Is Indian start-up space in a funding bubble?

Mohit Ralhan | Updated on October 29, 2021

Start-ups Exciting times   -  istock

Given how VCs raised $3 billion to invest in Indian start-ups, there is little evidence of that

Entrepreneurship is on a rapid rise in India. India is amongst the top five start-up ecosystems in the world. According to the India Venture Capital Report 2021 published by Bain and Company, the number of cumulative start-ups has grown at a CAGR of 17 per cent since 2012 and crossed 1,12,000.

India has 47 unicorns, which makes it the third largest after the US and China. The industry continues to see strong funding momentum, with more than $14 billion invested in the first half of 2021.

While in absolute terms, the number of start-ups and quantum of funding appear on the higher side, but in relation to India’s economy and market size, the evolution of Indian start-up ecosystem is still in its early stage. The funded start-ups are about 8 per cent of the total start-ups and India’s share in the number of unicorns globally stands at 4 per cent, in comparison to the US’s share of 65 per cent and China’s share of 14 per cent.

Both these numbers have potential to be far higher given the constructive policy support by the government. The start-up ecosystem in India has gone through its trials and tribulations over last 10-12 years and has now built a strong launchpad.

This is not only evident in the building of structural strengths such as over 1.5 million engineering graduates, over 500 incubators and accelerators, over 600 million internet users along with one of the fastest growing consumption economies, but also there has been an extremely encouraging shift towards engineering and product start-ups. It is also critical to go beyond hard data and look for anecdotal evidence as well. The strength of Indian start-up ecosystem reflects the most in the increasing risk-taking ability and ambitions of young Indians.

Strong structural factors

We believe that the structural factors have now become quite strong and the momentum should not only continue but accelerates from here on.

The accelerated development of start-up ecosystem needs significant funding and therefore the role of venture capital and angel investors are critical. The valuations they pay, to fund start-ups, have always created debates across the globe and India is no different. Over last 10-12 years, investors have put $70 billion in Indian start-ups and the annualised funding growth of 16 per cent has kept pace with the increase in number of start-ups. Therefore, at the broad level, there is no evidence of a funding bubble.

Investors understand quite clearly that start-ups inherently have a comparatively lower success rate, and their investment strategies are built upon this premise since only one-fourth of the start-ups get follow on funding and less than 10 per cent succeed eventually. This is a well understood phenomenon and the venture capital investors need to have adequate risk management frameworks at the portfolio level, which has been a critical part of all successful venture capital operations.

The fear of a funding bubble or the high valuations that venture capital investors appear to pay on few occasions emanates from inadequate understanding of the investment strategies and risk management frameworks that successful venture capital firms deploy. Also, a few highly successful start-ups with astronomical valuations and a few spectacular failures get discussed disproportionately creating the perception of a funding or valuation bubble. Overall, the venture capital asset class has done well for its investors who understand and provide for the high-risk nature of these investments.

After 10-12 years of investing experience, the India-focused venture capital firms continue to raise funds and invest further in Indian start-ups. In 2020 they raised over $3 billion to invest in Indian start-ups. This is in addition to what global venture capital firms invests from its global pool of capital. This would not have happened if venture capital investors would not have been overall successful in their India investments. The exits have been quite significant and over last 8-10 years, the venture capital investors have generated more than $35 billion in returns from India. The success creates virtuous circle, with both successful entrepreneurs and investors putting more capital into the start-up ecosystem. This creation of virtuous circle is another critical force, that would help in accelerating the start-up momentum in India.

The government has taken several steps to give Indian start-ups required fillip, especially with its Start-up India initiatives recognising its criticality in the growth of Indian economy. With the combined efforts of entrepreneurs, investors and government coming together, this decade is likely to be the best decade for start-ups and we can expect to witness the rise of a few global enterprises from India.

The writer is Managing Partner & Chief Investment Officer of TIW Private Equity

Published on October 28, 2021

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