Startup hotspots around the world enjoy certain reputations. Israel is known for deep tech in all kinds of applications. Silicon Valley can throw up world-conquering tech and social networks but also companies that focus on the imagined needs of the urban American elite.
China has created massive platforms, helped along by state protectionism, but has also managed to embed mobile commerce in daily life to an extent unfamiliar in the West. India is known principally for the promise offered up by its large domestic market, and lately also for the rich harvest of fast-growing start-ups valued at more than $1 billion, known as unicorns.
But when it comes to the cold logic of returns on investment, the stark metric that underpins all of the frenetic activity and froth that bubbles to the surface, the stories can be very different.
Silicon Valley is what it is because it is where investors have made dizzying returns on the small angel investment cheques they wrote. The thirst for returns of the financing business that facilitates technology innovation at great risk of failure has been richly satisfied again and again.
It is an asset class that nothing else in the world can quite match when it comes to the rate of returns, as long as one has a solid appetite for risk, and an understanding of technology and consumer needs.
Indian startup ecosystem and the ancillary financing business are of course at their infancy compared with Silicon Valley. But for more than a couple of decades now, it is focused on soaring valuations and furious deal-making.
Now that matters have gotten to a degree of maturity, and the halo of the promise has made way for the reckoning among returns, a few interesting trends can be discerned. One, the conversations in boardrooms and slick corridors of well-funded startups have changed from market potential and market share to earthy realities such as unit economics and path to profits.
Second, while the aggregate picture of returns from Indian startups has not been terrific — $50 billion in returns for the $48 billion in foreign risk capital that came in, by some estimates — we are beginning to see healthy exits being made by investors who came in early.
This will likely have two fallouts. Competitive investors who are yet to have good exits will start to push for one. And secondly, as the gospel of returns from Indian startups spread among the flock of global investors, the current round of healthy exits will likely spur the next wave of risk capital.
And lastly, investors seeking an exit without the conventional IPO route or in subsequent funding rounds are helping shape an informal secondary market in shares of hot startups — a healthy mechanism that will ease investor worries about the lack of an exit path.
Together, these trends are making it an interesting time and signalling maturity in India’s startup ecosystem — one that puts exits and returns, instead of fundraising and valuations, firmly at the centre. While the Walmart-Flipkart deal may have been a catalyst, there has been a noticeable change in the mindset across entrepreneurs, bankers, and investors.
“There has been a change in a blinkered investment-only focus from investors as other late-stage options become available and corporates and strategic investors become convinced of India’s startup story,” Vijay Shekhar Sharma, founder of Paytm, told ET Magazine. “So, we are seeing more hard-nosed conversations around topics such as unit economics and profits than before, which can only be good for the industry.”
There has been some good news on returns over the past two or three years with investors making handsome returns on their investments. Examples include Flipkart and Ibibo — founded in the past decade — being acquired by Walmart and Makemytrip, respectively.
Late-stage investors are making their impact felt, according to management consultancy Bain.
In its India Private Equity Report 2019, the firm noted that exits have increased consistently, with 265 exits in 2018, valued at nearly $33 billion.
“Even excluding the $16 billion Flipkart sale to Walmart, it was one of the strongest years for exits in the last decade,” the report notes.
But, in between, there have been hundreds of investments that have crashed and burnt or died a slow death. In ecommerce, for every Flipkart, there is a Snapdeal and Craftsvilla that have struggled, in fintech, Paytm and Phone Pe’s outsize success has seen Momoe and Loan Meet overshadowed, while Swiggy and Zomato have seen their valuations skyrocket in food tech even as Dazo and Hola Chef flopped.
A key driver for both investors and entrepreneurs in making a successful exit is timing. Too early on and the venture is undercooked. With an unproven business model or inadequate traction, valuations can be underwhelming.
Wait too late to exit and the ecommerce company or fintech upstart can be too costly, as it has scaled rapidly and is already talking of being the next unicorn out of India. The unit economics also begins to turn adverse as spending on customer acquisition begins to mount to maintain market leadership.
Founders too have their own concerns — they are fully invested in the first couple of rounds of investment, but by around series D, they own 10% or less and have limited say over the firm they started, or its future. Instead, top investors may lead the way, pushing to sell their shares to private equity giants or a wholesale acquisition itself. The returns sweet spot lies somewhere in between, balancing the outsize returns demanded by the financiers and the aspirations of entrepreneurs.
As entrepreneurs and investors have sharpened their focus on exits, some of the largest names in the industry, including ridesharing firm Ola, eyewear provider Lenskart, fintech company Pine Labs, food delivery unicorns Swiggy and Zomato and edu-tech firm Byju’s have all been able to rejig their cap table (list of investors) over the past six to 12 months, giving significant returns to old backers even as new ones come in.
In the case of Lenskart, existing investors such as TPG, Chiratae and TR Capital will fully or partially exit the company as behemoth Softbank looks to make a $350 million bet on the firm, taking its valuation past $1.3 billion.
Bessemer Venture Partners, Norwest Venture Partners, Accel and SAIF Partners sold a chunk of their stake when Swiggy raised $1billion in December 2018. Similarly, Sequoia Capital part-exited Byju’s while DSG Consumer — the first investor in Oyo — completely exited the company in March 2019.
“Investor returns are a key focus for Lenskart, even as we make plans to take our business global,” Peeyush Bansal, founder and CEO of the firm told ET Magazine. Lenskart plans to have 150 stores by March 2020 and 2,000 worldwide in five years.
According to K Ganesh, founder of Growth Story and a serial entrepreneur, the local ecosystem has suffered for years from a lopsided investor set up that effectively shut down returns.
While the public market route is mostly written off (entrepreneurs say their ventures are poorly valued), other exit options, including secondary (when one investor sells to another) or strategic sales (like the Walmart-Flipkart deal), are yet to become commonplace.
What has helped investors has been the growth of later-stage venture capital and private equity funds. “Softbank is just the biggest example of this in the last couple of years … others such as Mirae, A91 and Iron Pillar are filling a vacuum in the market,” Ganesh adds.
According to estimates from Tracxn, a provider of deal data, over $45 billion has been invested in series B (typically second round of investor or institutional financing for a startup) and later stages of funding from 2014 to date.
Bankers and consultants, such as Pankaj Naik of Avendus, a boutique advisory firm, say that later stage investors such as Softbank are willing to pay a premium to get a bite of India’s hot startups.
While everyone talks of Softbank’s Flipkart flip — buying its stake for $2.5 billion and selling it for $4 billion in under a year — there may be others in the market such as Lenskart, Big Basket and Swiggy that could provide similar, if not better, returns to late entrants.
As India’s startup story grows beyond the metros and the next wave of the country’s 100-200 million users become well-versed with these apps, more growth potential looms for these companies. “There could be three or four big large public listings from these Indian companies, in parallel to secondary and strategic sales,” Naik says.
This flush of financing has convinced investors and entrepreneurs that the tide may be turning. “Exits are never easy and it takes a lot of time and effort to deal with everyone’s expectations and regulatory issues,” says Suresh Shanmugham, cofounder of Saama Capital, an early stage investor that counts Chai Point, a tea store chain, and Ninja Cart, a daily needs grocery deliverer, as its investments.
“There are now a lot many late-stage investors … both older players and new ones, who are helping this along.”
In 2018, Saama says it profitably exited three investments — fintech firm Mezi to American Express, SCIO Health to tech outsourcer EXL and enterprise mobility solutions provider Mobilya to QuEST Global, a technology company. Shanmugham expects this pace of deal-making to only accelerate as companies sharpen their exit focus.
In a shallow market for public listings, secondary and strategic sales (as seen with deals investors made for ventures such as Dream 11, the fantasy gaming firm, online grocer Big Basket and Mahindra Partners, the in-house incubation unit of the auto giant, acquiring Matrix Partners’ stake in eyecare chain Centre for Sight) may hold sway for some time yet. “Unless it provides an avenue to raise capital in the future and provides liquidity for investors over time, it is better to stay private and seek alternative exits,” Shanmugham contends.
Investors and entrepreneurs debating these options also say that the market has now evolved to a point when late-stage investors — and acquirers— are getting distinct for B2B and B2C ventures.
According to Sanjay Nath, managing partner at Blume Ventures, an early-stage investor in the likes of robotics company Grey Orange and daily tasks firm Dunzo, B2B followon funding is increasingly coming from western funds and strategic investors, even as B2C startups are seeing heightened interest from operators across Asia. “Asian companies know mobile apps, they know scale and they know consumer businesses better,” he says. “Entrepreneurs looking to rapidly grow their consumer-focused startups may be best served by working with them… Entrepreneurs run the business … it has to be the investor or investors who try to leverage the best return on their investments.”
Finding a profitable exit path for their investments, while keeping growth unabated, should dominate startup conversations going forward.