Mumbai: After betting like never before on e-commerce start-ups in 2011, venture capital (VC) firms are set to change their investment gears next year. Mobile start-ups and consumer products and services companies are set to emerge as the top favourites for investors seeking to ride on the Indian consumption story. Deals momentum is expected to accelerate next year compared with 2011, although exits remain a challenge.
VC firms invested $822 million across 144 deals this year, compared with an investment of $641 million across 128 deals in 2010, according to estimates by VCCEdge, which tracks investment activity. This year, more than $500 million was invested in e-commerce start-ups alone across 68 deals.
Investors say that with increasing consumption of content on handsets as well as the adoption of verticals such as gaming, the emphasis will now be on investing in firms that can offer an integration of mobile phone and Internet services.
“In the mobile space, data usage on handsets, more application-based businesses models, gaming are big,” said Kanwaljit Singh, managing director, Helion Venture Partners. “Mobile is going to be stronger in the next 12-24 months,”
India’s VC industry has been broadly marked by a so-called preferred investment theme every year. In 2006, it was mobile; in 2007 and 2008, it was microfinance institutions and financial services; in 2009, it was education; in 2010, it was information technology (IT) and IT-enabled services.
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After 2006, mobile start-ups lost their attraction as they had to share a major chunk of their revenue with telecom operators. With more direct-to-customers models in place now, the interest in mobile start-ups is peaking. That India has the world’s second most mobile phone users, with over 881 million as of October 2011, according to the Telecom Regulatory Authority of India (Trai), adds to the comfort.
“Companies that have direct-to-customer models will get traction. Mobile commerce will also get subsumed by e-commerce,” said Alok Mittal, managing director, Canaan Partners India.
Consumer products and services will continue to find favour in 2012. Segments that investors are looking favourably at include healthcare, food and agriculture businesses.
“Consumer products and services will dominate as ultimately people are investing in India’s consumer story,” said K. Ramakrishnan, executive director of Chennai-based investment bank Spark Capital Advisors (India) Pvt. Ltd.
Investors expect 2012 to be another busy year for investments and slow for exits. “This is simply because we see an increasing number of high-quality people turning entrepreneurs. (I) don’t see capital markets affecting VC deals,” said Abhay Pandey, managing director, Sequoia Capital.
Pandey, however, added that 2012 seems like a tough year for exits from a capital market perspective. The market for initial public offerings (IPOs) has been closed for nearly the whole of 2011 amid jitters over the state of the US economy, the euro zone debt crisis, and rising interest rates at home to battle high inflation, while the pace of economic growth has slowed.
In the absence of an IPO window, investors are looking at other options such as strategic sales to exit portfolio companies, but such routes are not without difficulties. In Internet businesses, for mergers and acquisitions (M&As) there is not a big enough base of acquirers, said Mittal.
“It’s a fundamental problem. On the services side—BPO/KPO, we may see some M&A activity.” BPO is short for business process outsourcing and KPO stands for knowledge process outsourcing.
Canaan has companies such as iYogi Holdings Pvt. Ltd and Consim Info Pvt. Ltd in its portfolio from which it may look at exiting, said Mittal, adding that he is not sure if this would indeed happen in 2012 or later.
Investment bankers say deal closures will continue to be a challenge in 2012 as well. Deal closures are taking 25-30% more time now because of stricter due diligence processes, greater caution among investors and valuation differences.
“Earlier, there were hardly had any exiting investors. Now, there are existing investors and their expectations need to be taken into account. There are more variables, more challenges,” said Spark’s Ramakrishnan, adding that even a seemingly straight-forward deal is taking as long as 10 months to clinch.
Meanwhile, Series A funding—the first round of funding for a company after seed capital—is expected to become more difficult in months to come. Over the last two years, there has been a rise in the number of seed funds and angel investor networks. At least half-a-dozen private incubators and seed fund programmes came into being including the likes of Technovate and Seeders.
While this is a good initiative for start-ups that are getting capital assistance early in their lifetime, the number of Series A investors has remained more or less the same.
“What will happen to these seed-funded or angel-funded companies when they come in the market for Series A rounds…. Funding will become difficult,” said Deepak Srinath, director of Bangalore-based boutique investment bank Viedea Capital Advisors.
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