Early-stage investing in India

Early-stage investing in India took off in the late 1990s during the technology boom. All stakeholders in the startup ecosystem, including investors and entrepreneurs, were attempting to -- in the Indian context -- comprehend innovation, entrepreneurship and scale. Given the meltdown of the technology investing space in 2001, the boom was short-lived.

A couple of years later, the early-stage investing landscape was pretty barren, where both investors and entrepreneurs were few and far between. Additionally, early-stage funding is a very long game, where the average time to exit is around eight to nine years and where often early exits do not happen. Around the mid-2000s, “exit” was only a theoretical concept, with the investor community having minimal clarity on this important aspect of investments.

ALSO READ

[YS Learn] 8 key steps entrepreneurs need to write a great business plan

Exponential growth in early-stage investing

Given the void, it was difficult to visualise the huge leaps that the early-stage investing space has made over the subsequent decade. However, the Indian startup ecosystem has grown exponentially over the last few years, with both new-age entrepreneurs and venture capitalists mushrooming across the country.

The year 2019 was a peak for the early-stage investing ecosystem, where 50% of all startups received funding and nine startups joined the unicorn club and were publicly listed.

Early-stage investors poured in double the funds into the Indian startup ecosystem in 2019, with Bangalore and Mumbai continuing to constitute the largest part of the ecosystem. However, a majority of the investors believed that valuations in 2019 were higher than the intrinsic value of the startups being invested into and saw a correction coming up in 2020.

Today, angel investors and venture capitalists are seeking to invest in disruptive, innovative business ideas and models and are not restricted to investing in tried and tested business models. Investors are also increasingly comfortable with the idea of investing in startups that are in the pre-revenue stage with the hope of having the next big unicorn in their portfolio.

Looking at the demand side, initial investment amounts, as well as subsequent rounds, have increased substantially. A decade ago, the Indian startup ecosystem had less than 50 angel investors, whereas it boasts of angel investments from more than 2,000+ angel investors today.

On the supply side, while VC funds and angel investors have grown exponentially, there is only a select group of investors that invest in unproven startups, especially in the traditional brick-and-mortar space. However, once companies reach the early-growth stage, the entire landscape changes for startups.

A complementary partner to early-stage equity funds is venture debt funds. While equity is a great instrument for long-term funding needs, venture debt funds are ideal for short-term and time-bound funding requirements. These requirements could include working capital finance, bridge rounds, etc.

ALSO READ

A five-point advisory for all those planning to raise money for their ventures

Impact of the pandemic on early-stage investing

The pandemic has resulted in many changes in the early-stage investing ecosystem, resulting in short-term and long-term impact. Talking of short-term impact, early-stage businesses are in general, highly vulnerable to negative, extraneous factors.

Newly launched startups and business ideas that are seeking funding for the first time will be worst hit. Forward-thinking co-founders will ensure their startups will survive by reducing their expenditure and postponing long-term investments.

It is essential to know that VCs are not immune to the economic impact of the pandemic. Therefore, in adverse times, they make stringent decisions with regards to new investments based on requirements in the current portfolio and the fund raising scenario. Currently, early-stage investors are keen to invest in industries affected by COVID-19, including healthcare, edtech, fintech, food delivery and remote work solutions.

Companies in the travel segment and hospitality sectors have seen a decline in investments. Also, with a sudden revision in the foreign direct investment policy, funding coming in from Chinese VCs will see a sudden pause.

Indian startups and investors are hoping that the government will think through alternate solutions to this policy to ensure there is ample foreign funding for investments at the early-stage deals.   

Current early-stage investing landscape

Today, early-stage investors find themselves navigating market developments and understanding the effect of the pandemic in India and globally, which will eventually influence their investment decisions. The founding team’s background, skillsets and vision, along with a differentiated business model, are the most important attributes that early-stage investors are looking for while making their investment decisions. The biggest red flags are products/services that serve niche markets, or the lack of a product-market fit.

VCs are meeting potential founders and making investment decisions remotely, which is leading to stagnation in investment activity.

The fall in investment activity is likely to remain for the next quarter or two because of the various modifications that angel investors and VCs have had to make, including a revamp of their investment strategy and the change in funding requirements of existing portfolio companies.

For early-stage startups, while there is funding available for innovative business models, founders must re-examine their strategy, business model and immediate funding requirements.