An investor's take on the state of the Indian startup ecosystem in 2018 and trends to watch in 2019


IdeaSpring Capital Founder Naganand Doraswamy gives an investor's perspective on the year that was for the Indian startup ecosystem and the trends he expects will dominate in 2019.  

The year 2018 was a watershed one for the Indian startup ecosystem. Flipkart’s acquisition – the biggest in ecommerce globally – renewed investor confidence in late-stage startups. In fact, more than 30 Indian startups bagged funding in excess of $100 million this year, with Swiggy closing $1 billion in a single round towards the end of the year. Several of these late-stage startups – backed by large funding rounds – ventured into overseas markets.

While investments may have remained biased towards B2C startups (OYO: $1 billion; BYJU’s: $540 million, Paytm Mall: $450 million), let’s not forget that B2B companies like Udaan ($275 million) and Pine Labs ($207 million) were also among those that raised the biggest funding rounds.

When we as an investor speak to founders these days, we see so much confidence and customer orientation. The entrepreneurs are also bolder these days. They are very confident about taking their products to the world. The quality of their ideas and pitches has also vastly improved.

One of the entrepreneurs we were talking to is making trips to China to get more traction for the platform he is building. A company in which we are an investor was part of an incubator in Europe. A few companies are part of Y-Combinator early on. You can’t get into these places without a world-class story. One other startup we know of is taking a bold step to work in the satellite space competing against larger players. These are big positives for the eco-system.

A year in review for the Indian startup ecosystem

And yet, in our conversations with fellow investors this year, many are questioning the large cheques that have been doled out to a few startups. Also, we feel there are still some understanding gaps when it comes to profitability. Many startups that started with offering discounts six, eight or even 10 years ago are still doing that to acquire and retain customers; this certainly puts question marks on future profitability. It is not the lack of understanding, but how the ecosystem, in general, is addressing it - investors and VCs included.

Here, we think the Uber IPO will be an important barometer. If it does well, the trend may catch up. If it does not, the entire paradigm will be questioned. Many people we talk to in our circles are not sure if this is sustainable. However, this is one of those places where the market has to speak in the end!

Most of our investments at IdeaSpring Capital have SaaS models. One of our portfolio companies successfully migrated all their on-prem licenses in India to SaaS. This is a great achievement and an indication of where enterprises are moving. All investments in the software space need to have a SaaS story these days, else it will just not work. You may need both on-prem and SaaS models, but you can’t get away without a SaaS strategy.

It’s tough to build a scaleable, completely India-focussed B2B product startup. Hence we focus on investing in startups with B2B2C startups as they can reach a large audience. In one of our latest investments, we took such a bet as we believe its solution can service a majority of India’s population.

Also, selling to large enterprises in the US from India is tough. When you work on a product for large enterprises, you typically spend a year to two working closely with the customer on the product market fit. Hence, it is difficult for startups in India to address this space. However, selling to the mid-market in the US is easier if you have the right product-market fit. Sales cycles are shorter, and SaaS models work very well. Hence our focus has been on product innovation focussed startups addressing the mid-market enterprise segment in the US.

In the product innovation space, pre-Series A and Series A funding rounds are still a cause for worry. At these stages, most startups have a product with a reasonable product-market fit, but there are still a lot of questions to be answered. What we need is a lot more funds to take the risk to nurture product innovation in India. Pre-series A and Series A are all about collaboration between funds. In this space, you typically see India funds collaborating. In larger Series A and Series B and beyond, you see a lot of foreign funds as the quantum of the money is large.

Also read: Naganand Doraswamy on his journey from techie to entrepreneur and now investor

For investments in product innovation, we have realised that the money raised in the seed round should get a startup some customer traction. Pre-series A/Series A investment in product innovation space requires customer traction too. Hence, we have to be very careful in the kind of investments we make. We need companies to at least have a prototype. Once we have a few exits in the ecosystem, we expect this to change.

Exits are also still a big problem. While Flipkart is often quoted, it is an outlier as India still does not have a strong M&A culture. For funds to raising money from LPs outside India is still a big problem. That’s because the ecosystem has not exhibited strong enough returns. Also, the money invested in Indian startups is predominantly foreign capital. We need a lot more Indian capital flowing into the ecosystem through corporations, the government and family offices.

What to look forward to in 2019

The year 2019 will be very interesting, and as an investor, we feel the following are some of the key areas to watch out for.

  1. How Indian B2C startups, that have ventured overseas, will establish themselves in foreign markets.
  2. Expansion of the market by startups to address the next 500 million Indian customers will be tested in 2019. The trends are good, but what remains to be seen is whether revenues catch up.
  3. Investments in AgriTech, Logistics, and HealthTech will see an uptick. Industrial IoT is another area that may see an uptick in investment.
  4. Although investors in the US are shying away from SaaS, India will see success in the mid-market segment.
  5. Exits will remain important, but may still see some challenges.

All in all, 2019 will definitely be exciting for the startup ecosystem. The foundation is built – what needs to be seen is how we build on it.