidence of the same lies in the angel-tax saga in India. For more than a decade, Section 56(2)(viib) of the Income Tax Act let authorities treat any share premium above a “fair market value” as taxable income. This meant that if a founder convinced an investor that the company was worth more than a government formula said it was, the tax applied could be on the belief itself. This applied only to resident investors till 2023, when it was further extended to foreign investors.

The provision was then abolished for all in the 2024 budget. For most of the startup boom, India was taxing the very act of pricing risk optimistically. This exact act is what a venture ecosystem depends on. The consequences were visible and concerning because domestic institutional money barely even showed up. Roughly 15% of the capital going into Indian startups in 2023 came from domestic sources, and the rest from abroad.

Pension funds, despite being the single largest pool of patient domestic capital in any economic framework, were allowed to put only a sliver of their surplus into venture funds at all. Indian Pension funds are forced into a strict safety-first approach. High-risk venture capital investments are largely restricted, and indirect exposure through Alternative Investment Funds (AIFs) is permitted only up to a minor fraction of the portfolio at around 5%. 

THE AMERICAN ACCIDENT

The American venture industry that exists today is the product of roughly 3 years of policy change in the late 1970s. Through 1978, the “prudent man” rule under ERISA was interpreted as allowing pension fund managers to only make very low-risk investments, which meant that, similarly to India today, the country’s largest pools of long-term capital were legally barred from venture funds.

In 1978, only $218 million went into new venture funds, and individuals rather than institutions supplied most of that money. A capital gains tax cut introduced around the same period did similar work on the more individual and founder side, making the payoff for taking the risk worth it after tax. 

These changes did not just unlock money; there was never a deficit of how much capital existed in the market. It unlocked a structural willingness to let capital into genuine equity and loss-tolerant investments. The culture of investors accepting that most investments would fail and return zero while a handful would indeed return fifty times added the incentive to the economy to form a venture capital culture that did not just tolerate risk; it anticipated and accepted it.

Adding to this was the bankruptcy regime; Chapter 11 of the American Bankruptcy Code allowed a business to pause debt payments, stay open, and fix its finances. It acted as a second chance for a business without a debt burden on it. The system, in this way, did not punish failure; it started to price it into the risk the investor was taking. 

TEL AVIV ACTED LIKE A VENTURE CAPITALIST BEFORE GETTING OUT OF THE WAY OF THE MARKET

Israel acts as a more instructive case for India, as it started from a more proximate position to where India was rather than America during the 1990s. Israeli entrepreneurs were rather suspicious of venture capital and relied heavily on debt capital from banks, which created a roadblock in the commercialisation of technically strong products. Unlike India, the government refused to invest money in a loan guarantee scheme.

Tel Aviv's answer was the Yozma Fund. This was a massive $100 million vehicle that, rather than loaning money out, put up 40% of the venture capital for new venture funds alongside private investors, with the government stake being buyable back at cost after a period of 5 years. Nine out of the ten Yozma-backed funds exercised the buyout option, and by the early 2000s, the entire Israeli venture capital market was private-sector-driven.

There was no direct government participation left in the market after this early nudge. Within a decade, the number of active venture funds went from one to roughly sixty, managing roughly $10 billion. Along with this, Israel’s ratio of VC Investment to GDP became the highest in the world. 

Three fundamental choices made this scheme work where a loan scheme would fail. Firstly, the government invested its funds as equity, absorbing the same downside a VC would. This meant that it would, in fact, have to behave like a venture capital fund rather than disbursing loans to anyone who showed interest.

Secondly, Tel Aviv deliberately imported foreign fund managers rather than taking a protectionist approach for domestic industries. This instinct is also the opposite of the route India took with the angel tax as it related to foreign inflows.

Thirdly, the subsidy in itself was a way to bring in more private investment rather than create a system that would crowd out private investors. The presence of the government de-risked only the asset class for private money and then exited quickly when the asset class could afford to stand on its own. 

WHAT DOES THIS COMPARISON MEAN FOR INDIA? 

The pattern is obvious when we compare the three approaches. America solved its capital supply problem by reclassifying venture investing as a legitimate destination for pension fund money. The Americans changed who was allowed to take the risks necessary for the economy to grow. Israel solved the same problem by having the government invest in genuine risk capital, then smoothly privatising the government out of the picture once the capital market matured.

Ultimately, both approaches agreed on one thing that India still has not agreed on. Both nations treated startup failures as an acceptable cost of how this system would form. This was because both systems agreed that the volume of outsized winners and the additional investment would ultimately pay for the loss and add more to the economy. 

India has been the opposite of that. India offered guarantees to lenders as opposed to the risk-takers who would grow the system. Only recently, with the abolition of the angel tax in 2024, SEBI easing AIF investment limits, and a new 10,000 crore rupee Fund of Funds 2.0 announced for 2026, has the government finally started to identify its programmes as an attempt to strengthen the venture capital ecosystem as opposed to being a substitute for a non-existent system. 

Whether the government’s moves work depends largely on how they are executed, much like the Yozma fund’s evaluation. If India adopts a genuine risk-taking approach with fund managers, the policy could indeed provide substantial benefits to India's growing startup economy. However, if the programme takes the shape of another guarantee scheme, this would not be the case. Ultimately, any government policy would require the government to accept that it should be ready to lose money on purpose, in the specific and very disciplined way venture capital operates. 

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BY KRISH

TEAM GEOSTRATA

info@thegeostrata.com