While a flurry of growth-to-late stage startups in India have raised massive funding rounds that turned over a dozen of them into unicorns since the beginning of 2021, investments in early-stage companies that were passionately favored by venture capital firms last year seem to be declining.
According to the data collated by research firm Venture Intelligence, the number of early-stage deals came down to 86 in Q1 2021 from 144 in Q4 2020 and 117 in Q1 2020. Moreover, there were only 28 such deals last month, down from 42 in January 2021.
Despite the slowdown in small-sized investment deals, the VC community believes these deals will bounce back. As per a recent report by InnoVen Capital India, almost 74% of investors expect that this year the funding activity in early-stage companies will remain at the same level or higher than last year. That means, making up for the lesser volume in the first few months, early-stage funding is likely to gain momentum in the second half of the year.
But beyond the ups and downs in the deal volume and deal value for the early-stage investments, there are signs that the early-stage startup ecosystem is maturing in India, according to investors that KrASIA spoke to.
For instance, many new startups are waiting for the right time to raise money instead of jumping on any investment opportunity that comes across.
“A lot of founders are coming to the market to raise money a little later than they did before,” said Anirudh A Damani, managing partner, Artha Venture Fund. “Many founders are looking for the right moment to go to market.”
Damani believes that the cost of starting a company has come down significantly as there is no longer a requirement of having an office space or hiring full-time workers. “People are working out of their homes and opting for Amazon Web Services and Azure that would give them thousands of dollars in credits to get started and set up their systems,” he said. “Many are bootstrapping their ventures from their own pockets or with the support of their family and friends. So they are not seeking institutional funding to get started and approaching investors much later in their journey.”
“Founders are asking me: at what revenue run rate should they go to the market [to raise money],” he said. “I believe that in many ways, we are getting more mature founders coming to the market. A lot of these founders are either professionals with several years of work experience or are second or third-time entrepreneurs.”
For instance, a professional networking platform for blue and grey collar workers Apna, which raised a total of USD 82.5 million across Series A and Series B this year from investors like Sequoia and Tiger Global, was founded in 2019 by third-time entrepreneur Nirmit Parikh. Similarly, Mensa Brands, a newly launched venture by former Myntra CEO and Medlife co-founder Ananth Narayanan to build a house of consumer brands, landed USD 50 million check in May 2021.
Pranav Pai, founding partner, 3one4 Capital, believes that aside from serial entrepreneurs, highly experienced and talented people are entering the startup ecosystem since last year, which has improved the quality of founders in the country.
“As some of India’s largest startups head for IPOs, a lot of talented and high-quality people are leaving to start their own ventures. So they are reentering the startup ecosystem as founders,” said Pai. According to him, this trend is quite similar to what happened in China eight to ten years ago. “For instance, when Alibaba had its IPO, a lot of trained professionals and domain experts came back to the ecosystem, which led to accelerated value creation.”
“These professionals are coming with more experience and domain expertise. Their understanding of business models, growth strategies, and the domain knowledge—it’s all higher quality,” he added.
Thus the founder pool in the market at present—the repeat founders and former professionals who have led operations at big startups—have raised the bar for the entire startup community.
Maturing early-stage startup ecosystem
Since last year, the number of new startups being set up has increased manifolds. For context, in 2019, India added over 1,300 new startups. However, in 2020—amid the COVID-19 pandemic—around 7,000 companies were formed, according to a recent report by the Indian Venture Capital and Private Equity Association (IVCA) and Bain & Company. These startups primarily cater to the changing needs of consumers and businesses amidst the health crisis.
Pai believes a lot of new companies are being set up as the massive digital adoption in the country has “accelerated the expansion of the total addressable market across sectors” and “further opened up new niches in markets like education, digital health, and social media.”
Subsequently, the number of small value deals grew significantly in 2020—almost 500 deals were worth less than USD 5 million in value compared to about 390 in 2019, the IVCA-Bain report noted. Although this year, the early-stage funding activity dipped as growth-to-late stage startups scaled massively and became the darling of investors.
Read this: Micro VCs emerge as new force to foster Indian early-stage startups
Damani feels that while financing may not be as high in the early stage, the funding deals are much more interesting than before. “Instead of raising seed or idea stage money, many startups are approaching investors when they are already generating some revenues, and they need money to grow.”
“So there is an actual need and business model behind what is getting funded, which is a good thing for the ecosystem because it means these startups have much better chances of survival,” Damani added. According to him, this represents maturity in the ecosystem.
Pai agrees. “There are many more capable founders now. More VCs are competing for the same deals. Similarly, startups are competing by pursuing the same business models and markets,” Pai said. “These are the signs of the ecosystem maturing.”
Capital, competition, and category creators
The IVCA-Bain report observed that India-focused dry powder has remained stable over the last four years, ending 2020 at USD 6 billion. Moreover, with the number of IPO-bound startups increasing, a lot of money is being returned to investors in pre-IPO rounds that are giving exits to early backers.
“A good portion of this capital will be reinvested into the startup ecosystem, so there will be higher availability of capital for new companies,” Pai said.
However, despite the capital being there, not many newly formed startups are able to raise money. For context, among the 7,000 startups that were created last year, there were a mere 178 seed investment deals, as per the InnoVen report cited above.
That is because, with the increasing quality of founders and startups being set up, investors have become “a lot more selective” in who they want to work with. This also means that investors often end up picking experienced founders over rookie entrepreneurs.
“The market is changing in the sense that investors are more cautious about funding ventures that do not have a solid revenue model,” said Damani.
Interestingly, there is a higher amount of risk capital going into startups that are pursuing new business models and markets altogether, according to Pai. This is in stark contrast to how local startups used to build their empires—by bringing in and replicating the business models of successful startups in the US and China.
Read this: VCs pump USD 7.8 billion into Indian startups in the first four months of 2021
“Investors are more aggressive about opportunities where the market is not yet established, or still early, so that they may participate in the creation of category leaders,” Pai explained. He added that creating a new category is a difficult process as it needs a “high-quality team, domain expertise, and significant capital” to build these business models, invest in growing the market, and educate consumers to create awareness.
“A good example is online gourmet protein [online meat delivery] startup Licious. Before Licious, there was no other company pursuing direct-to-consumer farm to fork protein. It created the category and emerged as the market leader,” said Pai, who is an investor in the company. “Another example is Koo, which is now attempting to build for the opening up of the social media space.”
Although there are bigger, global competitors, one-year-old Koo is addressing the needs of regional language users and thus creating a new alternative for Indian users, Pai added. Another category creator is Cred, a reward-based platform for credit card bill payments that was founded in 2018 and became a unicorn earlier this year.
“Cred has created a valuable niche targeting prime retail consumers on the back of credit card and rental payments,” said Pai.
At the end of the day, as a number of factors come together—quality founders with domain knowledge expertise, expanding total addressable market, increased availability of risk capital, better business models, and new category creators—the Indian early-stage startup ecosystem is slowly evolving, paving the way for more local ventures to survive and, eventually, thrive.
