Tales Of Trade: Managing Agencies, India’s First Venture Capitalists

As late as in 1954, managing agencies accounted for 51 percent of the share capital of all companies.

A table and chairs sit inside a conference room on a floor. (Photographer: Daniel Acker/Bloomberg)
A table and chairs sit inside a conference room on a floor. (Photographer: Daniel Acker/Bloomberg)

This is a series based on The Stories of Indian Business Series: 10 Extraordinary Tales of Trade, published by Penguin Random House and edited by Gurcharan Das.

Goras and Desis: Managing Agencies and the Making of Corporate India

- By Omkar Goswami

The managing agency system evolved in the second quarter of the nineteenth century as an answer to the scarcity of venture capital, lack of trained managers, undeveloped capital markets and political uncertainty. Here is how the system worked: the managing agency was the entrepreneur; when it saw an opportunity, say a jute mill, it quickly raised venture capital from friends and partners of the managing agent or promoter, borrowing the rest from a bank; with this money the agency set up the jute mill; once it tasted some success with the mill, it sold its majority shareholding in the venture to the public; the proceeds were now invested in, let’s say, a tea garden. Meanwhile, the agency continued to manage the jute company, despite its small shareholding, as a result of a long-term management contract with the company.

In this way, a managing agency was able to control a number of enterprises with only a small financial stake in each.

It made the key managerial decisions on behalf of its operating companies about what products to make, what markets to seek and what raw materials to exploit.

A managing agency’s ability to raise capital from a bank or from the public was in direct proportion to its track record and reputation. It also had access to the reserves of its managed companies, which it employed to fund new enterprises or subsidize dividends of its less successful ones. The managed companies, in turn, benefitted from (1) the low costs of a lean, common management, (2) economies of scale in the purchase of common raw materials and (3) access to common marketing networks in the sale of products. The partners of the agency had a high appetite for entrepreneurship because they earned generous commissions, either as a percentage of sales (in the early years) or profits (later on), plus other fees and cuts on purchases and sales. Best of all, the managing agency was light-footed, nimble and free for much of its existence.

With all these advantages, managing agencies were quickly successful, and the innovative structure became popular both with British gora and Indian desi business communities; it went on to guide India’s entry into modern industry, trade and commercial agriculture over the next century and a half. By the First World War, managing agencies controlled 75 percent of the industrial capital of India and accounted for half the industrial employment.

As late as in 1954, managing agencies accounted for 51 percent of the share capital of all companies.

For centuries, business in India has been concentrated in the hands of trading communities, the vaishyas, who have run it as a family firm. Typically, the eldest male managed the organization with the help of other family members and the sympathetic support of his community.

Business families arose from the bazaar through trade and moneylending, and over time they were responsible for a number of outstanding trading and financial innovations— the hundi, a bill of exchange that facilitated mobile credit and long-distance remittance; the goladari, a warehouse receipt financing; fatka, a sophisticated trading system in the futures market; teji-mandi, a contract for put and call options; and in recent times, rotating savings-and-credit funds such as chits, nidhis and kuries.

The managing agency structure played to their strength as innovative financiers. It provided them a low-risk means to either buy existing weak industrial enterprises or start new ones. Once the colonial government extended a degree of protection after the First World War, they invested exuberantly their wartime profits in emerging industrial opportunities. Suddenly, they became proud industrialists. In the process, however, they skipped the long and hard learning curve of technological innovation that had brought the industrial revolution to the West.

They had not got their hands dirty on the shop floor; nor had they spent long hours in the laboratory to come up with a new product. Their approach was a practical one. Why reinvent the wheel when you can buy the latest technology?

As a result, the ethic of technological innovation has eluded Indian industry.

The managing agency system is partly responsible for this—it made it too easy for a trader/financier to transform into an industrialist.

Managing agencies also failed to separate ownership from control. As a result, they did not develop sufficient professional managers in their managed companies, which became uncompetitive over time. Even within their own managing agencies, they did not realize the power of functional expertise—they did not recruit enough technical specialists who could have solved technical problems across their managed companies.

The Indian managing agencies did overcome some of these flaws, but in the end, both the desi agencies and the British burra sahib agencies remained creatures of their own history. They failed to evolve with the times and did not fully capitalize on the opportunities that opened up in the twentieth century.

Mounting Corporate Governance Problems

Shareholders of both desi and gora enterprises began to grow restive after the 1920s, especially during the Depression and up to the Second World War. As markets became more competitive, their profitability declined, and so did the dividends to shareholders. Reports also appeared of unscrupulous managing agencies abusing their power to enrich themselves at the expense of shareholders in their managed companies. Some of the Ahmedabad and Bombay managing agencies attempted to reform managing agency contracts by moving from commissions on sales or production to commissions on profits, which helped to align the incentive system of the managing agency closer to that of the managed company.

- Edited excerpt from Gurcharan Das’ introduction to the book.

Watch Omkar Goswami, in conversation with Gurcharan Das, on the history of ‘managing agencies’ in corporate India.