Reshmi Khurana, managing director and head of South Asia, Kroll said the Flipkart-Walmart deal would not be key to setting the tone for the VC space in India
For start-ups in India, the encouraging funding environment from mid-2017 sends a positive message that if entrepreneurs have their house in order, then there is enough global capital waiting to be deployed, Reshmi Khurana, managing director and head of South Asia, Kroll (a corporate investigations and risk-consulting firm), said in an interview.
In its recent report, Kroll had pointed out that private equity (PE) and venture capital (VC) investors nearly tripled their investments in tech deals (in India and South-East Asia) to $18 billion in 2017, compared with $6.5 billion in 2016. In the first quarter of 2018, 170 tech transactions worth $2.6 billion were recorded in this region, the report said.
Khurana said the Flipkart-Walmart deal, or the possibility of an Ola-Uber merger would not be key to setting the tone for the VC space in India this year and the next. Instead, she shared the view that the tone for the VC space in India has already been set. “For example, I do not believe the interest Amazon and Walmart—both strategic investors with an ostensibly long-term view of India—are showing in the e-commerce space in India is the result of irrational exuberance. This sends the message to smaller start-ups that there are potential investors—e.g., strategic investors, sovereign wealth funds—who will back entrepreneurs that are building businesses painfully, slowly and successfully," she said.
Khurana said “investors were ‘refocusing on India and South-East Asia (SEA) for the individual merits of these markets’, and their ‘increasing understanding and comfort with the local business environment, talent—both investing and entrepreneurial—and the rising need for PE funding’. Edited excerpts:
You are able to see the big picture in India and SEA when it comes to VC and PE deals. What are the common factors, what are the notable differences? How far ahead is India when it comes to VCs and start-ups space, compared with SEA?
There are many similarities in the PE and VC space in the India and the SEA markets. They are both at similar levels of economic development and potential for mass market consumption. Although the scale of the market in India is potentially much larger, it is not a homogenous market; so, in some sense, it’s more similar to SEA than its population of 1.3 billion would suggest. India and SEA are both politically stable, especially SEA, where many countries are fledgling democracies but relatively speaking, are experiencing a level of political stability that did not exist a generation ago. Political steadiness is important for PE and VC investors, especially when they are investing in disruptive technology-driven businesses. Local entrepreneurs from India and SEA seem to have a deep understanding of their respective markets and access to local talent which is a key ingredient for scaling up businesses.
India is a few years ahead of SEA in the VC and start-up space because of scale, which impacts everything. There is volume and quality of talent in the country which attracts capital and which further attracts entrepreneurs. That virtuous cycle started a few years earlier in India, but we can already see that a number of businesses in SEA are growing along similar lines as those in India.
When it comes to VC deals, what changed in 2017 when compared with the year earlier? Again, when you look at India, does the encouraging funding rally from mid-2017 till now indicate the downturn in the local VC market has come to an end?
Nothing changed overnight. I think VCs and start-ups in India are both learning from their past mistakes. Our VC clients today want to see sustainable businesses that are solving a real mass market gap, are delivering profitable growth early on, backed by a high-quality product or service, and for entrepreneurs that are committed to scaling the business. The funding rally is a positive message to entrepreneurs that if they have their house in order, then there is enough global capital waiting to be deployed.
The technology scene in India has still largely been a VC play. When do you see this evolving into a PE play?
It will evolve into a PE play when India’s tech start-up environment evolves. Mid-market growth-focused PE funds look for track record of earnings, which many tech start-ups have not achieved yet in India. As the tech start-up environment evolves, PE funds may be able to include them in their strategy.
Strategic corporate buyers and sovereign wealth funds may enter this space before traditional PE players. They are investing in tech and innovation to stay ahead of competitors. Some have established their own VC arms, like SoftBank, Google, Alibaba and Cisco. Others are partnering with financial investors to share risk exposures and gain access to wider capital pools. In 2017, Alibaba partnered with SAIF Partners in a $200 million funding round for Paytm (Mall). This marked Alibaba’s entry into India’s e-commerce market.
Do you think the impending deals involving Ola and Flipkart will, to a great extent, set the tone for the VC space in India in this year and the next?
I think the tone for the VC space in India has already been set. For example, I do not believe that the interest Amazon and Walmart—both strategic investors with an ostensibly long-term view of India—are showing in the e-commerce space in India is the result of irrational exuberance. The target firms you mention have gone through months of ups and downs in terms of strategy, leadership and performance, and tried to find an equilibrium that potential investors must find attractive. This sends the message to smaller start-ups that there are potential investors—e.g., strategic investors, sovereign wealth funds—who will back entrepreneurs that are building businesses painfully, slowly and successfully.
Exits, which were a major concern earlier, have started easing with more secondary deals and IPOs happening. Is this trend sustainable? How do you view the exits environment in India in the short-term? How do exits compare in SEA?
In the past two years, India has offered some spectacular exits to PE investors—so, currently, the concern related to exits appears to be easing for many investors, especially if it relates to deals that took place in the more sombre period that followed the great financial crisis. A large number of exits have been through secondary deals and our experience is that in both India and SEA, corporate governance in companies remains a concern for incoming investors.
In your recent report, you mentioned the political risks affecting PE and VC investors in India and SEA. Can you elaborate on that?
Many economies in the region, such as India, Indonesia and Vietnam, are seeing more political stability than they ever have, but an element of risk associated with ad hoc change in government or government policies remains. In India and SEA, business, politics and bureaucracy often interact with each other closely and any sudden change in the “rules of the game", can impact a business profoundly, especially in sectors where government interface is high.
This risk is more acute in tech-based startups in regulated sectors such as financial services, insurance or healthcare. The Grab-Uber scenario in Singapore is a reminder that regulators are always playing catch-up with technology, by imposing regulations around licensing, competition and price controls to protect consumers and existing traditional businesses. Investors and entrepreneurs need to watch (and try to predict) how regulators will impact their businesses. Not easy to do when technology, business models, and regulation are all evolving fast.
Your recent report rates India, Singapore and Indonesia as popular destinations to invest in the region. In terms of a risk-reward basis, how do you rank these countries? Second, from an limited partner (LP) perspective, what do you think their allocations should be in percentage terms for these markets?
India has seen the majority of total tech PE/VC activity since 2015. India accounted for 56% of deal value and 71% of volume. Singapore was second—33% of deal value and 10% of volume—and Indonesia was third—7% of deal value and 7% volume.
The deal activity is a function of many factors, including scale of the economy, the depth and maturity of PE markets, and how entrepreneurs treat PE capital, to name a few. In our experience, investors that have an APAC (Asia-Pacific) wide mandate, evaluate each transaction and business individually on its own merit and based on the PE/VC’s experience and track record in a particular country. So, it is difficult to do a simple ranking of the countries. India is a deep and increasingly mature PE market that offers scale, but valuations are high. Singapore offers an enabling environment to entrepreneurs, but it’s a small economy and PE and VC funds may struggle to find enough large-scale deals. Many businesses in Indonesia are developing in a similar fashion to those in India but the regulatory landscape is still developing.
In each market, it is important to understand the background of the founders to assess what motivates them and how they might be expected to behave post-investment, particularly with respect to their ability and commitment to scale up and manage the business and to maintain the governance standards that the investor expects.
The prospects of China have been less encouraging of late. Against this mindset, for investors looking at Asia, do you see them refocusing their attention on India and South-East Asia?
The PE/VC markets in India and SEA cannot be compared with that of China. The scale of the Chinese economy and PE/VC industry are vastly larger than India/SEA. In 2016, GDP (gross domestic product) was $11.2 trillion in China against $2.3 trillion in India. In 2006-16, the China market (including Hong Kong) raised $532 billion in PE and VC funding. In comparison, over the same period, India raised $75 billion and Singapore raised $43 billion. Secondly, the Chinese PE and VC markets are hyper-local. There are hundreds, if not thousands, of PE/VC firms in each province in China investing in their respective backyards. It will take years for India and SEA to get to that level decentralization.
Investors are refocusing on India and SEA for the individual merits of these markets and their increasing understanding and comfort with the local business environment, talent—both investing and entrepreneurial—and the rising need for PE funding.
Cryptocurrency, bitcoin and ICOs all have got mixed reviews in your report. How do you view this trend?
The market related to cryptocurrency is still at a very early stage in India and SEA, and while the investor interest is palpable, the regulatory landscape is far from clear. The central bank in India—the Reserve Bank of India (RBI)—has barred banks from dealing with cryptocurrency-related entities and some of these entities have challenged RBI in court. Till the regulator gets comfortable around this technology and its impact on investors, consumers and the financial ecosystem, it will be difficult for this sector to succeed in India.
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