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What’s driving early-stage investment in India

Radhika P Nair
29th Aug 2017
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2015’s funding frenzy may have been followed by a funding freeze in 2016, but investments look like they’re back on track. This year, startups have raised $11.2 billion, with investors picking India-specific companies in sectors like healthcare, finance, logistics, education and retail. Dig deeper, though, and the numbers tell a different story.

Indian e-commerce leader Flipkart wrapping up a record ~$4 billion in funding fed the news cycle for days. But it wasn’t the only one in the limelight this year. BYJU’s, the nine-year-old online tutoring startup, has raised over $170 million in funding since March 2016, not to mention an undisclosed round from Tencent Holdings last month. In May, Acko, a general insurance company registered last year, announced a $30 million seed round of funding—one of the largest seed deals in the Indian startup ecosystem. Larger seed rounds, bigger late-stage deals and companies raising big rounds of funding in quick succession seem to be the new trends. It’s a far cry from last year’s gloom-and-doom scenario when close to 1,000 startups, including those who had raised funding, shut shop.

Combine this with the fact that companies have raised $11.2 billion in funding in 2017 to date (compared to just $4.9 billion in 2016 and $8.6 billion in 2015) and it would seem that the startup ecosystem in India is in for good times once more.

But look a bit closer and the picture is a little different. Just 10 companies accounted for 80 percent of the deal value in 2017 until August (see Graphic 1). All the other deals put together totalled just $2.3 billion. At the same time, VC firms have raised fresh funds in the past couple of years—smack in the middle of the downturn (see Graphic 2). According to the Grant Thornton Fourth Wheel Report 2017, as of December 2016 India-focused investors were sitting on dry powder worth about $25 billion. It does not seem to matter that India lags not only the US but also China by a long distance. YourStory spoke to a handful of India-focused early-stage investors, especially those who raised new funds in 2016, to understand what the investment climate is like, at least based on their sentiment. And we discovered a few rather interesting trends.


A strong macro story

India’s macro story remains strong. The market, across sectors, is showing growth. India’s GDP grew by 7.1 percent in FY 2016-17, making it the fastest growing large economy in the world. Growth has been almost uniform across categories.

This is also true of segments that new-age startups are focused on, right from e-commerce to fintech. Online retailing, an industry that has seen massive startup activity, actually grew slower in 2016 compared to previous years, but still clocked 12 percent growth year-on-year. The digital payments sector in India is estimated to grow to $500 billion by 2020, according to advisory firm PwC in 2017, up from roughly $50 billion last year, and representing around 15 percent of GDP in 2020.

T C Meenakshisundaram (aka TCM), Founder and Managing Director of IDG Ventures India, says:

If you look at the ratio of funding to the economy’s size, it is much smaller compared to the US market. There are still very few VCs focused on India. Some that existed a few years ago are not around now. But the market opportunity is growing and so is the investment opportunity.”

IDG, an investor in Flipkart, raised a $200 million fund in 2016.


A large, mobile-first economy

The macro growth story is further boosted by the fact that India has clearly become a mobile-first economy, where, as TCM says, the adoption of new technology among the youth is unprecedented. This view is echoed by Rahul Chowdhri, Founding Partner at Stellaris Venture Partners.

India is still far behind compared to global markets in the area of value created by tech. In US, public tech companies have over $2 trillion market capital; in China, it is $600 billion. In India, public and private combined, the market cap is about $35 billion. That shows there is scope for growth as India is not a small GDP economy. This is the piece that excites us—the journey from $35 billion to $500 billion,” says Rahul, who was earlier Partner at VC firm Helion Venture Partners.

Stellaris, according to Rahul, will invest in around 25 companies in the Series A or pre-Series A stages, with an investment contribution of $1 million. They are raising a $100 million fund.

Driving their optimism are the opportunities that Indian companies are waiting to tap. “Since India is an open market we know that an Uber or an Amazon will capture some of this value, but we feel a number of new Indian companies will also capitalise on this opportunity,” says Rahul.

A better quality of startups

While India definitely enjoys a demographic dividend—according to 2011 Census about 41 percent of India’s population is below the age of 20—the average startup entrepreneur is quite unlike the popular belief that s/he is an inexperienced, just-out-of-college youngster. In fact, the average Indian startup founder comes armed with industry experience.

A study by Kalaari Capital (Disclosure: Kalaari Capital is an investor in YourStory) found that Indian startup founders, on average, have around a decade’s work experience.

Anecdotal experiences show that increasingly, it is individuals with more relevant experience who are starting up. Further, with the Indian startup ecosystem maturing, a number of new founders are those who have been employees at older startups. For instance, over 200 startups have been founded by former Flipkart employees alone, giving them the borrowed label of ‘the Flipkart mafia’.

“We see over 150 startups a month and all of them are of good quality. Many are started by people with some startup experience who have seen both sides—startups raising easy funding and then the tough times,” Rahul says. Karthik Reddy, Co-founder and Managing Partner at Blume Ventures, which focuses on early-stage investments, agrees.

The number of quality founding teams is increasing dramatically. But quality in percentages won't go up as dramatically – more youngsters will be motivated but it takes time for them to learn how tough it is,” explains Karthik.

Rationality in venture investing

What stood out in 2015, when a number of “hyperlocal” startups raised funding, was the clear lack of differentiation. Each company seemed to have a business model similar to the next, and yet many investors backed a number of young and unproven ‘me-too’ startups. That frenzy is missing this time around.

“There is a marked rationality in venture investing. Investors remain bullish. What has gone is the frenzy in investing when founders were opportunistically trying to raise funds. It was more of a spray-and-pray approach,” says Raja Lahiri, Partner (Transaction Advisory Services) at accounting and advisory services firm Grant Thornton.

This new approach could well explain the $2.3 billion deal value of 2017 to date if the top 10 investments were taken off the list. The general sentiment, though, seems to be one that markets call ‘cautious optimism’.

TCM of IDG, for instance, says his fund will continue investing at a similar pace as last year when they deployed a record amount of capital at $40 million. is good, (the) willingness to invest is there, but the bar has gone up after every correction. Investment sentiment improves when the mess has been cleaned up, which could be in the form of companies shutting down or improving business metrics. I think we are there; more investors are comfortable investing now,” TCM says.

Trickle-down stability

The mammoth amounts of fundraising by top new-age companies like Flipkart, Paytm and Ola has also had a positive domino effect down the chain to early stage investors and startups. Karthik of Blume says: “The settling down of the big boys' fates – Flipkart, Snapdeal, Paytm and Ola – and the renewed confidence in the next generation of rising stars have helped.”

Investors also feel the funding stress of the past year had a character-building effect on entrepreneurs.

“It [funding crunch] was good for the market overall. I don't think a lot of entrepreneurs in the last six to seven years had seen tough times. With less capital you are more margin-focused. When capital is constrained you become more innovative,” Rahul says.


The rise of angels

A dearth of angel and seed investments was seen as one of the biggest challenges for Indian entrepreneurs as recently as 2012. That has changed, especially in the last couple of years, with the rise of entrepreneur-angels. Entrepreneurs like Sachin Banal and Binny Bansal of Flipkart, Kunal Bahl and Rohit Bansal of Snapdeal, Vijay Shekhar Sharma of Paytm, Girish Mathrubootham of Freshworks, Anupam Mittal of Shaadi.com and Manav Garg of Eka Software are some prominent entrepreneurs who are active angel investors.

Veterans from older technology companies and even those from traditional industry have donned the angel investor hat. Infosys founders like Nandan Nilekeni and Kris Gopalakrishnan and former senior executives like TV Mohandas Pai (Disclosure: T V Mohandas Pai is an investor in YourStory) have been active angel investors for a few years now. Ratan Tata, the most prolific angel investor of the past couple of years, has made over 40 angel investments since 2016.

Rahul of Stellaris says: “Successful founders are backing high-quality new entrepreneurs. That is a change that has happened in the last four to five years.”

In fact, Stellaris, which has announced three investments so far this year, has created a Founders Network of about 50 entrepreneurs, senior executives and fund managers. These individuals have invested in the fund, help with the due-diligence process and sometimes co-invest.

Growth pangs remain a challenge

Series B and C rounds have never been easy to come by in India (except in 2015, when over 130 Series B deals and 35 Series C deals were signed). The number plummeted to 53 and 16, respectively in 2016. This year, a slight recovery seems under way with 35 Series B deals and eight Series C deals in H1 2017.

“It's always tough to raise Series B and C. One has to understand that post-money valuations for such companies are $30-50 million for a B and $50-100 million for a C round. This means investor exit expectations are in the $250-$500 million range. This is tough to visualise sometimes and investors pause,” Karthik says.

What’s more, there are fewer India-based funds that focus on just growth funding than international ones. As Rahul points out, “The challenge in the Indian ecosystem around five years back was that there were no investors at the early and later stages and just about 10 VCs, who focused on the Series A stage. Now there are a lot more investors in the seed and angel stages but no pure Series B and C funds. Only global ones primarily.”

TCM doesn’t feel that’s a big challenge. He says even with few India-based funds focused on late-stage investments, there is no dearth of available capital from global funds that are willing to invest.

A company might think they are Series B-ready, but the investor might not. At the time of fundraising (Series A), the founder plans that at a certain phase they will raise next round of money, but if there is a correction then that changes. This has happened recently. Also, there are many instances where an entrepreneur wants a specific valuation and so has not taken the next round,” TCM says.

Clear market leaders in each category have not faced any problems raising follow-on capital. Ready-to-cook Indian food startup ID Fresh Food, which raised $25 million in Series B in March 2017 from Premji Invest, is an example. The same is true in the Series C stage. Hospitality brand OYO Rooms snapped up $250 million this year.

The trouble is if the startup is not the clear market leader. “Fund flow can increase when reliance on foreign-only capital reduces at B and C. Some alternatives are emerging with new India-centric managers like Iron Pillar, Epic and Premji Invest but are still far and few between,” Karthik says.

This clear gap has resulted in the launch of a few funds that are focused on the growth stage of investments. Iron Pillar, launched in 2016 by former Citibank India Head of M&A and tech investment banking Sameer Nath and Morgan Creek’s Asia former Business Head Anand Prasanna, is targeting a fund of over $30 million that will invest only in the growth stages. Iron Pillar is also raising a Mauritius-based fund that will add around $70 million to the total corpus. Former Infosys CEO Nandan Nilekeni and Helion Venture Partners’ Co-founder Sanjeev Aggarwal launched a $100 million growth-stage-focused VC firm, Fundamentum Partnership, in July.

Dry-Powder-story-4
Infographics by Anisha Tulika

Wide sectoral spread

Investors aver that the opportunity is present across all big sectors from finance to healthcare. Startups that will raise funding in the early stage, they believe, will be those that are using technology, especially new tech like AI and Machine Learning, to disrupt these sectors.

But one of the common complaints about the Indian ecosystem has been that cutting-edge technology has not come out of the country. But what Indian entrepreneurs are doing increasingly is to build applications or tweak new technology to fit Indian requirements.

Either way, IDG’s TCM says he expects continuous disruption in healthtech and fintech. “Digital health, where technology is helping and not replacing existing diagnostic methodology, is of great interest to us. We are seeing many interesting AI-led healthcare companies like SigTuple. They are solving real problems with new technology,” TCM says.

Fintech remains a darling of the investors. While Paytm with its $1.4 billion fund raise has dominated the category, many smaller fintech and financial services firms have also attracted capital. Digital lending startup Capital Float raised $45 million in a Series C round in August.

Our overall thesis is (to) invest in companies solving India problems. We are interested in companies that are targeting large markets—healthcare, finance, logistics, education and retail. We need to see long-term defensibility as well. India specificity is important—others can still disrupt but this gives you an edge,” says Rahul.

The consensus, then, is that the India opportunity is so large that disruptive companies will emerge. Investors just need to keep their eyes and ears open so that the right company does not slip past them.




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