Seed or late stage? The dilemma before VC investors
Data on start-up investments in the last year suggest several trends on the future of venture funding in India.
While late-stage start-ups raised over $10 billion and are in a different league, seed-stage and early-growth stage start-ups together raised a total of about $2 billion in about 700 deals. While the share of seed-stage deals by numbers was about 30%, its share of fund-raise was less than 10% of seed-stage plus early-growth stage deals.
The trends in recently concluded fund-raises by venture capital funds suggest that both larger global VC funds like Sequoia Capital and home-grown VCs like IDG Ventures, Matrix Partners and Nexus Venture Partners have significantly enhanced the fund-sizes and consequently the dry powder for India. To add to this, there are successful fund-raises by veteran professionals as spin-off outfits coming out of larger VCs with niche practices and actively looking to deploy. Another trend was domestic seed-funds and angel-funds by financial services conglomerates backed by Indian family offices and high net-worth individuals (HNIs).
The key question is which segment of start-ups will be the bigger beneficiary of this pool of funds. Arguably, a large section of multiple VCs might, through coincidental but unplanned consensus, be focused on either becoming the first institutional investor in a seed-stage start-up with $2-3 million or be a late-stage investor in Series B/C/D with double/ triple digit multi-million cheque. The theme—to either get in early to shape the start-up as you want playing the highest risk—highest reward (without interference from other influencers) or to get in late-stage playing for larger growth of evolved start-ups with minimal mortality risk.
This quite naturally evolves into situation where sources for seed-funding proliferate—HNI angels, angel investor networks, crowd-funding angel platforms, seed-stage funds, family offices and corporates. While it might suffice for experimentation and early validation for quick wins and successes, the bigger challenge is likely to be next rounds or Series A for a large proportion of start-ups moving to the next level post-seed.
Despite early wins, sub-scale stage and an already semi-established model for many start-ups may leave limited scope to pivot and match preferred business model for Series A, posing challenge for next-stage funding for growth. Besides, venture debt Funds, as an emerging outpost expected to bridge the gap, is itself in evolution stage and is likely to focus on tail-gating debt exposure alongside Series A funding rather than independently providing bridge. Call it proverbial “valley of death” for startups in that stage, if you may.
That brings us to another important aspect for VCs and investors—exits. If late-stage large start-ups are excluded, the scenario for exit from seed-stage and early-growth stage start-ups was muted in the past. We may witness an encouraging trend in 2018 where corporates and strategics play a prominent role in taking strategic stakes in seed-stage and early-growth stage start-ups who succeed in making serious impact in markets or areas relevant for these moneybags.
The same players are likely to also engage in M&A with potential acquisitions across the stage of start-ups, so long as it bridges the gap in offerings, technology, markets etc. for acquirers.
We can already see early signs of such moves in consumer/brand start-ups while an emphatic validation is microfinance firms where serious traction for merger and acquisitions (M&A) by financial services players and banks is evident. The disappointing absence of M&A in the start-up ecosystem by large technology players is unlike the global trend and could change for good in 2018, with improved sentiment in core business of Indian IT players.
While exit through initial public offerings may take time to evolve in India, the trend of large number of successful listings of on SME exchanges has potential of replicating itself with start-ups listing on Institutional Trading Platform and SME exchanges with attention from the regulator providing it a real chance. It will need alignment with regulations on subjects like angel tax and regulations around angel networks.
I believe self-regulatory organizations (SRO) for angel/ VC industry, approved by the Securities and Exchange Board of India and the finance ministry could be a step in the right direction and pave the way for a more vibrant and viable start-up ecosystem.
Bharat Banka is managing partner at consulting firm Fideliment Ventures Llp, and was founder and former CEO of Aditya Birla Private Equity Fund Practice.
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