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Mumbai: Nimbler hedge funds are ready to write cheques to start-ups in record time, cutting out venture capitalists (VCs) from investing in promising young companies, underscoring the challenges faced by VC funds in India, where valuations have soared so high that they are drawing comparisons to the heady days leading up to the dot-com crash in 2001.

“Earlier, we could tell an entrepreneur that we are going to the valley (Silicon Valley) and we will come back and do a deeper due diligence and close the deal in a month’s time, but those days aren’t there any more," said a VC investor, referring to the intense competition to invest in fast-growing start-ups in India. He declined to be named.

In the changing Indian start-up funding ecosystem, competition to invest is coming not just from within the VC community, but increasingly from these hedge funds. Hedge funds and other institutional investors invested $4.35 billion in private deals in India in 2014, more than fourfold the $883 million they invested in the previous year, according to data by CB Insights, a venture capital database backed by the National Science Foundation. That’s set to rise this year.

During the three months ended March, hedge funds have already invested $1.36 billion across 69 private companies in India—the highest number of deals seen in any quarter. The investment figures in some cases include funding rounds closed along with VC funds.

“In some of the situations, VCs have been outbid on valuations, or hedge funds have moved too fast, they have put money on the table and closed the round, or in some cases the cheque sizes have gone beyond what VCs would be comfortable with," said Nitin Bhatia, managing director at Signal Hill, a tech-focused foreign investment bank.

Hedge funds that have been most active over the last year include Valiant Capital Partners, Steadview Capital Management Llc and Hillhouse Capital Group.

Emails sent to these funds asking about their India investment plans did not elicit any response.

Typically, hedge funds invest across several asset classes, both in public and private companies, while VC funds invest mostly in early-stage private firms. Also, hedge funds do not get involved in the operations of their portfolio companies, while VC funds take up board seats and nurture the companies during the entire period they stay invested.

According to investment bankers, hedge funds that usually invested only in late-stage investment rounds are now becoming more comfortable with investing at earlier stages such as Series B and C rounds along with VC investors.

They are also willing to make smaller-ticket investments.

“Hedge Funds which were earlier investing in late stages such as Series D and E have now started to invest in Series B and C rounds. Mostly, these funds are trying to invest in companies they think will become potential leaders. There is a strong belief that if you are the leader, then there will be an independent path to an IPO (initial public offering) or a strategic firm will see value and acquire you," added Bhatia.

Founders of start-ups are happy with the quick decisions, easier terms and high valuations offered by the hedge funds.

“Their terms are far easier and they do not take the same amount of time that venture capital funds were taking to close deals. Also, access to capital is no longer a problem and capital is not the barrier to entry any more," said Yashish Dahiya, co-founder and chief executive at Policybazaar.com.

Policybazaar raised $40 million in a Series D round in April this year from hedge fund Steadview Capital and other investors such as PremjiInvest, Tiger Global, Ribbit Capital and ABG Capital.

Historically, strong ideas have lost out because they were unable to raise capital at the right time, Dahiya said, adding that the entry of hedge funds is helping solve this problem.

The relatively lower levels of engagement from hedge funds when compared to VCs is also a positive, according to some promoters.

“Hedge funds usually don’t have operational involvement or intent. Like many funds, they have an investment horizon of two-to-seven years," said Kunal Shah, founder of Freecharge.com, who sold his business to Snapdeal.com in the biggest ever deal in the country’s start-up domain.

Before Freecharge sold out to Snapdeal last month, it had raised $80 million in February from Valiant Capital Partners, Tybourne Capital Management, Sequoia Capital, Ru-Net Ventures and Sofina.

Some VC firms say there is a downside to this change in the profile of investors, pointing to the quick jump in valuations.

“In some cases, it does seem that the valuations and expectations are out of whack. It seems like it is more about raising large rounds of capital without much underlying traction," said the VC investor cited above, adding that this should correct once few of the companies fail to meet the expectations of investors.

Bankers disagree with the notion that hedge funds will look to exit and churn investments quicker than VCs.

“Given the long-term growth potential, valuations are relatively expensive in the Indian market. But if these investors stay invested for, say, three-five years, then they will definitely make good returns," said Ashish Bhinde, executive director, Avendus Capital Pvt. Ltd.

Avendus has closed the highest number of digital media, e-commerce and technology deals in the country last year.

Bhinde believes that these hedge funds are looking to stay invested for at least two to four years before they sell their investments.

“Most of these funds generally have an allocation ranging from 5% to 25% of their fund for investments in private companies. Generally, these funds do not invest with the perspective that they have to exit these investments in one or two years," Bhinde added.

Bhatia of Signal Hill adds that VC funds, too, are adjusting their investing style.

Some VCs have responded to the situation by going from Series A to early stage and making smaller investments, identifying interesting niches and going after them, said Bhatia. “Some are saying that this is the time to stop investing as valuations have gone haywire and create as many exits as possible," he added.

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