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Early-stage startups emerge as the sweet spot for investors in India

In the first four months of the year, India has seen 55 to 60 early-stage deals, almost the same as last year.

Photo by Nathan Anderson on Unsplash

At a time when a majority of growth and late-stage startups are struggling to raise money as they weather the COVID-19 induced slowdown, early-stage companies are turning out to be the bright spot for investors in India, the world’s third-largest startup ecosystem.

Early-stage investors including InnoVen Capital, Venture Catalysts, Prime Venture Partners, YourNest Venture Capital, WaterBridge Ventures, and Sequoia Capital’s accelerator Surge are on the lookout for innovative ideas and products that have the potential to become significantly big in the post-coronavirus world.

“The seed and Series A investment landscape continues to be active – though at a somewhat slower pace,” Rajan Anandan, managing director, Sequoia Capital India told KrASIA. “At the seed stage, an investor takes a 10-year view on the word and all of us can agree that the long term outlook for India and SEA [Southeast Asia] is very positive.”

Ashish Sharma, CEO of Temasek-backed venture debt firm InnoVen Capital, believes that while the overall funding has come down since COVID-19 unleashed itself, the impact on early-stage companies has been moderate.

“In January and February, the amount of funding was significantly higher, but it was largely concentrated in growth and late-stage [companies],” Ashish told KrASIA. “So when the funding slowed down [starting March, when the crisis hit India], it was more pronounced in growth and late-stage companies.”

According to him, pre-series A and Series A companies continue to maintain the first two months’ pace of raising money–roughly about 25-30 deals–in March and April as well.

Also read: We will invest in 100 early-stage startups in three years: Q&A with Apoorva Ranjan Sharma of Venture Catalysts

One of the reasons early-stage startups remain an attractive opportunity for VC funds during the healthcare crisis, is that they can get a better deal at a comparatively lesser valuation than what funds would have to pay for, if things were hunky-dory.

“When the market is booming, you don’t get the right valuation,” Apoorva Sharma, co-founder and president at Venture Catalysts, an incubator backed by a network of angel investors, told KrASIA. “So most of the VC funds, especially early-stage investors, are aggressive right now because they can get deals at very reasonable prices.”

But the more important reason for investors to scout early-stage deals is that they will have dibs on companies that are offering products and solutions relevant to the new habits or the behavioral changes the pandemic would likely create.

“A lot of economic and social challenges that will emerge over the next several months will be COVID-19 related,” said Rajan. “We are keen to partner with startups that are using technology to disrupt the world, founders who are looking to solve problems at a national or global scale and ideas and products that can have a massive impact on the lives of people or businesses.”

Investors who go after Series B and higher funding rounds are currently busy softening the impact of COVID-19 on their portfolio companies. Since the focus is on saving their own companies, they are looking at primarily internal rounds and not new rounds of funding as much.

Furthermore, funding in late-stage companies requires stricter due diligence which calls for people on the ground.

“We are in an unprecedented situation, the likes of which the world hasn’t seen in a century and on top of that, the investors can’t meet the founders or conduct traditional due-diligence, among other things,” said InnoVen’s Ashish.

“But if you look at Seed or pre-Series and Series A investors, there is a good level of dry powder,” he said. “A lot of funds were raised in the last couple of years which will be available to invest over the next two to three years.”

Accel, Blume Ventures, Unicorn India Ventures, Ankur Capital, Mantra Capital, and Venture Catalysts, among others, have raised funds in the last six months. Just recently, AngelList’s India head, Utsav Somani announced a micro VC fund iSeed to back up at least 30 startups over the course of two years.

“Most early-stage VCs have a local presence and local decision making, which makes it easier to take investment decisions,” Ashish said.

The changing power dynamics

Till earlier this year, when the Indian startup ecosystem was seeing an uptick with a few technology firms making successful exits, global and local venture capital firms were chasing startups, ready to write cheques even at a higher valuation.

The novel coronavirus crisis has changed that. According to investors, it’s VCs who are dictating the terms today, as it’s no more a founder’s market.

“Today, there is more demand for capital than supply as compared to the last three years,” said Ashish. The terms of the investment agreement, he said, “might be a bit tighter than what was prevalent when the market was hot over the last three years.”

A tighter investment agreement, according to Ashish, might translate into slightly lower valuations, and money coming in tranches depending on the milestones achieved by the company. “There will be more down-side protection that investors may seek.”

Moreover, VCs are looking at sectors that have performed relatively better than others during this healthcare and economic downturn.

“While the majority of the sectors are adversely affected due to COVID-19, there are certain sectors that are seeing tailwinds. So investors are actively looking at six to seven sectors which will benefit due to the new normal,” Ashish said.

Companies working on content and OTT (over-the-top) offerings, online education, hyperlocal delivery, online grocery, gaming, telemedicine, and online fitness would see an increase in interest from investors.

According to Rajan, the US-based firm is excited about sectors like edtech, digital health, SaaS, SME tech, B2B commerce, and direct-to-consumer brands.

“SMEs are the backbone of the economy in both India and Southeast Asia, and we believe the time has come to drive innovation for this segment,” he said. “Products and services which help to digitize SMEs have massive potential. Many of our Surge companies across all three cohorts—such as  Khatabook in India and BukuKas in Indonesia—are building for SMEs.”

Venture Catalysts’ Apoorva said their preference has changed due to the new normal, and now they are specifically looking at sectors such as healthcare, biotech, deep tech, supply chain, and FMCG (fast-moving consumer good) companies.

Some of the early stage startups that raised money over the last two months include Pune-based fitness startup Fittr, Yoga and wellness startup Sarva, data collaboration startup Atlan, online virtual event organizer platform Airmeet, location analytics startup Locale.ai, an edtech startup Winuall, physician engagement startup Doceree, and agritech startup Intello Labs, among others.

While the sectors mentioned above are attractive to early-stage investors, it doesn’t mean companies in this space will have it easy, as VCs are setting the bar high for the startups they would want to invest in.

“The biggest change in the ecosystem is the renewed focus on building companies that have viable business models. The era of ‘growth at any cost’ and ‘fund your way to growth while burning large sums of money’ is behind us,” Rajan said.

He believes demonstrating positive unit economics is extremely critical for founders. According to him, investors are looking to understand how a startup will evolve, and assessing how likely it is that this company will be able to build a viable economic model. For the next batch of Surge program, Rajan said, they would look at sectors that can either counter the fluctuations in the economic cycle or have the potential to recover faster once the situation improves.

“In a nutshell, the bar has gone up and it is more important than ever to focus on building very quality companies,” Rajan added.