The real crunch

Are we celebrating a ‘conspicuous paradox’? The Indian venture capital industry has been celebrating the increase in the number of deals, year after year. According to VCCEdge, 2012 saw $60 million being invested in 114 angel- and seed-stage deals, compared with $19 million in 65 deals in 2011. In 2013, 72 deals were already announced in the first quarter. Of this, 66% of the declared $140 million worth of investments was seed/angel-stage investments.

Over the years, the quantity of deals funded and capital invested have augmented the spirit of entrepreneurship. These numbers and activity around early-stage investments clearly indicate a vibrant and growing startup ecosystem. However, amid all the optimism, let us focus on one aspect that is required for entrepreneurs to hoist their business towards growth and success. Funding is definitely part of the answer, but there is more to it.

Though the total number of deals churned out of accelerators, incubators and angel networks is on the rise, a majority of them don’t make it to the next level of funding. According to NextBig- What, only 27% of seed-financed companies happen to raise the next round of funding. Of these, only 20% are successful in raising a Series A round. While trying to cross the chasm, slow- down (and eventual death) occurs owing to lack of timely capital and access to quality dedicated mentoring, trapping the majority of the funded startups into a worrisome Series A crunch.

Vibrant early-stage ecosystem with expanding gaps:

Starting 2006, India witnessed the emergence of a strong startup ecosystem supported by university incubators and VC funds. Over the years, accelerators and angel networks joined the bandwagon with different investment strategies and value propositions. Eventually, we also saw niche media players, exclusive entrepreneurial events and entrepreneurial education programmes adding more glamour and value to the ecosystem.

Though a variety of investment models emerged, each of them has its own limitations. The table on the next page gives an overview of the various early-stage investors in the ecosystem. Incubators, being research- and alumni-focused, provide only lab/office space and initial capital. Angel networks are good for very domain-specific businesses, where the entrepreneurs are fairly seasoned and already know what they want to do; however, they remain loosely coupled and dispersed to hand-hold entrepreneurs. Accelerators provide quick mentoring and drive momentum for startups to pace up to Series A funding. They may be effective for fast moving businesses — such as internet, mobility and cloud — but the model continues to struggle for consumer retail or medical technology companies. That message is getting mixed up in India.

India’s mortality rate for startups is 80%, which conveys that only 20% live through the cycle of evolution from the startup to the growth phase. Despite a growing VC ecosystem and ready-to-fund entrepreneurs, the question that alarms us is why do only a few startups graduate to Series A.

The tyranny of plenty?

Though there are many early-stage investors, each has its limitations, resulting in an 80% mortality rate for startups

A startup can only generate so much of organic revenue in a short duration of 18–24 months post the initial round of financing. They require capital on a continued basis to scale up into viable businesses. Clean and medical technology companies need longer gestation periods to make that leap. We have seen that the existing investment models are all constrained by either insufficient capital, time and/or by resource capabilities to graduate their portfolios to the next level. Hence, a number of startups remain orphaned.

This leap from their first cheque to the next is turning out to be arduous and time-consuming for startups. Though there are many VCs who are willing to invest in Series A ($3 million or more), not many angel/accelerator/incubator-funded startups make it to the finish line. VCs ready to fund Series A look for complete teams with domain knowledge, business model validation, clarity on market size and opportunity and customer traction. To achieve all of these, it costs more and takes much longer than what entrepreneurs think while pitching to angels or accelerators.

Sufficient seed funding backed by co-creation sup- port is the answer:

These gaps bring out the need for specific type of funds that can hand-hold the start-ups from their initial years of learning to sustenance until adulthood.Seed funds can achieve and fill gaps that arise out of other limitations by providing enough capital for a startup to sustain until Series A and mentoring the team by validating and refining their business model and achieving product or market fit to sail through the restraint path and achieve escape velocity. The co-creation chart illustrates the components of this model.

The inherent feature of a seed-stage fund to pump capital over multiple tranches adds value to a startup’s growth prospects. In transactions where a seed VC and a multi-stage VC partner up, the rate of follow-on investment is recorded to be as high as 59%. In addition to multiple tranches of funding, the co-creation model ensures a consistent and meaningful role in the business build-up, thereby ensuring a smoother ride for the startups to Series A and beyond