Are VCs in India going the PE way?

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The two countries fighting wars on two separate continents take the top spot when it comes to US Foreign Aid in 2024. These are followed by a host of troubled nations across Asia and Africa expect Jordan.

The Short Read 📝

How to Get Rich by Peeping Inside People’s Fridges - by The Wired

As Founder and Managing Director of Trinetra, a London based investment firm, Tassos Stassopoulos, has cultivated and monetised the unique habit of peeping inside people’s fridges to develop investment insights. He travels around the world to document how people use refrigerators. Tracing the evolution of its contents across income levels showed a journey.

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Made in Bihar: How Superfood Makhana Works its Magic - by The Mint

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Publisher’s Parmesan 🧀

Are VCs in India going the PE way?

In 2021, venture capitalists (VCs) showered startups with unprecedented capital, promoting rapid growth at any cost. However, the landscape has dramatically shifted. VCs are now prioritizing profitability or at least a clear path to it. This transition raises several questions: What catalyzed this change? Is it typical of funding winters, or does it indicate a fundamental shift in venture investing in India? Are venture firms reconciling with modest returns instead of aiming for grand slams? This article explores these questions and the broader implications for India's venture capital ecosystem.

Historically, VCs have chased exponential growth, often at the expense of immediate profitability. The rationale was simple: a few successful bets could deliver outsized returns, offsetting losses from multiple failed ventures. However, the windfall capital inflow in 2021 and subsequent market corrections have prompted a reevaluation of this strategy. The focus has shifted from growth-at-all-costs to sustainability and profitability.

This shift is not unique to India. It is a typical response to economic downturns and funding winters. However, the Indian market presents unique challenges and opportunities that necessitate a nuanced approach.

The Indian Context: Market Size and Outcomes

India's venture capital market began in the early 2000s, with investors patiently awaiting a large, scalable market. Despite 25 years of growth, India has produced only two startups valued at over $10 billion: Flipkart and Zomato. This scarcity of "super large" outcomes poses a significant challenge for VCs who rely on such successes to justify their investments.

In contrast, markets like the US and China have consistently produced numerous high-value startups. This discrepancy forces Indian VCs to rethink their strategies. With a limited number of high-value outcomes, VCs must consider smaller fund sizes and diversified investment strategies to achieve reasonable returns.

This shift is evident in the actions of major investors like Sequoia and Alpha Wave. Sequoia, after nearly two decades in India, exited the market, while Alpha Wave refocused on traditional businesses over tech and tech-enabled ventures. Similarly, prominent investors like SoftBank and Tiger Global have reduced their activity in the region.

The Indian venture capital landscape has also seen high-profile exits and strategic mergers. For instance, Nexus Venture Partners' MD Sameer Brij Verma left to start his own multi-stage fund, focusing on more modest outcomes rather than multi-billion-dollar valuations. On a more optimistic note, General Catalyst's merger with local outfit Venture Highway signifies a commitment to doubling down on India, signaling hope amid the broader recalibration.

Adapting to a Smaller Market

Given the constraints of the Indian market, VCs are increasingly adopting smaller fund sizes, typically in the $200 to $300 million range. These smaller funds can achieve reasonable returns by investing in startups with $1 to $5 billion valuations. However, larger funds, often exceeding $500 million, struggle to deliver high returns in the Indian context.

This recalibration echoes the strategies of successful US venture firms, which have historically maintained fund sizes around $500 million, even in a more fertile market. Indian VCs are now following suit, adjusting their expectations and investment strategies to align with the realities of the local market.

A significant trend in Indian venture capital is the growing interest in traditional, offline-led business models. Historically, VCs have focused on tech-first, high-growth startups. However, the limited number of successful tech startups has prompted a shift towards offline businesses with robust unit economics and established markets.

The Role of Family Offices and Private Equity

Family offices and private equity firms are playing an increasingly prominent role in India's venture capital landscape. Unlike traditional VCs, family offices prioritize stable, long-term returns over high-risk, high-reward bets. This approach aligns well with the current market dynamics, where large-scale tech successes are rare.

Family offices invest in businesses with clear revenue models and growth potential, often focusing on traditional sectors like retail and manufacturing.

Balancing Tech and Traditional Investments

The venture capital model is rooted in finding disruptive ideas that can scale rapidly. This model thrives in large domestic markets where startups can test and refine their products before expanding globally. While India has yet to fully develop this ecosystem, VCs are balancing their portfolios with both tech and traditional investments.

This balanced approach is a pragmatic response to current market conditions. VCs are hedging their bets, investing in stable, offline businesses while continuing to seek out high-growth tech opportunities. This strategy is likely to persist for the next decade, as the market gradually evolves.

The Future of Venture Capital in India

The transformation of venture capital in India reflects broader global trends. As the market matures, VCs are adapting to new realities, focusing on profitability, sustainable growth, and diversified portfolios. This shift is necessary to navigate the unique challenges of the Indian market and deliver consistent returns to investors.

In conclusion, while the era of growth-at-all-costs may be over, the future of venture capital in India remains promising. By embracing a balanced approach and recalibrating expectations, VCs can continue to support innovation and drive economic growth in one of the world's most dynamic markets. The next decade will be crucial in determining the trajectory of India's venture capital ecosystem. Will be interesting to see how VCs navigate this evolving landscape.

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Disclaimer: The views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group or individual.