Private equity discovers bottom of the pyramid

With a staggering increase in capital invested across social ventures?$404.58 million in 2010 as compared to $150.36 million in 2009?private equity/ venture capital players are finding a fortune beyond the tip of the pyramid.

With a staggering increase in capital invested across social ventures?$404.58 million in 2010 as compared to $150.36 million in 2009?private equity/ venture capital players are finding a fortune beyond the tip of the pyramid. And, in a turn of focus, interstitially more and more mainstream PE/VC funds are also venturing in this hitherto reserved space of social venture capital funds, making the investment play in the segment dynamic like never before.

Fathom this: If social VC funds such as Acumen Fund, Gray Matters Capital and Omidyar Network, in tune with their goals, are investing in a lighting and power company D.light Design, which delivers affordable and quality solutions to serve families living without adequate electricity, it?s being matched up by investments made by mainstream players such as Draper Fisher Jurvetson India (DFJ), who are driven solely by commercial gains.

So what is fuelling this growing interest in the social investing space by mainstream players? Draper Fisher Jurvetson India has made recent investments in environmental & facilities services firm Attero Recycling Pvt Ltd and D.light Design Pvt Ltd. Mohanjit Jolly, managing director, Draper Fisher Jurvetson India, points out that there is no denying the sheer population and collective buying power in the rural/semi-urban India. ?It is clear that for India to continue on the economic growth trajectory, the needs of rural and semi-urban India will have to be addressed, whether that has to do with infrastructure, power, clean water, healthcare, education, financial services and retail/ distribution. With giants like P&G, Airtel, Nokia, Hero Honda and others seeing massive opportunity in that segment, it?s no surprise that start-ups and VCs are eager as well. With increasing successes as data points (telcos and MFIs for example), investors and entrepreneurs will continue to become increasingly confident about targeting the segment and creating large profitable entities,? he adds.

To cash in on the opportunity, several of DFJ?s portfolio companies already have a focus on this segment, including Husk Power (rural electrification) and mchek (in the mobile payments and financial inclusion space). ?Understanding and addressing the BoP is a key thesis for DFJ in India and we are actively looking at deals addressing rural/semi-urban India,? Jolly says, adding that he is delighted with the type of companies and entrepreneurs he is interacting with. DFJ has traditionally invested in consumer-facing technologies, including online and mobile, as well as having a large cleantech portfolio?with four companies in India, including D.light, Husk Power, Attero and Deeya Energy. In addition, DFJ is looking at healthcare and education very closely, with a bias towards technology or technology-enabled companies.

Indeed, an opportunity hard to miss. As Kunal Shrivastava, research director, VCCEdge, says, ?For a social VC fund, the opportunity lies in serving a social cause while generating returns. However, the scale and growth these opportunities present has now caught the attention of mainstream funds as well, where returns maximisation remains the sole agenda, and meeting a social target is just a derived benefit. These investment opportunities are difficult for even mainstream funds to ignore.? Shrivastava adds that businesses focused on provision of modern amenities, infrastructure, consumer and financial services, energy and technology distribution, etc, are penetrating the rural level and emerging as potential investment havens for VCs.

?We see several gaps in the rural/semi urban markets and we continue to seek opportunities that can leverage the large consumer base in this market segment. We are open to investing in rural and semi-urban opportunities, provided we see entrepreneurs and companies that have business models that can create large scaleable markets,? confirms Ash Lilani, managing director, SVB India Capital Partners. SVB India Capital Partners, and Elevar Equity Advisors, invested $3.24 million in Autoinvest Leasing & Finance Company, known as Vistaar Livelihood Finance, which provides affordable finance to women entrepreneurs.

Sanjeev Bhalla, head, equities and alternatives, Bank of Bahrain and Kuwait, and founder of India PE, a web portal dedicated to private equity, opines that social investing is growing due to corporatisation of projects in rural areas. ?PE/VC interest is growing in projects that make business sense; also, PE/VC funds provide management capabilities and resources to turn these projects into great businesses. There is room for making serious money in some social projects in rural areas. Investors made good profit by investing in MFIs. There is also a huge opportunity in agriculture and agriculture processing and exporting sectors. Moreover, outside investors will open doors by suggesting innovative farming methods and other resources,? says Bhalla.

Time frame

Betting on the agri space, the year also witnessed another mainstream player making a substantial investment in the agri arena, with Summit Partners investing $30 million in Krishidhan Seeds. Amit Chaturvedy, vice-president, Summit Partners, explains that Krishidhan Seeds is a great example of the kind of market-leading, rapidly-growing privately-held businesses. ?We saw tremendous opportunity for organic growth and consolidation in India?s fragmented agriculture sector, and determined that Krishidhan Seeds is well differentiated and on the cusp of capturing the larger market opportunity in India, Europe, south-east Asia and Africa,? he says, adding that Summit Partners sees enormous opportunity in the sector, particularly with businesses that use technology to deliver products and services to mass populations in rural and semi-urban markets. ?A number of these companies are scaling up quickly, but the key to profitable growth is an acute focus on the unit economics of the business.? Since its founding in 1984, Summit Partners has made growth equity investments in more than 300 companies across sectors and in India, it is particularly interested in technology, healthcare, education, financial services and consumer products.

However, given the longer gestation period in rural and social capital space, experts debate if the social sector will continue to enjoy similar traction. Chaturvedy explains that businesses operating in the rural/SC space have to scale up in size, prove that they can be run profitably, and also improve their corporate governance practices, all of which takes time. ?From an investor?s perspective, it?s a question of the cost of capital and where you can deploy it globally to maximise returns on a risk-adjusted basis. The rural/SC space offers strong market potential, which balances the longer investment horizon?a point that patient investors have to understand,? he says. In similar vein, Jolly opines investors will need to be patient and let the space evolve over time. ?Those who are looking for a quick flip will be disappointed, but those who understand the enormity of the opportunity, but at the same time are willing to work with start-ups over a period of time, will reap the benefits in future. The key, like any other venture, is to find teams that have the right combination of passion, persistence and domain knowledge to address the large, but highly fragmented market,? he feels.

Gestation period is a function of the business model, avers Alok Mittal, managing director, Canaan India. ?One of our companies, Naaptol, for example, does majority of its home shopping business in smaller towns and semi-urban areas. The model is extremely scalable within the four-six year time frame that we invest for. The relevance of businesses in rural/SC space to venture capital will be critically dependent on the returns and timing constraints inherent in the venture investing model,? he says. Canaan India invested $9.66 million in Equitas Micro Finance India Pvt Ltd in 2010.

Parking lot

So where is the moolah being parked? Even as microfinance is grabbing a lion?s share in the social capital space, other sectors, too, are catching the eye of mainstream investors of late. Avnish Bajaj, MD Matrix Partners, which has recently invested in Bhartiya Samruddhi Finance Ltd (BSFL), opines that often in India, infrastructure is touted as the biggest draw, but within infrastructure, the softer infrastructure segment will hold the key. ?These will include financial services, health and education. Matrix is investing in these soft infrastructure sectors, even as we do not necessarily classify them as social investing. The driver for investment is how deep the opportunity is. Markets get far deeper and interesting if you look beyond the tip of the pyramid. The idea is to concentrate on key verticals,? he says.

Matrix Partners is playing in the middle to the BOP category and has invested in Muthoot Finance, ItzCash and MFIs such as BSFL In sync with their global investing strategies, some fund houses are sticking to their overall investment basics. Globally, Canaan focuses on early stage technology-enabled ventures and Mittal says its focus on India mirrors that. ?It includes areas such as consumer Internet, mobile value-added services, offshore services, enterprise software, payment technology and the like. We believe that this is a growing area of interest and will amplify in the coming years. Both the markets, as well as quality of entrepreneurs in these areas, are visibly improving and capital will follow those.?

So how will this growing interest by mainstream investors in the social capital space playout vis-a-vis social VC players? Rohit Madan, associate director, private equity,

KPMG India, says both have a role to play and eventually can be complimentary to each other. ?Social VC funds are generally smaller and invest at a very early stage. They can help a business by funding it at a pre-revenue stage and nurturing it till it has stable revenues and is larger. Mainstream VCs can then get involved and fund the next stage of growth.?

However, some experts believe that mainstream players in the long run will give social VC funds a run for their money. As Bajaj rounds up, ?We anticipate more mainstream players entering the BOP/social sector segment and there will be an increase of 70% investment in the segment on an yearly basis by mainstream funds. At the moment, 80% investment in the segment is coming from SVC funds and development financial institutions (DFIs), but within the next four years, it will be a 50-50 market for mainstream and SVCs.? And the scale, Bajaj predicts, might tilt in favour of mainstream investors, ?As opportunities in the segment will grow, more and more capital will be needed to scale up and that scaling up capital will come from mainstream investors with deep pockets.?

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First published on: 05-12-2010 at 22:30 IST