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Venkatesh Guda

Venkatesh Guda, Developer, The Foundary.

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Indian Startup Ecosystem - Opportunities and Challenges

Venture funding situation in India is a favourable one for entrepreneurs for several reasons. Money is available for good fundable ideas. Scarcity of good qualified ideas makes it easier for entrepreneurs that can define venture scalable businesses around their ideas to get noticed and to get quick decisions.

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PART 1: IS STARTUP FUNDING IN INDIA AS HARD AS IT SEEMS?

This is the first of a 3-part series from the perspective of a Silicon Valley entrepreneur who has been studying the Indian startup ecosystem over the last two years interacting with both entrepreneurs and investors.

An adage in startup ecosystems is that you can have at most two out of the three critical components - funding, talent, and real estate - favourable at any time. At the moment, the Indian startup ecosystem is uniquely positioned with all of them favourable. Yet, most Indian entrepreneurs feel getting venture funding is very hard. Here are some factors that play into this perception and those that improve chances of getting funded.

Most startup ideas don’t get funded. This is true in India. This is true worldwide. So, it is not surprising that entrepreneurs everywhere feel getting funding is hard. But, there is a perception amongst most Indian entrepreneurs that it is likely much harder in India than in more mature startup ecosystems (for example, US). Is this perception justified?

Two rationales are frequently advocated by entrepreneurs. One, that there just isn’t enough capital available in India for startups. Two, that Indian investors (Angels and VCs) are either very risk-averse or reject far too many good ideas while in search of unicorns. On the other hand, Indian investors bemoan the scarcity of fundable ideas.

While there is some truth behind these perceptions, the reality turns out to be much more nuanced. By several measures, the current funding potential in India is a relatively favorable one for the entrepreneur but one that is difficult to benefit from for all but a few savvy entrepreneurs. Part 1 of this series examines the reasons behind this seeming contradiction.

Is there enough funding available in India?

Fig. 1 depicts the annual VC investments in India over the last 10 years along with the number of deals. In 2017, roughly $1.2B (₹ 7,800Cr) was invested over 320+ deals. For comparison, the corresponding  investment in the US was $84B (₹ 546,000Cr) over 8000+ deals. Clearly, the total amount of investments in India is much smaller but does that necessarily equate to funding scarcity for qualified ideas?

Almost every VC spoken to say they have enough “dry powder” for new investments. Note that in absolute terms $1B is quite a large amount especially for a relatively nascent and small ecosystem with significantly lower cost structure. The average investment per deal also indicates that there are a large number of small early stage investments in India, and numbers are not skewed by large unicorn and late stage investments as in the US. So, the rationale of inadequate funding availability does not hold up.

Do Indian investors play hard to get?

While it is difficult to come by hard statistics on rejection rates in India (rejections are not tracked like funded ones are), anecdotal data from conversations with investors indicates rejection rates are greater than 98%.  Rejection rates in the US have been reported to be as high if not higher. So, while this may lead to equal levels of frustration, it does not suggest that getting funded in India is harder. On the other hand, anecdotal data from conversations with funded entrepreneurs in India suggests that the decisions, on average, are quick without much “pounding of pavements” needed unlike in the US, even for first time entrepreneurs.

Are Indian investors missing out on good ideas by being risk-averse or short-term oriented as entrepreneurs believe or are fundable ideas hard to come by in India to put available money to work as many investors suggest?

Based on one-to-one conversations with over fifty entrepreneurs in early stages over the last two years, the problem in India is a conceptual gap that exists between “good ideas” and “venture fundable ideas”. While this gap is not unique to India, it appears to be relatively large in India and persists due to a widespread misunderstanding of venture funds as well as a legacy approach to entrepreneurship. It is necessary to understand this gap to be able to bridge it.

The “Venture Scaling Gap”

Fig. 2 graphically illustrates this problem for early stage companies. Entrepreneurial ideas span a spectrum from hobby projects with no business model to ventures with huge return potential. Each part of the spectrum attracts different sources of funding as noted.

Higher the potential for returns (“Venture scaling” on horizontal axis), higher is the amount of funding available (green line). The red line roughly represents the distribution of ideas across return potential spectrum in the Fig 2 group of entrepreneurs spoken to.

The mismatch between the number of ideas and availability of funds along the spectrum explains the perceptions of both entrepreneurs and investors about the funding situation in India. Most of the ideas are in the region of return potential where there is very little funding available, while the region with higher availability of funding has much fewer ideas. The consequence is investors either lowering their standards to fund weak ideas often or chasing dubious ideas in whatever the current hot areas are – Blockchain, AI, FinTech, IoT, etc.

It is import to note that the spectrum is not correlated with how “good” the ideas are in terms of impact or even the technology or the target market. In fact, it is gratifying to note that, unlike the hubris in Silicon Valley, many of the ideas encountered targeted real problems in the Indian context, with social impact in the fields of Agriculture, Education, Infrastructure, Transportation, etc. Many of them used current technologies in AI, Mobile systems, Robotics, IoT, or Big Data.

While some of them were naturally constrained in scope to be not suitable for venture funding, most of them were just not ambitious enough or did not look far enough ahead to envision a business that would attract venture funding even when that potential existed.

Entrepreneurs, who are convinced of the “goodness” of the idea, may incorrectly interpret lack of funding interest in such weak pitches as investors either avoiding risk or looking for the next unicorn rather than good ideas.

Part 3 of this series will discuss in more detail how the Indian ecosystem of entrepreneurs, angels/incubators/venture funds and advisors contribute to this problem and how they can solve it. The rest of this article will focus on the self-limiting aspect of the legacy approach to entrepreneurship in India and on common misunderstanding of venture funding both of which lead to negative perceptions on the ease of funding.

Entrepreneurship in India has legacy conceptions

Entrepreneurship in India is not new. If you loosely define entrepreneurship as anything in which an individual or a team set out to create a business, it has existed in India for centuries. Traditionally such businesses were boot-strapped with self-funding to become profitable. Subsequently, money was obtained if necessary from banks, wealthy friends or community members to scale the business. The capital providers then received their money back with some returns as the company scaled to derive sufficient profits. This model is valid and will continue to be valid for creating many types of businesses.

The problem arises from looking at venture funding as another source for the same model. This can be unproductive for a couple of reasons:

1.  Venture funds value returns over social impact

Nobility of purpose may sacrifice financial upside of a business idea. Wealthy patrons, grants or trusts may be more pre-disposed to invest based on impact in the legacy model. While some venture funds invest in a few companies for the social impact value, this is more of an exception than the norm.

Venture funds are pooled money management entities set up to realize significant returns over a certain period of time, typically 8 to 12 years, and hence judge ideas based more on ability to generate such returns than on impact. This is not necessarily a bad thing. Unfortunately, a not uncommon expectation that venture funds should look at the impact leads to entrepreneurs being less than aggressive in business models to achieve higher returns. Impact and returns are not mutually exclusive. However, impact is not a substitute for return potential in most venture funding decisions.

2.  Venture funds are designed for exits with multiples of investment

The need for venture investors to exit preferably with returns of multiples of investment within a certain time frame is not universally understood. Extreme opinions such as investors

“want to get 10x returns within 2 years” or they “only want to invest in billion dollar unicorns or companies with hockey-stick projections” are incorrect but persist often as a reaction to not getting funded. The real reason for not getting funded, even for good ideas and good teams, is, quite simply, not understanding the venture funding expectations which are far less than those extreme views. At the other extreme, the legacy approach of creating a profitable, sustainable business slowly over a period of time often results in “lifestyle” businesses which may be great for the founders and employees but unattractive to venture funds.

So what are the expectations to satisfy for venture funding? As the bottom line, the business idea and progress should lend itself to provide an exit for the venture investors in reasonable time. This is the only way venture investors realize returns and the reason for them to invest.

Fig. 3 shows the relative strength of the four types of exits in India for investors over the last 10 years. Secondary exits are events in which large investors come in at a later stage and purchase shares from early investors. Examples include Softbank purchases into FlipKart, Ola and Paytm. Strategic exits are acquisitions by larger companies.

Examples include Ola’s acquisition of Taxi For Sure and Snapdeal’s acquisition of Freecharge. Initial Public Offering (IPO) and buybacks from the company itself are much less common in India. Business ideas which are likely to have realistic opportunities later on for secondary or strategic sales are much more likely to get venture funded.

The legacy approach to entrepreneurship typically realizes first revenue and looks for funding to get more revenue. This, by itself, is not sufficient for venture funding. One would need to make the case that the business has the potential to grow in scale to be more than a “lifestyle” business and do so in a reasonable amount of time.

Contrary to some commonly held views, venture investors are not looking to flip companies in a year or two. Fig. 4 and 5 provide a sobering view of the reality of exits in India. Most exits (not all are able to exit) provide 2x-5x returns and can take 4-8 years to do so.

The reason it is important to understand this is so that entrepreneurs are not discouraged from seeking venture funding based on misconceptions. Understanding the expectations allows them to design a business around their ideas at a scale that makes it attractive for venture investors.

Summary

Venture funding situation in India is a favourable one for entrepreneurs for several reasons. Money is available for good fundable ideas. Scarcity of good qualified ideas makes it easier for entrepreneurs that can define venture scalable businesses around their ideas to get noticed and to get quick decisions. This makes it easier than in more mature startup ecosystems where a large number of well-designed business ideas are always competing for the limited bandwidth of venture investors to process and make decisions.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house


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