Mumbai: It is no secret that for the past several months, more than a few venture capital portfolios in India have been up for sale en masse and at steep discounts.

The problem is that there aren’t many buyers out there for those portfolios. Most of the portfolios on sale represent the so-called copycat investing that has marked the greater part of the past decade of early-stage investing in India and aren’t worth much today in the midst of what is now clearly a prolonged downturn.

“We (the venture capital industry) are getting branded globally for not being able to show much (in returns) for the money that’s gone in so far. There are a lot of portfolios on sale but such sales are not easy to price. Buyers are naturally wary that people are trying to get rid of the lemons through these secondary portfolio sales," says a fund manager at the Mumbai offices of a global venture capital firm who spoke on condition of anonymity.

Since 2007, when venture capital as an asset class returned in earnest to the Indian market, venture capital firms have invested more than $10 billion in local start-ups, mostly in the technology and Internet sectors, according to data compiled by Chennai-based researcher Venture Intelligence.

So far, such investors have struck exit deals worth $8.5 billion. After providing for fund manager fees, which is calculated at 2% on the fund principal on a recurring annual basis, and accounting for principal investments, the profits left for distribution wouldn’t be a very significant sum.

All of that is just the early-stage capital that’s been sunk into the market. Add to that the later-stage or growth capital that has followed the early-stage money, and the overall investment would easily ride up to at least $20 billion.

Much of the later-stage money, which has come mostly from global hedge funds and strategic investors, also remains unrealized, further compounding problems for the early-stage market.

For the past 18 months, since the venture capital market slipped into a downturn, early-stage investors have been more focused on conserving cash and less eager to back new start-ups.

Last year, Series A investments, the first institutional round of capital raised by a start-up, nearly halved to $559 million. The funding crunch continues into this year and, by most accounts, will last several more quarters.

“Early stage investments will remain on pause till investors are able to consolidate existing portfolios. Right now, nearly every venture capital firm out there is trying to get rid of assets that aren’t going anywhere in the hope that they will get at least the principal (investment) back," says a venture capitalist at a Bengaluru based-firm who also spoke on the condition of anonymity.

Copycat investing

The current crisis that the venture capital industry finds itself in today can, to a great extent, be attributed to investors backing too many so-called copycat businesses, especially in the consumer Internet sector.

A substantial portion of the money that has been invested over the past 10 years has gone into businesses that one way or the other tried to clone successful versions from elsewhere in the world.

In the consumer Internet sector, these manifested themselves across a variety of segments such as e-commerce, cab-hailing services, food ordering and delivery services or the so-called food-tech segment, online classifieds and property search.

Now, there’s absolutely nothing wrong with borrowing business models from overseas markets. Except, it cannot be done without paying heed to ground realities.

“Even if business models are borrowed from the West or East, they will need to have some strong India-centric localization to make the business both differentiated and better suited for Indian consumers. For example, we have fintech models that cater to the mass consumer market," says Niren Shah, managing director at Norwest Venture Partners India, a franchise of Silicon Valley-based Norwest Venture Partners which invests in early- and growth-stage companies.

Furniture retailer Pepperfry, classifieds platform Quikr and food ordering and delivery platform Swiggy are among the less than handful of consumer Internet bets the firm has made in India.

In rushing after copycat businesses, investors may have forgotten to diversify their bets enough to cushion themselves against a downturn in select segments.

By nature, venture capitalists tend to invest in a herd. As the so-called copycat businesses gained popularity, investment portfolios became heavily skewed in favour of such businesses.

Further encouragement came from unlikely quarters such as hedge funds and strategic investors who jumped onto the bandwagon.

The entry of such non-traditional investors in the start-up market would lead to a ballooning of valuations that would eventually crash.

The consumer Internet sector alone is estimated to have been the recipient of nearly 80% of all the money that has been invested in start-ups, early- and late-stage, over the past decade.

Eroding valuations

The downturn that is currently in session is largely on account of consumer Internet start-ups losing their bearings in the deluge of capital that flooded the market, especially in the later part of the decade.

“Indian entrepreneurs need to change their mindset. The goal should be to build viable and profitable companies with great business models as quickly as possible. I just don’t understand funding (for start-ups) in billions. I also don’t understand entrepreneurs getting rich without building great companies," says Kanwal Rekhi, founder and managing director of Bengaluru-based venture capital firm Inventus Capital Partners.

The firm has largely stayed out of the consumer Internet rush and invests across the technology spectrum both in India and the US.

Even the celebrated unicorns, start-ups privately valued at $1 billion or more, haven’t been able to withstand the downturn.

Delhi-based e-commerce company Snapdeal, once India’s second most valuable technology start-up, is on the block after running out of cash. Its valuation has crashed from a peak of $6.5 billion to about $1 billion in a matter of months.

Flipkart, the Bengaluru-based e-commerce company in talks to buy Snapdeal, has also seen its valuation erode from a peak of more than $15 billion to about $11 billion over the past 18-odd months.

Though it has recently been able to raise $1.4 billion in a fresh funding round, the jury is still out on whether that will be enough for the company to square off against Seattle-based Amazon.com Inc.

It doesn’t help that the company’s founders, Sachin Bansal and Binny Bansal, have taken a back-seat and its affairs are largely in the hands of its largest investor Tiger Global Management.

But just blaming copycat businesses for the current crisis is a bit harsh, says Karthik Reddy, co-founder and managing partner of Mumbai-based venture capital firm Blume Ventures.

“We tried to build the ecosystem with some large copycat business models and then a bit of classic herd mentality meant that a disproportionate chunk of capital went into these copycats," he said. “But it wasn’t as if these businesses weren’t appropriate for India. The business models needed to be tweaked."

Blume was an early investor in cab-hailing service Ola, one of India’s consumer Internet unicorns, among a host of other start-ups across the technology spectrum.

“The deluge of capital, the need for speed and scale and, funds that were initially disproportionate to the size of the opportunity has created relatively sub-optimal returns. Without an infrastructure for scaling or pools of trained skills or exit routes such as small IPOs (initial public offerings) and M&As (mergers and acquisitions), the first 10-year cycle was destined to be a mild disappointment," adds Reddy.

The next 10-year cycle

While the downturn may have slowed down early-stage investments, they haven’t come to a grinding halt.

Overall, venture capitalists still put $1.5 billion to work across 450 early-stage deals in 2016.

This year isn’t looking too bad either.

In the first five months of the current calendar year, venture capital firms closed 127 deals worth close to $500 million in early-stage companies (from the seed to the Series D stages). Out of that, 59 deals were at the Series A stage and accounted for $254 million in investments, which is nearly half of what was invested at the Series A stage in all of last year, according to data compiled by Venture Intelligence.

Let’s take a look at where the money is headed.

Last year, Sequoia Capital India, the country’s largest venture capital firm by funds under management, made an unconventional bet.

It led a $4-million Series A investment in Bengaluru-based education start-up Cuemath. The start-up offers math tutoring services to low- and middle-income students and was initially seeded by impact venture capital firm Unitus Seed Fund.

Education, with an underlying technology base, is an important area of focus for the storied venture capital firm’s new $920-million-fund raised last year.

Its big bet on the sector from recent times is Bengaluru-based Byju’s that offers online and mobile app based learning content.

The company has also made forays into the relatively new life sciences sector with an investment in Bengaluru-based personalized cancer care and drug development company Mitra Biotech and MedGenome, a genomics diagnostics and research firm based in San Francisco with operations in India.

In December last year, Sequoia managing director Abhay Pandey said in an interview, “We would like to do more Series A deals and some seed. Seed investments are done with the aspiration of converting them into Series A in a short time."

Sequoia has already closed nine deals in the first five months of this year, which include new and follow-on investments.

In Bengaluru, Accel India, which also raised a large fund last year ($450 million), has put money to work across eight deals this year. The early-stage ones in the portfolio include SigTuple, a medical technology start-up that is using artificial intelligence to digitize pathological tests, AgroStar, a company that makes agricultural inputs and products directly available to farmers using a missed call service or an Android mobile application and, trucking logistics start-up Fortigo Network Logistics.

Accel, an early investor in Flipkart and several consumer Internet start-ups over the past decade, has slowed down a bit on early-stage deals but continues to be extremely focused on seed and Series A stage start-ups.

Blume’s Reddy thinks that investing strategies over the next 10 years will be significantly different.

“We still have all forms of bottlenecks in the angel and seed to Series A through B and eventual exit value chain. But, starting with funds like ours, we are finally seeing the core ingredients of a long-term, sustainable ecosystem. The ability to build more viable and profitable portfolios and the confidence to return 3-4X on smaller funds seems suddenly much more probable in the current 10-year cycle," he says.

New generation of investors

The sustainable ecosystem Reddy is talking about includes a vast population of angel investors, a growing number of local family offices and, most important, a new generation of smaller venture capital firms that have taken root in the midst of the downturn over the past 18-odd months.

These new firms, in particular, represent a new generation of venture capitalists who bring somewhat different sensibilities to the table and will play as critical a role in shaping the next 10 years.

For example, in Gurgaon, Pravega Ventures, a venture capital firm founded last year by former SAIF Partners fund managers Mukul Singhal and Rohit Jain, wants to do only seed stage technology deals and back businesses at the concept stage.

Its investments so far include Crofarm, an agri-tech start-up that aims to make fresh produce supply chains between farms and businesses more efficient, and PropertyShare, a platform that claims to enable property buyers to own fractional shares in completed residential and commercial real estate projects.

In Hyderabad, Sateesh Andra and Ramesh Byrapaneni, formerly with Ventureast, are taking a different approach to backing technology and life sciences businesses with their new firm Endiya Partners.

They look for start-ups that are building technology products and medical devices that necessarily have the potential to roll out their offerings in global markets.

Silicon Valley serial entrepreneur and angel investor Vinod Dham is part of the team and will bring his expertise to bear in helping portfolio companies tap overseas markets.

The firm’s portfolio includes CelesCare, a virtual health clinic for women, Kissht, a financial technology platform that makes small loans available to underserved consumers, and SigTuple.

Then there’s Stellaris Venture Partners, founded by former Helion fund managers Ritesh Banglani, Rahul Chowdhri and Alok Goyal, that will target technology start-ups primarily in the Series A stage.

“We are very bullish on business models that are either solving problems unique to India or leveraging the India advantage to provide software products to global markets. Such companies are likely to be less capital intensive and will also hold an edge over their global competitors," Ritesh Banglani had told MintAsia in an earlier email interview last year.

Consumer start-ups

Not all the activity among new funds is restricted to the technology sector.

Kanwaljit Singh, co-founder of Bengaluru based venture capital firm Fireside Ventures, for instance, believes that the time is just right to back a whole host of start-ups that are building home-grown consumer brands. He’s backed a number of these as an angel investor.

These include Hector Beverages, which owns packaged beverages brand Paperboat and Drum Food International, which retails ice cream under the Hokey Pokey brand. He’s now raising a $45 million fund to invest exclusively in such businesses.

Fireside isn’t the only early-stage firm looking at non-technology or specialist consumer start-ups.

Also in Bengaluru, Saama Capital, which has been around for a while and is an investor in New Delhi-based consumer Internet unicorn Paytm, counts fresh fruit juices retailer Raw Pressery and Veeba Food Services, a company that makes food ingredients such as sauces and dressings, among its recent bets.

In some ways, the ongoing downturn in the venture capital market offers early-stage investors a window of opportunity to rebuild some of what they may have lost from the past decade.

There’s certainly more than enough money still available to back the next generation of start-up businesses.

Three of the largest India-dedicated funds, totalling $1.8 billion, have been raised in the midst of the downturn.

At the end of last year, the dry powder, or uninvested capital, available with India-focused venture capital funds stood at more than $3 billion.

That number has grown since then with the launch of several smaller funds and it is a matter of time before the investing cycle begins to pick up momentum again.

Norwest’s Shah, however, sounds a note of caution.

“The early-stage market in India is still relatively nascent and competition between similar start-ups remains intense. Hence, it is important to keep the bar high and look to fund those teams and models which are likely grow despite competition and create enough positive unit economics and scale to be able to exit through an IPO (initial public offering)," he says.

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