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Business News/ Companies / News/  Venture capital hunt for early-stage start-ups fuels valuations
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Venture capital hunt for early-stage start-ups fuels valuations

VC firms, which mostly funded later-stage start-ups, have now shifted to early-stage deals

Photo: MintPremium
Photo: Mint

Bengaluru: It’s not just the large e-commerce firms that have seen their valuations skyrocket in the ongoing boom. The valuations of even early-stage start-ups have doubled or tripled from a year ago, as venture capital (VC) firms such as SAIF Partners, Sequoia Capital and Tiger Global Management seek out the new new thing.

VC firms, which mostly funded later-stage start-ups, have now shifted to early-stage deals, pushing out angel investors in many transactions and pumping up valuations of the nascent companies, many of which don’t even have a proven revenue model, let alone clear profit potential, according to angel investors, analysts and VCs.

Accel Partners, Sequoia Capital, Helion Ventures, Tiger Global, Saif Partners and IDG Ventures have been particularly active in early-stage deals.

The six investment firms together did more than 40 early-stage start-up deals in 2014 and so far in 2015, compared with less than 10 in 2013, according to Tracxn, a research firm that provides data on start-ups.

Analysts have questioned whether the rising valuations of large e-commerce companies such as Flipkart, Snapdeal and Ola are justified. The rapid pace at which valuations of early-stage companies have increased are fuelling concerns about excessive money floating around in the Indian start-up business.

One of the key problems, according to analysts and investors, is that increasingly Indian start-ups are copying the business models of US companies that have attracted large amounts of venture capital, regardless of whether such models are scalable in India. Investors, fearful of missing out on the next big Flipkart or Ola, are infusing millions of dollars in many of these unproven companies.

For instance, start-ups in food delivery and local services such as laundry have recently found favour with investors in the US. Sure enough, investors backed several Indian start-ups in these two sectors over the past few months.

Food and groceries delivery start-up Grofers has raised money as many as three times in the past seven months, including $35 million this week from Tiger Global and Sequoia. Since February, its valuation has increased by roughly three times to more $100 million, two people familiar with the matter said.

A bunch of other delivery start-ups, such as TinyOwl, Frsh and PepperTap, have also received money from investors this year.

Services marketplaces, which either connect customers with service providers such as electricians and plumbers or perform these tasks themselves, are also attracting VC funds. At least 10 such start-ups, including UrbanClap, Taskbob and LocalOye, have been funded by investors over the past six months, according to data by Tracxn.

“The problem (in the broader start-up world) is that raising money is being seen as a sign of success, just by itself," said Sharad Sharma, co-founder of iSpirt, a lobby group for the software products sector. “Many entrepreneurs are asking for large cheques even before having the right product or technology. This is clearly not the right approach. When investors pull back, many of the recently funded start-ups may struggle to raise money."

Independent consultant Santosh Kanekar, who advises several start-ups funded by the Mumbai Angels network, agrees.

“You can see that there’s a get-rich-quick mindset among many of the entrepreneurs today. This is both caused and exacerbated by the fact that so much money is available today because of VCs coming lower down in the ecosystem. While angel investors are missing out on a few deals, I’d say that it’s good for them in a way because they will avoid investing in some of the unviable ideas that are getting funded today," Kanekar said.

Over the past six-nine months, many early-stage start-ups have been demanding funds and valuations that are three-four times more compared with year-ago levels because of the availability of VC money, said Anirudh Suri, founding partner at early-stage investor India Internet Fund.

“In general, taking VC money at such an early stage carries risks for start-ups. It increases pressure on them to show results instantly and reduces their appetite to experiment and take risks. Angel investors tend to be more patient than VCs," Suri said.

Some experts said the move by several VC firms such as Sequoia Capital, SAIF Partners, Accel Partners, Helion Venture Advisors and Tiger Global to invest in early-stage start-ups carries a so-called reputation risk for these investors.

VCs typically work like this: they put money in several relatively mature start-ups, betting that while they may not make money on most of these investments, the two or three companies that do well would deliver massive returns. After entering a company, VCs may or may not invest in subsequent rounds of fund-raising.

While such an approach is the accepted norm for companies that have been around for a few years, early stage start-ups are more vulnerable. If a VC firm declines to back one of its early stage start-ups in a later round of fund-raising, potential new investors are wary of putting up money.

“Yes, there is a potential reputation risk of early-stage investing," said Mukul Singhal, principal at SAIF Partners. “But to avoid it, we not only encourage all our start-ups to go out in the market to raise their next round, but we participate in the new round as well. This gives confidence to potential new investors."

To be sure, there are benefits of start-ups getting venture capital at an early stage. VCs typically offer better terms to entrepreneurs than angel investors and for start-ups that can handle large amounts of money at an early stage, the rewards can be lucrative. Snapdeal, for instance, raised its first round of about $12 million from VC firms barely a year after starting out.

VC firms investing in the early stage is a positive development as companies get more capital, and deep-pocketed institutional investors typically give better terms to entrepreneurs than angel investors, said Gaurav Dani, co-founder at law firm Indus Law.

“Institutional investors come with their global network, are very result-oriented and they set aggressive growth targets and include terms such as dealing with an IPO (initial public offering) down the line. These are not things that typical angel investors tend to do," Dani said.

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Published: 16 Apr 2015, 11:56 PM IST
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