In 2011, when Darshan Patel founded Vini Cosmetics and raised $5 million for a 15% stake, it should have been an easy investment decision by normal standards. After all, he was “a second-time entrepreneur with one of the best marketing brains in the country and with a determination to better his first innings”. Similarly, when Neeraj Kakkar of Hector Beverages set out to build a new-age beverage company, he already had a proven track record in the industry under his belt.
Although these investments appear to be “no-brainers” in retrospect, they were “bold” decisions at the time, given the paucity of funded consumer and healthcare start-ups that were eventually successful. Patel and Kakkar were different in that they sought funding at the outset of their start-up journeys. This approach was unlike that of most others who build their businesses slowly, and with limited external capital. We believe that the catalysts for this mindset change are falling into place with both entrepreneurial and investing activity being reinforced by many success stories. The increasing confluence of talent and capital will, without doubt, create more well-funded consumer start-ups that develop into valuable businesses.
A few years ago, when we conducted an exercise designed to bring more focus into our business, we realized that our aim of “being an early partner to founders in India who want to convert ideas into enduring companies” was best being done by large family groups such as the Tatas, Birlas and Mahindras. Similarly, MNCs and larger Indian companies dominated the landscape of new brand and product line launches. They had proven very effective in incubating new ideas that were executed by a few high-quality professionals. What they may have lacked in entrepreneurial energy was made up by the access to capital and group resources that helped these businesses scale rapidly, especially in the early days.
In most cases, the professionals at the helm of these businesses weren’t always adequately rewarded when the businesses became valuable, as they had not taken the “risk”. The act of assuming “risk” and raising external capital generates significant personal value for the individuals involved. The current and next generation of similar professionals are likely to see the opportunity differently and are more likely to take that initial risk. This will be particularly true for asset-light parts of consumer and healthcare businesses that can be built with limited capital. In general, sectors with the highest ROCEs (return on capital employed) and generating higher market capitalization per dollar of investment (figure 1 and 2) are leveraging talent to generate the surplus. It is therefore “fair” that capable individuals in these sectors share a greater part of the value created. It is commonplace to hear of professionals participating in wealth creation in technology companies and sometimes in financial services, but we seldom see this in consumer and healthcare sectors in which total employee cost as a per cent of sales is typically lower.
We believe that while capital-intensive business incubation will continue to be dominated by large groups, venture funded start-ups will increasingly comprise a larger share of capital-light business incubation. This will be driven by the synergistic confluence of talent and capital at the early and scale up stage, as seen in the following trends.
Lower cost and complexity of starting up: Just a decade ago, many good ideas failed to get off the ground because their originators didn’t know how and where to begin. Today, most students in their final year of college are aware of what’s involved in starting a company. Both the cost and complexity of the process are now greatly reduced. The buzz and enthusiasm around start-ups is unprecedented and has resulted in a quality ecosystem with legal, accounting and administrative services easily available. Most major cities have co-working spaces aimed at start-ups. Freelancers can help with initial market research, product development, packaging design as well as brand positioning and communication—all at a reasonable cost. Firms can even help with initial access to distribution. A new business may not need to avail all these services, but they are available if needed, to facilitate the process of starting up. In fact, many of these services are offered by talented professionals who may have attempted to launch their own businesses before the ecosystem was in place and are now offering their services as independent operators.
Increasing availability of risk capital at early stages: When Sequoia was debating an early investment in Hector Beverages in 2011, a $5 million investment seemed large and bold. However, in 2013, a $15 million commitment in Koye Pharma, a start-up brand generics company, seemed appropriately sized. In 2014, we saw Goldman Sachs commit $50 million to a start-up aiming to build a consumer platform. In all these cases, the compelling proposition was a start-up idea led by a proven and capable professional or professionals. These individuals were aiming to either create a new category or challenge incumbents in large markets. In hindsight, these are not very difficult investment decisions as the aspiring entrepreneurs are attempting to replicate what they were successfully doing in larger companies. This is merely a reflection on the investor’s viewpoint and is not meant to trivialize the risks involved or the efforts of the entrepreneurs. As the market for various categories expands, it gets simpler to envisage $100 million revenue businesses being built from scratch during a typical investment horizon of 5-10 years. As success stories similar to those of Vini Cosmetics and Prataap Snacks emerge, we are likely to see more capital flowing towards building the next wave.
Greater willingness for talent to start or join start-ups: In the 1990s and early 2000s, consulting firms, investment banks, and leading FMCG and financial services companies attracted the best talent. While many still seek security and the ability to build safety nets through employment, the past five years have seen a strong inflow of young talent into start-ups. Another exciting trend is the manner in which more experienced talent is gravitating towards new ventures. In the first wave of this trend, we have seen seasoned professionals seeking out senior roles in young companies, accepting lower compensation in exchange for a higher upside through stock options. The next wave is even more exciting and includes many seasoned professionals absorbing even higher risks to start out on their own. In most cases, they stick with business ideas that are aligned with their own experience. We believe that this trend will strengthen with many more success stories emerging from this pioneering group.
Availability of business building ‘support services’: So far, successful incubators—primarily large business houses and corporates—have been very effective in surrounding new businesses with functional support services. The new business gets access to quality services in recruiting, marketing, legal, technology and business development that a young start-up would not otherwise be able to afford. Corporate resources in these business groups often helped them pull away from independent and cash-starved start-ups. This is changing as venture investing is placing world-class support-service capabilities—spanning recruiting, marketing, legal, finance and technology—within the reach of young companies. Venture funds have recognized the difference these capabilities can make to the trajectory of start-ups, especially in the early days, and are enabling them.
Most of us absorb and learn from our environment all the time and that is certainly true of both investors and entrepreneurs in the start-up ecosystem. Within the huge wave of largely technology-focused start-ups in India, there is a definitive mini-wave of valuable consumer and healthcare businesses being quietly built. Our belief is that the enabling factors for them to succeed—changing mindsets, evolving distribution trends and access to capital and talent—are aligning themselves optimally to help create tremendous value over the next decade. Venture capitalists who shied away from consumer investing in 2014 are now eyeing this area with a lot of interest. There has never been a better time for people with good ideas to explore ways to convert those into enduring businesses. There are several trailblazers—Yellow Diamond, Fogg, Paper Boat, Wildcraft, ID Foods, 24 Mantra and Eris Lifesciences, to name just a few—who have shown us that it can be done. As we look at these shining examples of venture- backed consumer and healthcare companies in the prior decade, we are excited about the names and stories that are likely to dominate the next one.
Abhay Pandey is managing director of Sequoia Capital India Advisors.
(Disclaimer: Paper Boat, Wildcraft, Yellow Diamond and Fogg are brands owned by Sequoia portfolio companies. ID Foods is a brand owned by a former Sequoia portfolio company.)
This article is the final in a three-part series highlighting key trends and developments in India’s consumer entrepreneurial space.