After the lull in 2016, it’s been raining deals for the Indian VC industry. There is renewed confidence. Over the past two years, Indian start-ups have received nearly $26 billion in funding across sectors. This year not only saw gangbuster exits but also saw eight start-ups join the much coveted Unicorn club. With nearly 7,700 start-ups, India now boasts of having the third-largest start-up ecosystem and most number of Unicorns after the US and China. Such euphoria was last witnessed in 2014-15, but that came crumbling down, thanks to blown-up numbers and overvaluation as investors threw money at just about anything as the fear of missing out gripped them. The current optimism would have you believe that it is going to be different this time, but will it?

In 2018, total funding shot up 108% compared to the same period last year (till September) according to Nasscom. Early-stage deals went up by 4%, but the momentum was more evident in late-stage where funding went up by a whopping 259%. But the headline wasn’t always this rosy. Exits have been bit of a problem for India-focused VC funds, dragging down their overall performance compared with their global peers. The situation is slowly changing now. In 2018, exits are up nearly 6x over the past year, according to data from Venture Intelligence.

While the $16-billion Walmart -Flipkart deal did skew the numbers, it came as a relief, after a choppy season in which Flipkart itself saw a fall in valuation. Its competitor Snapdeal, another Unicorn, had fallen by the wayside. The landmark deal showed it was not only possible to create internet businesses of scale in India but also generate significant return for its investors. “Thanks to this mega transaction, now the exit scenario is far better. Other Unicorns such as Paytm, Oyo and Byju’s too have given good exits through secondary sales,” says Arun Natarajan, founder, Venture Intelligence. “A good thing this year has been the frequency of exits and multiple funds returning capital to their investors,” notes Karan Mohla, partner, IDG Ventures India (since rebranded as Chiratae Ventures). While IDG Ventures India was among the beneficiaries of the Walmart-Flipkart deal, larger investors such as Tiger Global, Accel India, SoftBank and Naspers, raked in big gains. Accel reaped 6.88x its investment of $160 million, Tiger Global 4x on $1 billion, SoftBank 1.58x on $2.5 billion and Naspers 3.57x on $616 million.

Come join the party

The improving metrics and maturing ecosystem is attracting new investors. Silicon Valley is no longer all-powerful for funds beyond Series B, says Natarajan. “Earlier, every time Silicon Valley went through a crisis, Indian VCs would be affected too. But because of the Chinese and Japanese, the US ecosystem doesn’t impact Indian start-ups as much. The pioneers from Silicon Valley are still important, but they are not the only game in town. Alibaba, Tencent and Softbank obviously are the guys who are calling the shots, at least at this point. The likes of Tiger Global have taken a backseat in the past two to three years,” he says. But, the Flipkart exit may have revived Tiger’s interest too. After the stellar exit, Tiger Global raised $3.75 billion for its private market investments and is looking to increase its investments in India. 

The American fund could be back in the game but, on the secondary side, the Japanese and the Chinese have been the high rollers. Data from Tracxn shows that Chinese retailer Alibaba group, which entered the market during the peak in 2015, has so far pumped in $2.2 billion into five companies — Paytm, Paytm Mall, Snapdeal, Xpressbees and BigBasket — across just eight deals. The biggest beneficiary has been One97 Communications. This parent company of Paytm and Paytm Mall offered enviable exits to earlier investors such as Reliance Venture Asset Management, Saama Capital and Sapphire Ventures. Two months after Alibaba’s splurge, the company got its biggest cheque ($1.4 billion) from Softbank’s Vision Fund. Paytm was valued at $7 billion in May 2017 and it was Softbank’s biggest investment till date in India. But more was yet to come. 

In August 2017, Flipkart collected an even bigger cheque — $1.5 billion — from Softbank. Over the past five years, Softbank has flushed the system with $9.03 billion in 26 deals (Softbank Investment, Softbank Ventures and Softbank Group combined). During the same period, Chinese internet giant Tencent Holdings made 13 investments that cumulatively came to a little more than a third of that – at $3.38 billion with Flipkart being one of its biggest investments. The Chinese conglomerate made its biggest investment of $1.4 billion in the e-tailer in April 2017.

While Tencent refused to participate in the story, a spokesperson from Softbank said, “We are very excited by the vast potential that India offers and are committed for the long term.” The Japanese conglomerate invested in Flipkart after it failed to merge the e-tailer with another of its marquee investee Snapdeal. When Walmart acquired Flipkart, Softbank exited with 4x return in less than a year. After reporting a loss of nearly $1.4 billion in May 2017, Softbank saw its operating profit increase 49% due to the Flipkart exit and its Oyo investment doubling in the latest valuation round.

Softbank may be the big kahuna from Japan but the Chinese aren’t far behind. “Most of the Chinese money we have seen so far is coming from strategic investors or corporate VC — Ant Financial is associated with Alibaba and Shunwei to Xiaomi. Pure financial VCs may be the next wave, but we haven’t seen too many of them yet,” says Natarajan. “Among the Japanese, after Softbank, there have been at least 15 to 20 financial VCs such as M&A Capital Partners and Rebright Partners. So, for the Chinese, the focus is strategic while, for the Japanese, it is purely financial,” he adds.

Karthik Reddy, co-founder, Blume Ventures says, “For the past 15 to 18 months, we have had Chinese participation in five Series A in our portfolio. In 2016, it was zero. Therefore, the participation is happening even in early stage,” he says. Most of these firms are listed, funding their investments with public money. Blume, which has raised $130 million since January 2013, has invested in 93 companies and exited from 25. Its initial strategy was to invest in a wide range of start-ups but exits from few of its portfolio companies such as Adepto, Gharpay, SKoolshop, Karmic Labs and Moneysights proved to be below par. Therefore, when moving from its first fund to the second, it tweaked its strategy and decided to buy bigger stakes in fewer companies.

Mutual handshake

Besides secondary sales and acquisitions, the pipeline of IPOs such as Nazara Technologies, which is expected to raise 10 billion, would bring more momentum to the industry according to Mohla. IDG Ventures India’s portfolio company Newgen listed this January raising 4.25 billion. However, Rajesh Raju of Kalaari Capital is not very optimistic about IPOs. He says, mergers and acquisitions (M&A) would remain the predominant exit route, followed by secondary sales to larger funds. “For early-stage investors like us, those are the predominant exit options. IPOs are very, very rare,” he emphasizes. He adds, “I don’t see that improving dramatically in the future. In India, both institutional and retail investors in the public markets, have little understanding of the digital companies.” That has largely been the case with more than 90% of the exits in 2018 happening through acquisitions with about 40% of those acquisitions being made by Indian start-ups.

Lack of IPOs there may be, but that does not seem to bother many. “High-networth individuals or angels or venture funds are seeing great exits since there are a lot of secondary transactions,” says Ranjan Pai, co-founder, Aarin Capital. In 2016, Aarin had made a killing from selling 6-7% stake in Byju’s to Lightspeed Venture Partners for 1.5 billion. In its previous round of funding, led by Tencent, in July 2017, it was valued at around $800 million and now it is in talks with investors including General Atlantic to raise over $200 million, valuing the company at $3.5 billion.

Coming of age

This frenetic activity is attracting newer players such as New York-based private equity firm Stripes Group, New York boutique venture capital firm Harmony Partners, LA-based consumer focused venture fund Velos Partners and Singapore-based VC fund RB Investments. Does this rush signify the coming of age for the Indian VC industry? Mukul Singhal, who left SAIF Partners to found Pravega Ventures, notes that the market in 2006-07 stood around $50 million-60 million. But today, that figure comes to about $8 billion-9 billion. “As an industry, we have seen two to three business cycles. There are also far more players, compared with five years ago. Even at the Series C or D level, there are many bigger funds,” he says.

That said VCs can’t outright ensure a bumper payout every time. “2014-15 was a boom year, 2016-17 was downhill and 2018 again up,” says Natarajan. “There is volatility in this market. VCs that ride this volatility well, in terms of timing their exits, emerge winners. This is different from the US, where you invest the money, wait for five years and then exit via an IPO.”  Since the return generated by funds on exits and those earned by LPs are often disclosed in the US, assets under management and the ability to raise multiple funds is often see as a proxy for their performance. “Here, success will be defined by how much return on capital you generate. For that, staying focused on exits is the key,” adds Mohla. Data from Venture Intelligence shows that over the past five years, his firm has raised $420 million through three funds, invested in 69 start-ups and exited 17.

Raju of Kalaari sees signs of maturity across the industry — from entrepreneurs and investors to LPs. “Everybody is learning and finding their feet. Supply and demand mismatches, which lead to hype cycles, will slowly get moderated,” he says. Kalaari has raised nearly $290 million since 2013 and invested in 67 companies with 18 exits to its credit. Starting its journey in 2006, Kalaari Capital has so far raised $650 million across three funds and Raju says the strategy of their firm has not changed much since its beginning. “The primary focus, other than e-commerce, has been fintech. In addition, we have done a few healthtech and digital-content investments,” he says. Their marquee investments include Airpay, Creditvidya, Signzy, CureFit and Truweight.

The third round is the touchstone, according to Ganapathy Venugopal, CEO at Axilor Ventures. He says that most “vintage funds” are in their third round, which world over is the time by which the real performance of a fund gets clear. “The first and second fund, by now, would have started delivering return,” he says. Some of the largest funds raised serious money this year. In August, Sequoia closed its sixth fund at $695 million for India and Southeast Asia. Sequoia now has around $3.9 billion worth of assets under management making it the largest VC fund in India. Matrix Partners whose marquee investments include Ola, Quikr and Treebo raised $300 million for its third India fund this year while Nexus raised $313 million, about 70% of its target corpus of $450 million, as per the filing with US regulator SEC.

In-house capital

While Indian-focused VCs with a track record are finding it easier to raise money overseas, domestic rupee capital is on the rise. Some of these include 021 Capital, founded by Sailesh Tulshan, who has been the wealth manager for Binny Bansal and Sachin Bansal; Montane Ventures backed by Ajay Piramal; Arthavida Ventures; MTR Seed Fund, Equanimity Investments, Unit-E Ventures and Bharat Fund. Raising rupee capital is good for VCs on various counts. For one, they needn’t have to worry about currency-exchange volatility. Two, most of the domestic LPs are entrepreneurs themselves so they understand the challenges involved in scaling up a business in India. HNIs and family offices, too, have decided to grab a slice of the start-up pie. This has given several first-time funds a chance and provided follow-up funds the fuel to continue investing. Reddy of Blume says while LPs continue to support their existing relationships, they are less likely to give additional money to new funds in India. That’s where domestic capital comes to the rescue of the first-time funds.

Venture debt also has got a leg-up from this new breed. Take the case of Axilor Ventures and Aarin Capital, both of which are proprietary capital firms of high networth individuals, or Sixth Sense Ventures, which has family offices and HNIs among its funders. Mohla of IDG says, “This trend of domestic capital is a lot more stable. It is a lot deeper, in the sense that it understands the market.” Natarajan adds, “Even a big fund such as IDG is looking at domestic sources for about 50% of their capital. Most of the funds today, whether it is Blume Ventures or India Quotient, especially the seed-capital variety, are considering foreign money as an afterthought. For the new managers today, domestic capital is a clear option, which did not exist a few years back.

The pioneers of the start-up wave in India, such as the founders of Ola, Flipkart, Snapdeal and Paytm, have also become LPs or angel investors. In firms such as Stellaris, 021 and so on, these entrepreneurs have been investing in their individual capacity. Reddy points out, “If a single firm such as Sequoia or Accel raises more and more capital the pace doesn’t change dramatically. In fact, deploying large chunks of capital can be a challenge. But, if more funds and spin-offs are created, it can change the core of the start-up ecosystem.”

Apart from entrepreneur-turned investors and proprietary funds, a lot of professionals who were working with larger funds have ventured out on their own. For instance Epiq, launched by former Matrix Partners co-founder Rishi Navani; and A91 launched by VT Bharadwaj and Gautam Mago of Sequoia Capital. Iron Pillar Capital helmed by Anand Prasanna, Sameer Nath and Mohanjit Jolly closed its maiden fund of $90 million in October, Epiq raised $100 million and A91 plans to raise 20 billion. In the case of Helion Venture, the team fell apart because members could not agree on the investment strategy. Several of them walked out to form funds of their own including Kanwaljit Singh (Fireside Ventures), Ritesh Banglani, Alok Goyal, Rahul Chowdhri (Stellaris Venture Partners) and Helion’s founder Sanjeev Aggarwal joined hands with Infosys co-founder Nandan Nilekani to form Fundamentum.

Red flag

While Ronnie Screwvala of Unilazer Ventures believes we need more Indian HNIs in this space, he is worried about excessive money coming into the market. “A lot of investors may now push entrepreneurs to take money and spend to build revenue that is unsustainable. Excessive money is never a strategy for building a business.” Screwvala points to the deluge of money that hit the market after the 2008 crisis. “Money was made by lot of people in the 2012-2014 cycle. There was plenty to be deployed and much of that got written off in the next two to three years.” Ranjan Pai, too, senses a herd mentality. “I am seeing some of the HNIs and others with no experience. They know so-and-so has invested in some start-ups, so they’ll also invest there. It is a little dangerous, since you don’t put your own lens to it,” he says.

The concern apart, there is more than enough money waiting on the sidelines. According to industry estimates, India focused funds and Indian private equity fund managers have around $10 billion that is waiting to be deployed.

According to Manish Singhal of Pi Ventures, earlier the VC industry was led by market share. Now, it is looking also at products and IPs. “We have taken an approach that AI will be a leader across sectors and that is what we are funding. Fireside believes India has potential to create brands, so they are supporting brands,” he explains. Several specialised funds in AI and consumer such as Pi Ventures, Stellaris, Fireside, Saama Capital and Sixth Sense closed rounds this year. Pi raised 2.25 billion, Saama $100 million, Stellaris an undisclosed amount, and Fireside $52.12 million.

In the US, you find investors specialising in each stage. In India, that is not the case so far and there is a lot of cross-series funding. “Here, you will find the Series-A VC writing a lot of seed cheques, another Series-A fund doing a Series-B, a seed VC trying to do a Series-A and so on. The specialised focus is only beginning to emerge,” says Venugopal. He joined hands with Infosys co-founders Kris Gopalakrishnan and SD Shibulal in 2014 to start an early stage seed-fund and accelerator, Axilor. This June, it announced a new 2 billion fund for making seed and pre-seed investments over the next 10 years, in sectors such as media/content, consumer tech, enterprise, deep tech/AI, fintech and health tech.

VCs may have loosened their purse strings but they are cagey about spreading their bets. The consensus being that the Indian market can support a limited number of start-ups in a given segment. Therefore, larger funds invest in only the number one or the number two, and thus capital flocks only to a handful of start-ups. Take the case of Softbank. After many of its initial investments such as Housing and Snapdeal failed to deliver, the fund has been investing only in market leaders such as Paytm and Flipkart. The situation is unlike 2014-15, when several companies in each segment easily raised money.

Ground reality

Even as late-stage funding took off in 2018, seed funding has lost ground. According to Nasscom, seed funding is down 21% in 2018. Natarajan thinks it is a temporary hitch as he sees enough seed funding capacity with the emergence of newer funds. “Unfortunately, in India, venture funds came before seed funds and the angels. Therefore, the template for seed deals is actually similar to that of VCs. So they take as long as Series A or B, where due diligence is more complex. Typically, seed funding should be easier,” he says. Venugopal says that a lot of seed funds have come up in the past two to three years. “This could be the first cycle in which this whole metrics, around what it takes and what kind of capital is required for building out certain business, is being built. It would take another two to three years to sort this out.” According to him, companies such as Freshworks or Swiggy that are mature today got the first cheque from Accel or SAIF when they were seed-stage companies. “It is difficult for the same firms who were doing early stage three to five years ago to now do the same kind of deals. If a SAIF is to vacate an early stage, then a Stellaris will come and fill the gap. That is really the natural progression,” he says.

With India-focused VC funds having raised nearly $1.5 billion in 2018, most investors expect the existing optimism to last. However, the challenge might be discovering another sector like e-commerce, which is amenable to multiple exits. While more could come from other consumer verticals such as food tech, ed-tech or fintech, KS Vishwanathan, vice-president, industry initiatives, Nasscom predicts, “The next wave would definitely come from deep tech. It might take another six to ten years for a cycle similar to that of Flipkart, but that is where the next big growth opportunity is. They will not need huge capital for marketing, like Flipkart did, but they would need money for R&D.” The rewards are not guaranteed but having tasted success, everybody is scrambling onto the start-up ship.