Each and every step in the formation of a start-up is a journey in itself. Receiving the incorporation certificate, getting investors, either selling the business or going public are momentous milestones in the journey of the entrepreneur.

Among the thousands of companies that get formed every year, many wither away. But the good news is that, there are several that are successful. In the last 18 years, more than 1.25 million companies have been incorporated. Close to 6,500 of these have received venture investments and about 1,700 companies gave an exit to the investors. What characterises start-ups that are able to achieve such home-runs?

Sectors

Figure 1 provides a proportional representation of the companies formed, funded by venture capital, and those that gave exits in different sectors. The outer circle indicates the proportion of companies formed, the intermediate circle indicates the proportion that got venture funded, and the inner most circle gives the proportion of exits. While agriculture accounts for a large proportion of the companies formed, the proportion of them receiving venture funding or providing an exit is low.

The proportion of companies formed in consumer products and services are lower, but a significant proportion of those getting venture funded belong to this sector. Similar is the case with health tech sector. While venture funds flow to some sectors, its availability is limited to several other sectors. If a start-up falls in the rain shadow region of venture funding, they should actively look at other sources of funding.

Cities

Figure 2 gives the proportional representation of the companies formed, funded by venture capital, and those that gave exits in the large and smaller cities. The representation is similar to the previous figure. Though more than two-thirds of the companies incorporated are from the smaller cities, the proportion of those getting venture funded is less.

The proportion of companies providing an exit is not different from those getting venture funding. Despite a thriving economic environment, access to venture funding is still limited to large cities or fundable start-ups are not many in the smaller cities. Therefore, ensuring an ecosystem enables capital flow to smaller cities while strengthening the venture formation process is critical to achieve more home runs.

 

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Funded and exits

Figure 3 shows the differences between start-ups that have given an exit and those that have not, in terms of the age of the venture, average number of rounds of investment, and the average number of investors in the company. The number in brackets indicate the number of observations.

As expected, the average age of companies that provided an exit was higher than those that had not, indicating that companies need to mature for the investors to get an exit. It takes approximately three years to exit from a venture. Ventures that provided an exit had more rounds of funding as compared to those that have not or yet to give an exit. A possible explanation to this is that staging increases efficiency and thereby has a positive impact on performance, which can lead to an exit. Number of investors is an indication of the level of syndication in the venture. The mean number of investors for companies that have provided an exit is significantly higher than the mean of the companies where there has been no exit. Having investors with complementary strengths can thus play an important role in completing the home run.

Summary

Start-ups that would interest venture investors form only about 22 per cent of the companies that are founded. Within that segment, companies that get venture funding is only about 2.3 per cent.

This indicates that there is significant scope in increasing the number of home-runs. Sectors such as IT, fintech and payments, and consumer products attract more venture investors. Additionally, the ecosystem in larger cities is more conducive for start-ups.

However, once the company gets venture funding, the sector or location advantages disappear. The proportion of companies that get funded and those that provide an exit is not significantly different. Thus, the start to the home-run may be favoured by the sector or the city, but completing the home-run is defined by venture performance. Being patient, aligning incentives to performance, and investors with complementary strengths makes all the difference between start-ups that win or wither.

The writer is a Professor atIIT-Madras, an Associate at Harvard Kennedy School, Harvard University, and co-founder of YNOS.in

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