Start-up ecosystem: A goldmine of investment opportunities

The word start-up was added to the layman’s dictionary in January 2016 when the Government of India launched the Start-up India initiative. It transformed how the markets, potential entrepreneurs, and investors viewed start-ups. It allows youth to take risks with their ideas and become job creators rather than job seekers.

Not once in India’s history have so many prominent figures come together to support start-ups and help them succeed globally. After all, it is not just about an idea and a lot of enthusiasm but also leadership potential, industry knowledge, practical communication skills, and flexibility in dealing with several circumstances. According to some reports, many high-profile CEOs leave their positions to create or work for start-ups.

All these efforts were fructified as India emerged as the third-largest start-up ecosystem in the world, with over 60,000 start-ups and 73 unicorns (those that reach $1 billion in valuation) in multiple industries.

Economic survey 2022 highlighted that at least 14,000 start-ups were recognised by the department for promotion of industry and internal trade in India having at least one new start-up. The cherry on the cake is that a record 44 Indian start-ups achieved unicorn status in 2021.

There is no fixed definition of a start-up. It can broadly be understood as a freshly formed business with a viable economic model that addresses society’s demands by generating a positive feedback loop. In an emerging economy like India, inclusive and efficient start-ups play a vital role in increasing economic development and reducing income inequality by discovering new solutions to industry-wide challenges.

One can aptly describe our country’s burgeoning start-up ecosystem as thriving, booming, and progressive. It is evident from the record growth of 3.8x in Venture Capital (VC) funding in India in 2021 over 2020 (faster than China’s 1.3x) and the number of VC investments minted in 44 unicorns, exceeding China’s 42 unicorns in the year. The primary reason is a positive macroeconomic outlook for India and capital flight owing to increased regulation on technology firms(fintech and edtech)in China.

The convergence of several factors is driving this investment in India – a perfect storm of educated young talent, digital infrastructure including the Unified Payment Interface (UPI) and Aadhar-based KYC, cheap data availability, increased financial and digital awareness; depth in demand and capital, among other enablers, is brewing.An added bonus is the relaxed norms of IPO by India’s capital market regulator, SEBI, which reinvigorated investor confidence. At least five high-profile IPOs in 2021 were the companies with VC backing.

Though more than two-thirds of VC investments by value are directed towards sectors like Consumer technology, fintech, and software as a service (SaaS), online business-to-business (B2B) marketplaces, digital and consumer health, tech-enabled healthcare services upskilling and life-long learning tech, cross-border commerce,Web 3.0 and crypto-based start-ups are seeing increased traction. Moreover, Indian unicorns became category-defining leaders globally, such as Postman in API management or BrowserStack in automated testing.

Industry 4.0, with robotics, data transfer, networking, artificial intelligence, and machine learning as its primary segments, is an opportunity for a start-up in India.It enables firms to understand their processes better and gain access to real-time data to boost efficiency, streamline processes, and drive innovation

Given this exciting Indian start-up landscape, India’s active investor base has significantly expanded, reaching 660+ from 516 in 2020. Early-stage rounds, from pre-seed to Series A funding, saw increased participation from several seed funds and family offices. New investors, like Tier 1 global VCs and crossover funds, Emerging domestic VCs, and international sovereign funds (Abu Dhabi Developmental Holding Company [ADQ], Qatar Investment Authority [QIA]), made investments.

The pandemic period proved to be a catalyst for many businesses, both incumbents and start-ups, to reimagine, re-engineer and refocus. Particularly, start-ups faced the unforeseen consequences of the pandemic, survived, and thrived on the uncertainty, showcasing their antifragility.

When firms are unlocking substantial economic value and aiming for the stars, why should we, as investors, miss this bus?Investors have already begun to consider these alternative investments while making portfolio decisions. It appears unlikely that the quantum and momentum of financing would shrink, as the private market remained reasonably steady amidst the recent foreign capital flight from India. Rather, as the comfort level of investors increases, in light of the robust regulatory framework, the total funds available for the start-ups would rise exponentially. The Indian entrepreneurial ecosystem offers a compelling investment opportunity, with a potential annual return of approximately 20% if done properly.

Focus on quality rather than mere popularity. Examine operational efficiency and corporate governance aspects of the firm. Understand unit economics and don’t be a victim of familiarity bias. If finance is not your area of expertise, it is better to invest in a venture capital fund managed by an expert, which will have a higher probability of success.

While searching for higher returns, don’t overlook the costs. Globally, 95% of VC funds underperform benchmark return after fees. So, investing in a low-cost venture capital fund is essential.Most funds charge 2+ 20 (2% per annum and 20% profit share). Profit-sharing fees of 20% eventually eat up all the returns, and investors make Nifty or even lower returns.

Global capital markets are under pressure, and this situation is expected to continue, impacting the start-up valuations. Look out for rationalised valuations in the emergent sectors in your satellite portfolio to the tune of 5%-10% of the portfolio.

Never ignore the fundamental rule of diversification while investing, irrespective of the asset class. Preferably, invest in at least five companies spread across sectors. Most probably, out of 5 companies, two will become zero, two will give an average return, and one will provide super returns.After all, starting a business is challenging, and one witnesses more failures than successes. One should be prepared to encounter setbacks and tremendous adversity.

In a nutshell, be a part of revolutionising and building long-term solutions for various sectors (such as healthcare, education, tourism, clean energy, poverty, financial services, security, agriculture, and so on) by nurturing an entrepreneurial ecosystem, which is an economic imperative for you as an investor as well.

The article has been authored by Mukesh Jindal, co-founder, Alpha Capital.

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