If we were to look at 2016, this year has been the toughest in terms of fund-raising for Indian start-ups. How do you see 2017 shaping up?
Big picture, if you were to look across every single industry, funding in 2017 will probably be flat, to may be a slight increase. I don’t expect a humongous change—but I do want to make the caveat that I see a significant correction that has to happen in the digital consumer story in India.
That party was over-funded for many years, and I think it has come to a point—especially where the appetite for risk globally is a little bit lower, that’s when dollars are a little bit more scarce—where people will start looking very closely at whether there is an end in sight.
And with the Indian e-commerce sector, especially, it’s very difficult to see that consistently across the board. In the past seven years, we have seen maybe close to 100-125 e-commerce start-ups from India who came and pitched to us here in Singapore.
I would say 85-90% of those have either been restructured, bought out or shut shop. So, it is a significant challenge in being able to raise a lot of money for a big digital consumer story, or an ongoing story—look what happened to Jabong. Look at Flipkart—their investors have reduced its valuations significantly, and Flipkart is having challenges raising further financing. I think it will hamper the overall growth for the digital consumer space.
But if it is FMCG (fast-moving consumer goods) or something around payments—for these sectors, I see more dollars flying in, especially with what’s happening in India currently with the demonetisation…
So in the current scenario, will funding then gravitate towards the market leaders in their respective segments—not just e-commerce, but across all sectors in the start-ups space? Will we have a situation where, say, player No. 5 or 7 in any particular segment will find very little investor appetite, even if they were to have a better product or services or tech platform?
Talking specifically about India, there are two factors that support this hypothesis. First—in the digital consumer space, it is a winner takes all, or two or three big players... It is very difficult to raise a lot of funding if there is consolidation happening among the big players, and a lot of uncertainty around what’s going to happen in terms of the smaller start-ups. Second, a couple of the big global majors—the strategic ones—I’m talking about Alibaba, Amazon, Softbank—they are all making significant play... But the other global majors are also going to be putting a lot of financial muscle behind the companies that they back.
So, as a pure VC, and this ties in very nicely on why we only focus on enterprise software, it’s going to be very difficult for guys who are running $50-$100 million dollar funds to take a big bet backing really early-stage digital consumer stories in India because, how are you going to continue fuelling the party?
India has a reasonably mature venture capital (VC) space but exits are still a problem. Are a lack of big exits hurting the ecosystem?
I think it is probably one of the biggest reasons why vintages 2015 and 2016 have been so poor for Indian funds. If you compare transaction data across the region, and if you look at Indian PE (private equity), I recall that they were projecting 15-17% target returns—but this is over unrealized or un-exited portfolios.
On an exited portfolio, it was coming into the single digits—so it was not very attractive... if you’re looking into the asset classes which are fairly risky, as performance-wise, once you start doing Fund-II or Fund-III, if you have not shown significant exits, it’s going to be a challenge. So India-focused funds—I mean again there are always outliers because there are people who outperform the industry—but on average, it is a challenging environment and I don’t expect it to change in the near future.
But even in the current environment, in the past 12 months, we’ve seen several new VCs being set up in India—some of them have raised a reasonably large corpus.
I’m a big proponent of guys who are doing more focused strategies around product stories. Amit and Arihant Patni, sons of Gajendra Patni, are launching a data-focused fund. That’s interesting because they have expertise in that sector, and people who have an extreme amount of focus and some dedicated corpus are backing them—they have the operating expertise, I think they will do well.
I don’t think there are many guys who jump in to being generic VCs, and even if you look globally, there are not many VCs who do anything and everything anymore. So if you look at in India, we call it VC/PE—most guys were sector-agnostic—they were just throwing money into everything, and I think the smaller ones that are coming up, some of them are seeing the opportunity, as we did in Singapore—there is room for very specialized players to grow and operate successful companies in specific domains—because being a VC requires a lot of rolling your sleeves up, getting into the companies and I would think players of that nature who come in are probably going to do OK.
You are of the view that a lot of crazy deals got funded in India, and a lot of capital was being pumped into start-ups there—but are not VCs to blame, too? They were pushing their portfolio companies to go all out, take a disproportionate amount of risks, expand, hire and grow despite having an unsustainable cash burn. Why were there not enough checks and balances?
I’ll draw the distinction very clearly—this is a digital consumer problem, and that party has been fuelled for a few years, and it has to face a correction. So, for these companies, the only way that you can raise money, because you burn a lot of money, is to continue showing a lot of growth.
So the whole focus around growth has been because that is the way the industry is financed. Honestly, like I said, because of the lack of exits, because of the way they are valued here versus mature markets like the US, etc., are completely different—that’s why VCs in these companies asked them to go for broke—because, they know $2 million might see you through two years, or you could burn it in a year, but at the end of the day, if you show that 150% growth, you’re likely to get your next big cheque of $5 million.
That’s the only way that you can differentiate in an industry where the barriers to entry are low.
So, like I said, I’ve seen more than a hundred of these guys, and it’s amazing the rate at which they run out of fuel—it is a much riskier space to be playing.
So, has digital consumer/e-commerce then taken away investment from other deserving or equally deserving sectors?
Talking tech—the sector which I think a lot of people have not built out expertise in—has been around this whole enterprise software and deep tech sector, and again, I meet so many entrepreneurs here who get surprised about the kind of fund we are, why we are staffed the way we are, why are we so focused... It is not so easy to dissect technology. It’s not easy to grow enterprise companies. Enterprise companies take seven to 10 years to grow. So, it’s not a story where you will see 100% growth year-on-year, and that’s where I feel some of the companies or some of the entrepreneurs have got frustrated—not so much in terms of what they were doing, but the lack of ability of VCs to understand their technology or their business models—because if you ask an enterprise guy on the number of users, it’s not comparing apples to apples.
If you were to look at South-East Asia, this region boasts of impressive numbers on all parameters—Internet penetration, smartphone usage, digital, large addressable youth population—yet, this region has failed to attract VCs or funding anywhere close to that of India. Why is that so? We can even argue that both India and South-East Asia present a similar market opportunity.
Again, the function of the biggest markets which have drawn a lot of consumer tech funding have been the ones that have big populations—US, India and China.
The Philippines, Indonesia and Singapore are very different markets with different operating models and with different cultural challenges.
Agreed, everyone says Asean (Association of South-East Asian Nations) is a billion, China is a billion and India is a billion—but you’re literally building out expertise in many different markets.
And again, a classic example is (Rocket Internet founders) Samwer brothers—they came in here and they said, ‘let’s recreate an Amazon equivalent’.
Now they have sold Lazada to Alibaba because they were confronted with the challenges of integrating Asean.
Within Asean, if you take Indonesia, Thailand, maybe at some point Vietnam, these would be some stand-alone markets in their own right. But for somebody to say I’m going to build an e-commerce business in Asean, I think it’s easier said than done...
Hedge funds were driving a lot of deals in India in 2014 and 2015. Now with many hedge funds taking a backseat, how do you see the scenario going forward?
While I can’t talk on behalf of all hedge funds, we are fortunate to have some hedge fund partners who are investors in our technology fund. What I’ve seen with hedge funds, many of them have made a conscious choice that they will not be in unlisted markets. Why? Because, they have to be able to mark-to-market their portfolios, and they need to be able to give their investors liquidity on their portfolios.
So, even if hedge funds were active before, it was a small portion of their portfolios, but what they have realized is that it is a headache versus the return versus the liquidity, and it was just not making sense to them.
Second, hedge funds as a whole, given the much increased volatility in the markets, it is very difficult for anyone to consistently make money on trade, even in terms of trading liquid products.
So many of the hedge fund friends that I have have been fairly quiet in their overall portfolio. I don’t know what the latest return information is, but I think it is low single digits, and if you look at the sub- optimal size which is maybe $100 million and below hedge funds, the closure rate of those was like 80-90%.
My data is dated, but there is a conscious pullback on the smaller transactions. Even on the bigger transactions, if there’s no liquidity in sight, I think they are not going to be very active going forward.