Indian VCs have contributed immensely to the technology ecosystem but the Indian venture market needs more domestic capital and homegrown investment firms, particularly in the growth and later-stage segments.
- By Sameer Nath
At the outset, let us assess the health of the Indian venture market today. Per the India Venture Capital Report 2021 by Bain & Co and IVCA, the market has developed significantly over the last decade. From 2012 to 2020, deal volumes grew around 3x from $3.1 billion to $10.0 billion, the number of deals grew around 2x from 458 to 809, and the number of unicorns grew from 0 to 37 (notably, 12 unicorns were created in 2020, the highest increase in a single year). Despite the COVID pandemic, 2020 saw one of the highest activity levels in venture capital investment, second only to 2019.
These heartening statistics indicate that the Indian venture market is thriving and that the pace of value creation is accelerating. However, there is some inequality within this expansion. First, a massive amount of capital has been invested through Series A, creating a robust early-stage segment in the market. 2016-2020 data from Tracxn shows that early-stage deal volumes were around 7x that of the growth stage on average. Second, a substantial amount of capital for venture investments in India has been raised from international sources. Of the $3 billion raised by India-focused venture funds in 2020, more than 75 per cent was raised internationally by four large global funds.
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What role have Indian corporates played
While no one has created an impact like that of Alibaba and Tencent on the Chinese technology ecosystem, it is instructive to analyze two illustrations in the Indian context: Reliance Industries and InfoEdge. Reliance has prioritized the technology industry: 17 out of 20 acquisitions and 9 out of 16 investments have been in technology, indicating a buyout orientation. In terms of stage, Reliance seems to have adopted a “barbell” approach: 6 investments have been in the Seed/Series A stage while 4 have been in public companies.
In comparison, InfoEdge has made several technology investments but has been very selective about acquisitions. Across InfoEdge’s 30 investments, 16 have been in the Seed/Series A stage while only 4 have been in the late stage. It will be interesting to observe how Indian corporates engage with startups in the coming years. It is reasonable to expect technology unicorns to add strategic investments in startups to their scaling playbook.
What role has the Indian government played
In a free-market economy, the government is best positioned to be an enabler of innovation and reduce friction across the ecosystem. The government has made valuable contributions to the development of the technology ecosystem in India via entrepreneur-friendly initiatives including Digital India and Startup India. Government-affiliated institutions have also played a significant role. Equally important, the government can mobilize domestic capital formation for the technology ecosystem. The Standing Committee on Finance made a revealing observation in their report to the Parliament last year: “Industry data indicate that more than 80 per cent of startup financing is coming through foreign capital, largely channeled through the venture capital and private equity industry. India’s financial system must be strengthened to ensure that much more domestic equity capital is available to scale up our startups. This will support our goal of building an Aatmanirbhar Bharat.”
The government has taken a series of positive steps to boost funding for the Indian technology ecosystem in recent years, both directly (via sovereign schemes) and indirectly (via policy reforms). Just last week, the government opened up another pool of domestic capital by allowing private pension funds to invest 5 per cent in Category I and II AIFs.
What else required to further develop tech ecosystem
Capital requirements for startups evolve as they grow from nascent ventures to full-fledged enterprises. While early-stage funding has come a long way in India driven by a wide range of risk capital available to entrepreneurs, downstream pools of venture growth and late-stage capital have remained relatively underdeveloped with ebbs and flow over the last decade. As companies cross the product-market-fit chasm and begin to double down on expansion strategies, growth capital can help accelerate their trajectories. Like the U.S. and China, India’s technology ecosystem will benefit from a more stable pool of capital dedicated to the growth and later stages.
Specifically, there is a need for increased domestic capital in these segments, which have been dominated by international investors (and a need for capital that is focused on investing fundamentals rather than global macroeconomic cues). For example, Tiger Global was the most prominent investor in India’s technology ecosystem in 2020, participating in seven investments above $100 million. SoftBank played a similar role in 2018-19. The slew of technology IPOs anticipated in the coming months has improved investor sentiment. Successful proof points will enhance overall confidence in the Indian technology ecosystem.
The regulator is examining rules to encourage startups to go public and other innovative regulations (e.g. allowing Indian companies to list internationally and creating India listed SPAC vehicles) are also under consideration. Happily, there are signs that the government’s constructive actions towards domestic capital formation are spilling over into the private sector, unlocking new pools of capital for technology investments. This week saw the timely launch of India’s first pre-IPO fund dedicated to technology listings by IIFL, raised entirely from domestic family offices and HNIs.
In conclusion, India may not need its own Alibaba, SoftBank, or Tiger Global to take the technology ecosystem to the next level. As analyzed, the technology ecosystem in India today is vibrant. Further development will follow a unique path and will be driven by India’s dynamics rather than direct replication of overseas models. Per NASSCOM and the India Venture Capital Report 2021, India already has the third-largest startup ecosystem in the world (trailing only the U.S. and China) with 112,000 startups, 520 active VC funds, and a track record of creating more than 3 million jobs directly or indirectly over the past eight years. India’s progression from this healthy position will require multi-faceted evolution and cooperation from key stakeholders. The quality of Indian founders continues to improve with recent cohorts including more seasoned and serial entrepreneurs. With the imminent advent of technology IPOs, Indian entrepreneurs will need to figure out the path to profitability as part of their growth journey.
Indian VCs have contributed immensely to the technology ecosystem but the Indian venture market needs more domestic capital and homegrown investment firms, particularly in the growth and later-stage segments. The sustained availability of public equity capital for Indian technology companies will represent a huge step forward. Indian corporates are in the early innings of engaging with the technology ecosystem and will need to discover their preference between the U.S.-style strategic acquisition and the Asian-style strategic minority investment approach. As technology companies scale and go public, they are likely to look to inorganic options to sustain their growth levels as well as strengthen expertise in specific areas. Finally, the government should continue to play its role as facilitator and enabler, as it did during the phenomenal success achieved by the Indian IT industry over the last three decades.
Sameer Nath is Managing Partner, TrueScale Capital and Iron Pillar India Fund I, and former Managing Director, Citigroup. Views expressed are the author’s own.