India Venture Capital and Private Equity Report 2016
Inspiration and Momentum for the Gladiators A Study and Analysis of the Start-ups
Department of Management Studies Indian Institute of Technology Madras Chennai 600 036 India
© Indian Institute of Technology Madras The India Venture Capital and Private Equity Report Series is an annual publication of the Indian Institute of Technology Madras. Previous reports 2009: On top of the world, still miles to go A report on venture capital and private equity investments 2010: The contours of smart capital A report on venture capital and private equity investors 2011: Fueling growth and economic development Private equity investments in real estate and infrastructure 2012: Stimulus for the new and the nascent A report on angel investments and incubation 2013: Convergence of patience, purpose, and profit A report on social ventures and impact investments 2014: The fuel for wealth creation Capital providers to the Indian venture industry 2015: The alchemy of judgment and objectivity Valuation and structuring of investments
All the previous reports are accessible and can be downloaded from ResearchGate at www.researchgate.net Any correspondence can be addressed to: Thillai Rajan A., Professor, 202, Department of Management Studies, Indian Institute of Technology Madras, Chennai 600036. India. Telephone: +91 44 2257 4569 Email:
[email protected]
India Venture Capital and Private Equity Report 2016
Table of Contents Tab le o f Con tent s
(i )
Li st o f Tab le s
(i ii )
Li st o f Fig ur es
(i v)
Li st o f E xhib it s
(v i)
E dito ri al Tea m and Au th o r s
(v iii )
Adv is or y Rev ie w Bo a rd
(x )
E dito r s’ N ot e
(xi i )
Executive Summary
1
Articles 1. The Start-up Effervescence and Impact
5
2. The Spatial Diffusion of the Start-up Ecosystem
23
3. Trends in the Sands of Time
51
4. The Gladiatorial Arena of Start-ups
77
Perspectives 1. Fintech Start-ups: Making the Elephants Dance
11
2. Should Incubators Romance the Equity Share?
37
3. The Acceleration of the Indian Start-up: A Brief Outline of the Regulatory Changes
67
4. Summary of the Case Studies
99
Reflections 1. The Equitas Journey: A Conversation with P.N.Vasudevan
19
2. Contours of Venture Investing in India: A Conversation with Samir Kumar
47
3. Bootstrapping to $500 million: A Conversation with Sridhar Vembu
73
4. Evolution of Start-ups: A Conversation with Mahesh Murthy
93
Case Studies 1. The Accelerator Program at Axilor
105
2. The Chennai Angels
109
3. Keiretsu Forum, Chennai
115
4. Saffron Incubation and Acceleration
123
(i)
India Venture Capital and Private Equity Report 2016
Appendices 1. Definitions and Explanations
129
2. Useful Websites for Start-ups
131
Acknowledgements
135
(ii)
India Venture Capital and Private Equity Report 2016
List of Tables Table No.
Description
Page No.
1.1
Leading start-ups from India and their overseas comparisons
7
1.2
Scale of reach of start-ups
9
2.1
Comparison of angel investments in Tier 1 and Tier 2 cities
35
4.1
Founding year of start-ups
77
4.2
Maturity index for start-ups in different cities
78
4.3
Number of start-ups founded and funded
78
4.4
Percentage of start-ups funded by type of city
79
4.5
Tier I cities: Maturity index and percentage share of start-ups funded
79
4.6
Maturity index for funded and non-funded start-ups
81
4.7
Profile of start-ups that have been part of incubation or acceleration facility
81
4.8
Funding trends for start-ups in incubators or accelerators
82
(iii)
India Venture Capital and Private Equity Report 2016
List of Figures Figure No.
Description
Page No.
1.1
Venture investment in start-ups across time periods
5
1.2
Number of venture funded companies across time periods
6
1.3
Number of start-up deals across time periods
7
2.1
Host institution of the incubators
23
2.2
Geographical spread of incubators
24
2.3
Type of city and incubator host
25
2.4
Sectors supported by incubators (representation 1)
26
2.5
Sectors supported by incubators (representation 2)
26
2.6
Incubatees in different sectors
27
2.7
Incubatees classified by sectors based on the incubator host organizations
28
2.8
Geographical spread of accelerators
29
2.9
Start-ups supported by a sample of accelerators
30
2.10
Geographical spread of funded Start-ups
31
2.11
Geographical spread of SMEs
31
2.12
Angel and venture investments in start-ups classified by city type
32
2.13
Patterns in start-ups funded in different states
33
2.14
Patterns in start-ups funded in different cities
33
2.15
Average age of start-up in different cities at the time of receiving angel funding
34
2.16
Average angel investment received by start-ups in different cities
35
3.1
Growth in the number of incubators
51
3.2
Year of founding of incubators by type of city
52
3.3
Incubatees classified by sectors
52
3.4
Incubatees classified by the host organization
53
3.5
Incubatees classified by geographical region
54
3.6
Incubatees classified by type of city
54
3.7
Angel deals over the years
55
3.8
Estimated amount invested by angel investors
56
3.9
Number of angel investors in different years
56
3.10
Number of angel investors who are reinvesting in different years
57
3.11
Average investment in an angel round
57
3.12
Average investment made by an angel investor
58
3.13
Number of angel investors in a round
58
(iv)
India Venture Capital and Private Equity Report 2016
Figure No.
Description
Page No.
3.14
Average age of start-ups at the time of receiving angel investment
59
3.15
Number of angel deals in different sectors
60
3.16
Trends for quartile classification of angel investors
60
3.17
Trends in investment amount for quartile classification of angel investors
61
3.18
Number of investments made by angel networks
62
3.19
Number of angel networks that have made investments in different years
63
3.20
Average number of investments made by angel networks
63
3.21
Start-up funding classified by sector
64
3.22
City wise funding of start-ups by the year of incorporation
65
3.23
City wise funding of start-ups
65
4.1
Proportion of start-ups at different stages (LV funded and not funded)
80
4.2
Proportion of start-ups at different stages (Overall funded and not funded)
80
4.3
Location of angel investors in LV platform
82
4.4
Number of angel investors who joined the LV platform in different years and the number who have made their 1st investment on the LV platform in the corresponding year
83
4.5
Percentage of angel investors from different city categories
83
4.6
Percentage of Tier 1 city angels from different cities
84
4.7
Number of investors and average commitment amount
84
4.8
Cumulative investment and number of investors
85
4.9
Profile of angel investors
85
4.10
Professional background of angel investors
86
4.11 4.12 4.13 4.14 4.15
Proportion of start-ups that get founded and funded at every successive round Days elapsed since the last update made by the start-up and joining the platform Comparison of global and Indian trends: Grocery tech start-ups Comparison of global and Indian trends: Consumer Health-care and Health-tech Comparison of global and Indian trends: Home Improvements and Smart Homes
(v)
86 87 89 90 91
India Venture Capital and Private Equity Report 2016
List of Exhibits Exhibit No.
Description
Page No.
P1.1
Technology and delivery of financial services
11
P1.2
Penetration of digital banking in India
13
P1.3
Investment activity in Fintech, 2015
14
P1.4
Ecosystem of Fintech Firms in India
15
P1.5
Sector-wise 2014 vs 2020 Market Opportunity
16
P3.1
Changes made with respect to sweat equity and ESOP in Co Act., 2013
69
P4.1
Deal flow by the stage of the start-up
100
P4.2
Snap-shot of the deal flow in 2010 and 2015: A comparison
100
P4.3
Deal flow from different cities
101
P4.4
Deal flow from different sources
103
C1.1
Number of applicants at different stages of the selection process
106
C1.2
Comparative characteristics of applications
106
C2.1
Number of proposals received by TCA
109
C2.2
Proposals received in different sectors
110
C2.3
Investments classified by sector
110
C2.4
Source of all the proposals received
111
C2.5
Average fund requirement indicated in the proposals
112
C2.6
Average investment made in companies
113
C2.7
Investment made by the founders in the company till the time of proposal submission
113
C2.8
Reasons for proposals being rejected
114
C2.9
Comparison of invested and not-invested proposals
114
C3.1
Number of companies by sectors that have presented in the monthly chapter meetings
116
C3.2
Companies that have received funding through the Keiretsu Chennai chapter
116
C3.3
Average investment in different sectors
117
C3.4
Count of positive factors in the mindshare provided to entrepreneurs
118
C3.5
Count of negative factors in the mindshare provided to entrepreneurs
118
C3.6
Pattern of positives and concerns in different sectors
119
C3.7
Count of positives and concerns for domestic and foreign start-ups
120
(vi)
India Venture Capital and Private Equity Report 2016
Exhibit No.
Description
Page No.
C3.8
Count of positives for invested and non-invested companies for key parameters
120
C3.9
Count of concerns for invested and non-invested companies on key parameters
121
C3.10
Aggregate count of positives and concerns for invested and non-invested companies
121
C3.11
Average count of positives and concerns for invested and non-invested companies
121
C4.1
Proportion of applications received from different locations for participation in the incubation resident program
124
C4.2
Proportion of applications received from different locations for participation in the accelerator program
124
C4.3
Number of founders in start-ups
125
C4.4
Relationship between co-founders in the start-ups
125
C4.5
Sector classification of start-ups
126
C4.6
Business models of start-ups
126
C4.7
Expectations from the incubation program
127
C4.8
Expectations from the acceleration program
127
C4.9
Ratio of employees with engineering and business backgrounds in incubation applications
128
C4.10
Stage of start-ups at the time of applying for incubation
128
C4.11
Number of start-ups classified by the college graduation year of founders
128
(vii)
India Venture Capital and Private Equity Report 2016
Editorial Team and Authors Contributing Editor Thillai Rajan A. Thillai Rajan is a Professor in the Department of Management Studies at the Indian Institute of Technology Madras. His areas of research interest include venture capital, private equity, corporate finance, and infrastructure finance. He has edited and co-authored the past seven annual reports in this series. He received his graduate degrees from Birla Institute of Technology and Science, Pilani and completed his doctorate from the Indian Institute of Management Bangalore. He is also an alumnus of the Chevening Gurukul Program at the London School of Economics, the Endeavour Executive Fellow at the Macquarie Graduate School of Management at Sydney, and the Fulbright-Nehru Senior Research Fellowship at the Harvard University.
IIT Madras Research Team Chaitanya V S Veeraghanta Second year MBA Student, IIT Madras Hemanth Penmetsa Final year dual degree student in Mechanical Engineering, IIT Madras Keyur Vohra Final year dual degree student in Engineering Design, IIT Madras Niroopa Rani Ph.D. Candidate, Department of Management Studies, IIT Madras Parag Ray Second year MBA student, School of Management, NIT Warangal. Ramesh Kuruva Ph.D. Candidate, Department of Management Studies, IIT Madras Reeba Devaraj Principal project officer, IIT Madras. Previously, Deputy Research Director at GFK. Sahithi Sampath Yeleswarapu Final year dual degree student, Electrical Engineering, IIT Madras. Saurabh Awatade Final year dual degree student, Civil Engineering, IIT Madras. Sravani Alur Second year MBA student, School of Management, NIT Warangal.
External Contributors Aarthi Sivanandh Aarthi is currently a partner at J. Sagar Associates, a leading Tier I law firm in the country. She started her practice in the US in 2001 as a foreign legal consultant concentrating on the US-India business corridor and in 2004 she co-founded Vichar Partners in Chennai. Aarthi Sivanandh graduated in law from Dr. Ambedkar Law University
(viii)
India Venture Capital and Private Equity Report 2016 and completed her master of laws with distinction from Tulane University. She focuses her practice on the full spectrum of corporate transactional and other matters, including M&A, de-mergers & spin-offs, foreign collaborations – Joint Ventures, strategic alliances & licensing transactions, restructurings, Private Equity and Venture Capital transactions. Amit Garg Amit is the founder of MXV Consulting, a strategy and general management consulting firm. He has 2 decades of experience, working with more than 100 organisations on areas of business strategy, profitability improvement, sales effectiveness, operations improvement, and organisation. He earlier worked with the Boston Consulting Group, and is a graduate from BITS Pilani and IIM Ahmedabad. Atit Danak Atit is Director - Partnerships at LetsVenture. Atit has over 8 years of technical and general management experience, working in India and China, in areas of business development, product development, operational strategy, and materials management. He has worked across sectors and successfully led teams to execute strategic projects in Asia, Europe and North America for global clients. Atit graduated from the Manipal Institute of Technology, India. Dhritiman Borkakoti Dhritiman is a consultant with MXV Consulting. He has more than 10 years of experience working with clients across industry segments and sizes, providing advice in the areas of strategy, operations and organization design. He currently focuses on emerging technologies, analytics, and new opportunity assessment. He received his MBA from IIM Calcutta. Havisha Reddy Havisha is a Junior Consultant with MXV Consulting. She has experience working with clients on projects of strategy and operations. She has a Master’s Degree in Operations Research from Columbia University, New York. Josephine Gemson Josephine is an Assistant Professor of Finance at the Loyola Institute of Business Administration, Chennai where she teaches finance, quantitative techniques and business analytics. She completed her PhD in Finance at the Indian Institute of Technology Madras in 2013 where she analysed risk investment strategies and preferences of private equity investors worldwide. Her research interests include private equity and venture capital, corporate finance, and innovative investing under risk and uncertainty. G Sabarinathan Sabarinathan is an Associate Professor in the area Finance and control at IIM Bangalore. His research interests are in the areas of Financing Small and Medium Firms in India, Private Equity, Venture Capital and Regulation of Securities Market in India. He teaches an elective on New Enterprise Financing that has become popular over the years. He also conducts executive training on corporate valuation. Prior to joining IIM Bangalore, he was one of the founding members of ICICI Venture. Upendra Kumar Maurya Upendra is an Assistant Professor in the Department of Management studies, IIT Madras. His research interests are Brand Management, Entrepreneurship, and Marketing Interface Identity issues in Organization. He completed his doctoral program from the Xavier Institute of Management, Bhubaneswar.
(ix)
India Venture Capital and Private Equity Report 2016
Advisory Review Board Anup Bagchi, Managing Director & CEO, ICICI Securities Limited Anup Bagchi is the Managing Director and CEO of ICICI Securities. In his 18-year career with the ICICI Bank, Anup has held various key positions in the bank in Retail Banking, Corporate Banking and Treasury. Previously, as the Executive Director of ICICI Securities Limited, he pioneered the seamless online broking offering through ICICIdirect.com. Anup has been honoured with The Asian Banker Promising Young Banker Award. He was also recognised as one of India’s Hottest Young Executives by Business Today. Anup received his degrees from IIT Kanpur and IIM Bangalore. Dr. Archana Hingorani, Chief Executive Officer & Executive Director, IL&FS Investment Managers Limited Archana Hingorani has over 29 years’ experience in the financial services business, teaching and research. Her focus has been on private equity, project finance and financial structuring, with a specialisation in infrastructure, manufacturing and real estate projects. She has been with the IL&FS Group for 21 years and has performed a multitude of roles – starting off as an economist and moving on to project finance and asset management. Dr. Hingorani is a Bachelor of Arts (Economics) with post-graduate qualifications in Management (MBA) as well as a PhD in Corporate Finance from the University of Pittsburgh, USA. She is co-chair on the Investment Commission Board of the United Nations Environment Programme Finance Initiative. She is also a member of CII National Committee on Infrastructure Finance and is a member of the Advisory Council of Emerging Markets Private Equity Association (EMPEA). Arvind Mathur, Chairman, Private Equity Pro Partners Arvind Mathur is the Chairman of Private Equity Pro Partners, an organization he founded to provide consulting, training, and other services to the Indian venture and private equity industry. Previously, he was the President of the Indian Private Equity and Venture Capital Association (IVCA). Prior to joining IVCA, he has held a variety of positions, including Head, Capital Markets at the Asian Development Bank. Arvind has helped structure, and invested in, over 30 private equity funds, including 5 infrastructure funds and a number of General Partnerships. He has worked on funds with Limited Partners such as the Asian Development Bank, the International Finance Corporation (IFC), CalPERS, the Prudential Insurance Corporation of America and some of the leading institutional investors in Australia, Singapore, Malaysia and India. S. Gopalakrishnan, Chairman, Axilor Ventures and Co-founder, Infosys Senapathy ‘Kris’ Gopalakrishnan served as the Vice-Chairman of Infosys from 2011 to 2014, and as its Chief Executive Officer and Managing Director from 2007 to 2011. Kris is one of the co-founders of Infosys. Recognised as a global business and technology thought leader, he was voted the top CEO (IT services category) in Institutional Investor's inaugural ranking of Asia's Top Executives. Kris was also selected to Thinkers 50, an elite list of global business thinkers, in 2009. He was elected as the President of India's apex industry chamber, the Confederation of Indian Industry for 2013 – 14, and served as one of the co-chairs of the World Economic Forum in Davos in January 2014. In January 2011, the Government of India honoured Kris with Padma Bhushan, the country’s third-highest civilian honour. Kris holds master’s degrees in physics and computer science from the Indian Institute of Technology, Madras. Gopal Srinivasan, Chairman & Managing Director, TVS Capital Funds Limited; and Chairman, Indian Venture Capital and Private Equity Association Gopal Srinivasan is the Founder Chairman and MD of TVS Capital Funds Ltd. Gopal, part of the TVS family, is the founder member of TVS Electronics Limited and is a Director of TVS & Sons Ltd, the holding company. He is also a member of the Board of several Group Companies. Over a career of 25 years he has founded several companies operating in diverse industries such as IT & ITES and BFSI. Gopal was the Chairman of the Confederation of Indian Industry, Tamil Nadu State Council for the fiscal year 2007-2008. He was also the Chairman of the CII National
(x)
India Venture Capital and Private Equity Report 2016 Committee for Private Equity & Venture Capital for the fiscal year 2010-2011. Gopal received his degrees from Loyola College, Chennai and University of Michigan, USA. Gopal is also currently the Chairman of Indian Venture Capital and Private Equity Association. R. Ramaraj, Senior Advisor, Elevar equity Ramaraj works with Elevar Equity as a mentor and guide. He is a serial entrepreneur who has been involved in various ventures in IT, cellular and Internet. His last venture was Sify, where he was the Co-Founder and Chief Executive Officer. Sify was the first Indian Internet Company to list on the NASDAQ. He was recognized as the ‘Evangelist of the Year’ at the India Internet World Convention in September 2000 and was also voted the IT Person of the year (2000 and 2001), in a CNET.com poll in India. In 2010, the Confederation of Indian Industry recognised him with a Lifetime Achievement Award for nurturing the Spirit of Entrepreneurship and inspiring and mentoring numerous entrepreneurs. Until recently, he was the Senior Advisor at Sequoia Capital. He is a Member of the Board of Governors of the Indian Institute of Management, Calcutta. Roger Albert, Managing Director, Austin Flower Capital1 Roger is the Managing Director of Austin Flower Capital in India where he focuses on investing in Consumer tech, Education and Healthcare opportunities. He currently serves on the board of several investee companies of Austin Flower Capital. Prior to joining Austin Flower, Roger had worked at McKinsey Consulting and at Wipro Technologies. At Wipro, Roger helped several venture-backed networking start-up clients design and build customer premise equipment for next generation applications like VoDSL and the Internet over Cable. Sarath Naru, Managing Partner, VenturEast Funds Sarath is the Managing Partner of VenturEast Funds which has over $300 million under management. Prior to this, Sarath built a trading and manufacturing business spanning USA and India. He gained significant experience working for Procter & Gamble in the area of brand management in the USA and in manufacturing with British American Tobacco subsidiary, VST Industries in India. His academic qualifications include - Bachelor of Technology from IIT-Madras and an MBA from the University of Chicago. He was a past-secretary of the Indian Venture Capital Association and is a member of the Investment Committees of UTI Ventures funds. Srivatsa Krishna, IAS, Secretary, Government of Karnataka Srivatsa Krishna, 1994 IAS gold medalist, is also the first Indian career bureaucrat to figure in the prestigious list of Global Leaders for Tomorrow. He is also the first IAS officer in India's history to complete the Harvard Business School MBA. Krishna co-authored a case study with Professor Michael Porter on technology clusters and economic development in India that is used as a part of a global course taught at HBS. He was part of the team which pioneered E-governance in India and created one of Asia’s largest IT and investment clusters, Cyberabad. Sudhir Sethi, Founder & Chairman, IDG Ventures India Sudhir is the Founder & Chairman of IDG Ventures India. He specialises in identifying disruptive high growth technology firms with a strong leadership team and helps them grow rapidly with an eye for outsized financial returns. Since 1998 Sudhir and his team have advised on investments into 60 firms across Digital Consumer, Enterprise Software and Healthcare Sectors. Key investments include FlipKart (India’s leading e-Commerce player), Myntra (Fashion & Sports e-Commerce), Manthan (a global Analytics product play), Perfint (a global leader in image-guided oncology), Aujas (a global security firm), Newgen (a global software product leader), Yatra (a leading Online Travel Company), Mindtree Consulting, Lenskart, and Zivame.
1
Name and organization disguised on request. (xi)
India Venture Capital and Private Equity Report 2016
Editors’ Note Ad Augusta per angusta! The above phrase would appropriately reflect the gladiatorial spirit and motivation of most start-up entrepreneurs today. In a way, the report series, which is dedicated to a better understanding of start-ups, venture financing, and entrepreneurship, is in itself an entrepreneurial journey. As I sit to write this note for the eighth time in the last eight years, I can’t help but reminisce a bit. The annual Indian Venture Capital Report series started as a small effort in 2009, as a part of the research project sponsored under the New Faculty Grant of IIT Madras and later through the support of a research grant of Indian Council of Social Science Research. The reports for the years 2012-15 were supported by the Department of Management Studies, IIT Madras and the International and Alumni Relations Office, IIT Madras. At the end of 2015, as we were running out of gas, we got a lifeline through the generosity of ICICI Securities Limited, which would enable us to hopefully continue this series till 2018. The search for a suitable theme for this years’ report started in early 2016. In retrospect, the choice of subject for this year was not difficult. The Start-ups had captured the imagination across the spectrum – right from the Prime Minister of the country to the ordinary citizen. India had become one of the top start-up countries globally within a short span of time. Though India had always boasted a strong culture of entrepreneurship as seen in the number of SME’s, Start-ups brought in a new era in entrepreneurship – one that anchored on technology, innovation, and growth. People could experience the impact of start-ups in almost every walk of life. And successful entrepreneurs had a rock star like following, becoming role models for students in campuses. Given this context, we decided to have Start-ups as the focus of the 2016 India Venture Capital and Private Equity Report. Having decided the theme, the next question confronted us. There are several reports that have been done on start-ups. How are we going to be different? Our differentiation anchored on the following: (i) Focus not just on start-ups, but on the start-up ecosystem; (ii) Analyze the start-ups that are founded, and not just the ones that get successfully funded; (iii) Provide multiple perspectives that are based on individual experiences in addition to longitudinal data analysis. We hope that the report that you have in your hands would reflect the efforts we have made on the above factors. Every once in a while, the world had witnessed economic euphoria – the tulip mania in the mid-1600s, the California gold rush in the mid-1800s, and the dot-com boom in the 2000’s to name a few. While the victims of the euphoria far outnumber the conquerors, the winners have singularly made lasting impacts. For example, Amazon and Google in a way belong to the dot-com era, and look at the impact they have made on the day to day lives of so many people around the world. While the jury is still out on which of the start-ups would survive the decade, what is evident is the overall social and economic impact that the start-ups have made in the last couple of years. And as they say, acta est fabula plaudit! I hope you enjoy reading this report, and I look forward to your suggestions and comments.
Thillai Rajan A.
(xii)
Executive Summary Overview The context: The impact of start-ups has been significant in all walks of life. In recent years, India has emerged as one of the top three countries globally in terms of the number of start-ups founded. The total venture investment in start-ups during the period 2005-15 is estimated at ₹1117 billion (using 2015 as the base year). Actual investment could be much higher since details of investment amount are not available for many of the deals. The average annual growth rate in investment flow during the period 2005-15 is about 42 percent. Between the years 2005-15, more than 10,000 start-ups have received funding. The average annual growth in the number of start-ups that have been funded for the period 2005-15 has been 16 percent. In most sectors, there has been an equivalent Indian start-up to that of a foreign start-up. While many foreign start-ups have also started operations in India, the presence of an Indian start-up meant that the Indian consumer need not have to wait till the foreign company started operations in India. Global and Indian start-up landscape: Indian start-up landscape is very vibrant as seen by the number of companies founded. In some of the sectors, the number of companies founded in India is close to the number of companies founded globally. The average investment per round in a start-up is higher globally, but the difference is not very large. A major concern would be the low proportion of start-ups that get funded in India. For example, the percentage of global start-ups that are able to successfully raise capital in the grocery tech, healthcare and consumer healthcare, and smart home and home improvement are 41 percent, 52 percent, and 36 percent respectively. The corresponding percentage for Indian start-ups are 5 percent, 10 percent, and 11 percent. There is a time lag in the setting up and funding between global and Indian start-ups. The growth and the funding of the Indian start-ups in different sectors occurs later than what is seen for global start-ups. The report: In this report, we analyze the key trends in start-ups and start-up ecosystem in India. Broadly, the report includes the following components: incubation, accelerators, angel investors and angel networks, and venture funds. An important feature of this report is an analysis of the pool of start-ups that get founded and not just the start-ups that get funded. A comparative analysis of start-ups that have been funded and those that have not been funded provides interesting insights.
Incubation facilities Pivotal role of universities: About 56 percent of the incubators are located in universities, indicating the important role played by universities in supporting entrepreneurship and start-ups. One third of the incubators are located in private universities. Incubators in universities supported 58 percent of the total incubatees being supported in different incubators. In addition to the traditional teaching, research, and industrial collaborations, universities are increasing playing a very important role in creating ventures. Sector focus: Technology sector is supported by the largest number of incubators. After technology, the healthcare sector occupies the second position in terms of the number of the incubators supporting it. Telecommunications, industrials, and consumer goods come close, in terms of the third spot. The number of incubators supporting the other sectors are very limited. Incubation is not seen as the preferred approach in commercializing innovations such as in utilities or in the oil and gas sector. Growth in incubator presence: More than 50 percent of the incubators were set up in the last five years. While the number of incubators in different types of cities were more or less equal till 2010, there has been a dramatic increase in the number of incubators in Tier 1 cities after 2010. Incubation thesis varies between incubators: Average number of incubatees supported in the different type of incubators vary widely. While the average number of incubatees is around 36 in universities, it is only 13 in the
1
case of private non-universities. This indicates that different type of incubators could have different investment thesis. Independent private sector incubators without any university affiliation might have more stringent criteria because the financial sustainability of the incubators could depend on the success of the incubatees. On the other hand, incubators supported by the government institutions could have the primary objective of encouraging start-ups rather than just financial success, and thus they are prepared to support more number of incubatees.
Accelerators While incubators are present across different locations in the country, accelerators are essentially an urban phenomenon: Except for a couple, virtually almost all of the accelerators are located in the main cities – Chennai, Bengaluru, Hyderabad, Mumbai, Ahmedabad, and New Delhi. The highest number of accelerators are found in Bengaluru, followed by the NCR region and Mumbai. Scale of the accelerator programs: In our sample, 17 accelerators have supported a total number of 1816 startups. Though some of the accelerators like 500 start-ups, Kyron, TiE Bootcamp have been associated with a large start-ups, in general, accelerators are able to guide more number of start-ups as compared to that of incubators.
Angel Funding Angel investments in Tier 1 and 2 cities: Companies in Tier 1 cities are getting funded earlier and obtaining larger amounts of funding. Average deal sizes for companies in Tier 1 cities are about 62 percent higher than that of deals in Tier 2 cities. Investment rounds are more than 40 percent higher in Tier 1 cities as compared to that of Tier 2 cities. Growth in angel investments: Angel deals have shown an annual average growth rate of 124 percent during the period 2008 – 15. The estimated investment amount through angel deals has grown at an annual growth rate of 205 percent during 2008-15. The number of angel investors also has grown at an annual average of 107 percent during the above period. While the number of first time angel investors has grown at a rate of 98 percent, the growth rate of investors who are reinvesting has been 105 percent. Age of start-ups at the time of receiving angel investment has consistently decreased: There has been a steady decrease in the average age of the start-up at the time of receiving angel investment from 4.77 years in 2008 to 0.54 years in 2015, indicating that age of the start-up at the time of investment has reduced by about 27 percent annually. However, the average investment amount has increased. Profile of angel investors: Analysis of the angel investor sample indicated a good mix of experienced (i.e., who have made five investments or more) as well as new investors (i.e., who have made less than five investments). The proportion of the former was 48 percent while that of the latter was 52 percent, indicating that the mix of angel investors is well balanced. In terms of their professional background, senior executives from large corporations comprised the largest segment, accounting for more than half of the investors. Entrepreneurs comprise the second highest category, accounting for close to 40 percent of the investors. The traditionally wealthy, i.e., those engaged in family businesses account for less than 9 percent of the investor sample. Location of angel investors: Analysis of registered angel investors in Lets Venture platform shows that 88 percent of those are from Tier 1 cities. The number of angels in Tier 2 and 3 cities are 11 percent and one percent respectively. Among the six tier 1 cities. Delhi (i.e., the National Capital region that comprises of adjacent cities to Delhi such as Gurgaon, Noida, and Okhla) has the largest number of angel investors, followed by Mumbai and Bangalore. Taken together, these 3 cities account for 88 percent of the total angel investors in Tier 1 cities. The remaining cities of Chennai, Hyderabad, and Kolkata account for only 12 percent of the total investors in Tier 1 cities.
2
The active as well as the occasional angel investors have a part to play in the growth of angel investing: Angels investors were classified into two separate quartiles based on the number of deals and the amount of investment. Based on the number of deals it was found that top quartile investors have a higher degree of sector concentration with most investments in technology whereas the bottom quartile investors exhibit a higher degree of diversity in terms of the number of deals in different sectors. Based on the investment amount, it was found that the active angels invest lower amounts per deal, but make more number of investments whereas occasional angels on an average invest higher amounts per deal. As a group, the aggregate investment made by occasional angels are also higher than that of active investors. The rise of angel networks: A noteworthy development in the last few years has been the evolution of the angel networks. While many of the angel networks are organized around cities (such as The Chennai Angels, Mumbai Angels, and so on), there are other forms of networks as well. The annual growth rate of the number of investments by angel networks made during the 2009-15 period has been about 75 percent. In a span of 7 years, the number of networks have increased 20 times. Average investment amounts made by angels have consistently increased: The average investment received from an angel round by a start-up has increased from ₹10.63 million in 2009 to ₹46.76 million in 2015 indicating an annual growth rate of 27 percent. The average investment made by an individual angel investor has increased from ₹2.16 million in 2009 to ₹16.95 million in 2015, indicating an annual growth rate of 34 percent. Individual investments made by angels in a networking platform are lower. For example, data from Lets Venture indicates that the average investment per investor was about ₹11 million. The number of investors is the highest for the average commitment amount of ₹500,000, followed by ₹1 million. Beyond that, there is a sharp fall in the number of investors, indicating that the sweet spot for investors in an angel networking platform is between ₹0.5 – 1 million.
Venture Funding Contours of start-up founding differ from that of SME’s: The geographical spread of SMEs and start-ups show interesting variations. Tamil Nadu and Gujarat has the highest number of SMEs, but they are not the top states in terms of venture funded start-ups. On the other hand, Karnataka and Maharashtra, which account for the highest number of venture funded start-ups do not occupy the top slot in terms of number of SMEs. This indicates that the ecosystem for development of SMEs and start-ups could be different. Venture funding is concentrated in Tier1 cities: The 6 Tier 1 cities of India received the largest chunk of investment of ₹661.29 billion, accounting for about two-thirds of the angel and venture funding. Tier 2 cities received 31% of the total investment (about ₹306 billion) and start-ups in Tier 3 cities accounted for only ₹19.74 billion, which is about 2 percent of the total investment. There exists a big gulf in investment flow between startups in Tier 1 cities and the other two tiers.
Comparison of funded and non-funded start-ups Maturity index of start-ups that have received funding are higher: Maturity index of start-ups were calculated based on the lifecycle stage of the start-up. The average maturity index of start-ups that have received funding was 3.54 whereas those that did not get any funding was 3.00. Start-ups that were a part of incubation or accelerators also had a higher maturity index (3.4) as compared to those that did not receive any incubation or acceleration support (3.0). Incubators and accelerators can increase the probability of getting funding: In the overall sample, only 8.3 of the start-ups are successful in getting external funding. But among those who have been a part of an incubator or accelerator, 24 percent have been able to get external funding. Thus incubators and accelerators have been able to increase the chance of getting funded by about three times. Similarly, 5 percent of those who have been
3
with an incubator or accelerator have been able to get funding on the LetsVenture platform, while the proportion of those getting funded on the platform for the overall sample is only 1.1 percent. Incubators and accelerators have thus been able to increase the chances of getting funded on the LetsVenture platform by five times. Odds of success for getting funded continue to be low: In our estimate, for every 875 start-ups that get founded, only one is able to successfully raise 4 or more rounds of funding. Out of the total start-ups that get founded, about 6 percent take part in an accelerator or incubation program. 75 of the 875 are able to get first round of funding, out of which only 15 are able to get the second round of funding, and only 5 are able to secure the third round of funding. The line of separation that distinguishes the funded and non-funded start-ups can often be very thin: The case study of Keiretsu Forum, Chennai Chapter, indicates that the average number of positives (or concerns) is just higher by a count of 2 (or lower by a count of 2) for the invested companies as compared to that of non-invested companies. Similarly, the average prior investment made by companies as seen from Chennai Angels is not very different between the invested and applicant companies (₹7.98 vs ₹6.88 million respectively). However, the case studies also provide various pointers on increasing the probability of success. The most common causes of rejection of proposals has been limited interest among the angel network members, low traction, and scalability issues. Data from Keiretsu Forum indicates that the strengths of the business model, the value proposition, and market size are significant factors that influence the investment decision. The count of concerns for companies that were not successful in receiving investment was considerably higher for the following parameters: business model, customer traction, margins and profitability and market size. Approaching the funders through a reference can improve the odds of funding: Increasingly, investors are relying on developing a proprietary deal flow network. For one of the venture firms interviewed for this report, 37 percent of the deal flow was through personal contacts. In terms of the importance of references, the finding from The Chennai Angels case study provides an important perspective. Ninety two percent of the investments made by The Chennai Angels were sourced through or had a reference from angel investors or members of the angel network. None of the deals that were received directly without any reference were successful in getting funding.
4
India Venture Capital and Private Equity Report 2016
1.
The Start-up Effervescence and Impact “…When all at once I saw a crowd, a host of golden daffodils; Beside the lake, beneath the trees, Fluttering and dancing in the breeze... They stretched in never-ending line, along the margin of a bay: Ten thousand saw I at a glance, tossing their heads in sprightly dance...”1 Upendra Kumar Maurya and Thillai Rajan A.
Overview We are no Wordsworth, but the above lines reflect the sentiment and prevalence of start-ups in India today. Various reports have indicated that India is among the top three countries worldwide in terms of the number of start-ups. Many of these start-ups were incorporated post 2010. The start-up storm has literally caught the attention of everybody – policy makers, consumers, investors, regulatory agencies, prospective employees, and so on. Unlike a conventional storm which leaves a trail of destruction in its wake, the start-up storm has resulted in substantial positive impacts in the economy. In this chapter, we present evidence on some of the positive impacts from the start-ups.
Investment flow A big impact of the start-up boom has been the investment flow in start-ups. Available data indicates that the total venture investment in start-ups during the period 2005-15 has been about ₹1117 billion. It needs to be remembered that coverage of venture investment deals in most of the databases is not 100 percent, and investment amount is not available for all the deals. Therefore, actual investment would definitely be higher than the estimated amount of ₹1117 billion.
Figure 1.1: Venture investment in start-ups across time periods Figure 1.1 shows the estimated investment in start-ups (in 2015 values) for different years. While year-to-year investment flows could show a lot of fluctuations, a three year window shows more or less a steady increase (except for 2009-11 and 2011-13 periods) in the investment flow. The average annual growth rate in investment flow during the period 2005-15 is about 42 percent. An investment flow of such a magnitude would have
© Indian Institute of Technology Madras
5
India Venture Capital and Private Equity Report 2016 definitely led to several impacts on the ground – asset creation, employment generation, development of intellectual property, construction of office space and the resultant demand for other services, and so on. Much of the investment that is invested in start-ups is also foreign capital. Thus start-ups have played an important role in attracting investment capital to the economy.
Acceptance of entrepreneurship as a career choice For a long time entrepreneurship was not considered as an attractive or acceptable career choice in the Indian social and cultural milieu. However, with the supportive policy of the government and outstanding financial success of some of those who chose to venture on their own, the social perception of entrepreneurship has gradually undergone a change and venturing is increasingly being accepted a preferred option. Figure 1.2 gives the number of start-ups that have been funded in different time periods. Between the years 2005-15, more than 10,000 start-ups have received funding. The average annual growth in the number of start-ups that have been funded for the period 2005-15 has been 16 percent. While the number of start-ups that are founded would be several times more than the number of start-ups getting funded, availability and growth in the funded start-ups are attracting many to venture on their own rather than pursuing employment in established companies.
Figure 1.2: Number of venture funded companies across time periods
Venture capital and private equity as an asset class Investing in start-ups have yielded attractive returns to many investors. This in turn has enticed several institutions and individuals to consider allocating a part of their portfolio to venture investments. Increase in the capital available has led to an emergence of a strong venture fund management industry. As the number of venture firms increased, they started to aggressively scout for start-ups to deploy their capital. Increase in the number of venture firms (along with other simultaneous progress in technology and the increasing risk appetite among the founders) increased the number of start-ups that were getting funded. This encouraged more and more people to start on their own, resulting in a virtuous cycle. The increase in the pool of available capital increased the sophistication of the industry and venture capital and private equity is being recognized as a separate asset class. Figure 1.3 shows the number of deals for different time periods. Since a deal represents a unique investor-startup-date of investment combination, increase in the number of deals indicates an increase in the number of startups as well as the number of investors. During the period 2005-15, the total number of deals were 11,311. The average annual growth rate in the number of deals for the period 2005-15 is 52 percent. Though year-to-year
© Indian Institute of Technology Madras
6
India Venture Capital and Private Equity Report 2016 deal number could fluctuate, the number of deals in a three year window shows a steadily increasing trend. This shows that the attraction of investing in start-ups has drawn several new investors to allocate a portion of their capital to investing in start-ups. This trend can also be seen specifically for the angel investors where the number of first time angel investors has grown at an annual rate of 98 percent during the period 2008-15.
Figure 1.3: Number of start-up deals across time periods
Innovation in products and services The biggest contribution of the start-ups has been the innovation in products and services they have been able to bring in different sectors. Table 1.1 provides a list of some of the top Indian start-ups in different segments. Table 1.1: Leading start-ups from India and their overseas comparisons
Segment
Indian Start up
Taxi services Ecommerce and Marketplace Ecommerce and Marketplace
Ola
Furnishings
Date of Date of Foreign Startup Incorporation Incorporation 2010
Uber
2009
2007 2010 2008 2008
Amazon Amazon Yelp Olx
1994 1994 2004 2006
Urban Ladder
2012
Wayfair
2002
Mobile advertising Travel
Vserve Makemytrip
2010 2000
Admob Expedia
2006 1996
Travel Healthcare
Yatra Practo
2006 2008
Expedia Zocdoc
1996 2007
E-Wallet
Paytm
2010
Paypal
1998
Hotel aggregator Home rental
Oyo Rooms Stayzilla
2013 2005
Trivago Airbnb
2005 2008
Flipkart Snapdeal Restaurant search and discovery service Zomato Quickr Advertising platform
While the degree of innovation can differ or the quality of innovation can be contested, what has been generally accepted is that the start-ups have been able to bring a certain amount of newness to the consumer, which they had not experienced previously. What is interesting to note is that many of the new introductions have emerged from the start-up stable rather than established companies. This serves to underline the often observed
© Indian Institute of Technology Madras
7
India Venture Capital and Private Equity Report 2016 phenomenon that smaller firms continue to be at the vanguard of innovation and play an important role in driving change before the larger companies catch up. It is also interesting to note that in each of the segments there has been an equivalent Indian start-up to that of a foreign start-up. While many foreign start-ups have also started operations in India, the presence of an Indian start-up means that the Indian consumer need not have to wait till the foreign company started operations in India. For example, while Amazon started the Indian operations only in 2013, Flipkart started serving the Indian consumers much earlier. It is also seen that the time lag between a foreign and Indian start-up is also getting shorter, indicating that start-up entrepreneurs in India are able to quickly bring those products and services that are experienced by consumers overseas.
Influencing consumer behaviour In recent times, start-ups have made a significant impact on the people’s lives across the different facets of life. For example, cab aggregators like Ola have changed the way people used to travel either for personal or professional purposes. When it comes to buying household goods and lifestyle products, the likes of Flipkart, Myntra and Snapdeal have made a difference in the people’s lives by offering quality goods at affordable prices, easy access to finance and easy return. When it comes to health sector, Practo has made a difference by assuring the way people can get the prior appointment and minimize the wait time in addition to providing the ratings of the doctors which helps in deciding whom to approach. Lenskart has been making an attempt to change the way people get their eyes tested and eyeglasses made. They offer free eye check-up and eyeglass test at consumers' door step, this provides a lot of convenience to the buyers. There have been numerous start-ups impacting the other walks of life, for example, some companies offer the services of plumbing, technicians, and so on online. Start-ups like nearbuy has been changing the way people used to go for dining as they bring the affordable offers which people book and take the coupons along-with them while going for dining. If we look at mobile recharge or bill payments, there has been numerous companies like Paytm, Freecharge, Mobwiki which are impacting the way people used to recharge their mobiles, DTH, electricity bills, and so on. Even the way people used to consume cinema has been changed by the companies like bookmyshow and many others. Start-ups have been also changing the way people used to buy furniture and other accessories as start-ups like Urban ladder, Pepperfry, Fabfurnish and Gozefo are making a difference. There has also been a change in the way people used to dispose their old goods, as web pages like olx and quickr have really empowered the consumers and augmented the customer to customer trade. Yet another start-up “OYO Rooms” has changed the way people used to book their accommodation by offering greater value to both property owners and the prospective customers. These change in the consumer behaviour have been brought by start-ups by offering better value to the consumers in comparison to existing benefits. Start-ups have also impacted the lives of people indirectly by changing the rules of the game. Traditional businesses or businesses with traditional mind set are now under pressure. For example, the traditional mobile recharge points franchise by different companies are losing their business to the online recharge counterparts. Similarly, many traditional businesses like Banarasi sari weavers, Pochampally sari cluster, and so on are at the brink of change. If efforts could be made to skill them and connect them to the start-ups like Flipkart a huge amount of value can be created. Therefore, start-ups offer a ray of hope for bringing change to the lives of deprived section of society like farmers, traditional weavers and other traditional professions. However, not all offerings by start-ups represent higher value in absolute sense. The litmus test lies in retaining the gained customers, sustaining the growth and achieving profitability. A few start-ups like Tiny owl, Foodpanda, Askmebazaar and many others have been also in trouble due to their inability to sustain the value perception. However, it is very natural that with the increase in start-up formation rate, failure rates of start-up are also bound to go up.
© Indian Institute of Technology Madras
8
India Venture Capital and Private Equity Report 2016
Scale of reach An important feature of many of the start-ups is their scale of reach. Table 1.2 shows the scale of reach for some of the start-ups. What is to be noted is not just the scale of reach, but also how quickly they have been able to reach that scale. Table 1.2: Scale of reach of start-ups Indian Start up
DoI (Indian)
Scale Of Reach
Ola
2010
200000 cars; 7000 employees; 4 lakh taxi drivers
Flipkart
2007
75 million users; 35000 employees; 30000 sellers
Snapdeal
2010
10 million products; 5000 employees; 275000 sellers
Zomato
2008
90 million users
Quickr
2008
12 million listings in over 1000 cities
Urban Ladder
2012
15000 visits daily; 18 cities
Inmobi
2007
759 million users globally
Makemytrip
2000
13000 hotels in India
Yatra
2006
>15000 hotels worldwide
Practo
2008
7.5 million unique patients; 10000+doctors; 10 million electronic patient records; 7 million appointments
Paytm
2010
75 million transactions per month; 3000 employees
Oyo Rooms
2013
6500+properties
Stayzilla
2005
1000+bookings daily
Summary This chapter has highlighted the pervasive influence of start-ups in our day to day lives. The growth in the number of start-ups has led to new investors and significant investment flow to the economy. Start-ups have been able to ride on the wave of technology advances and smart phone penetration to offer innovative products and services. These innovations have fundamentally altered the consumer purchasing behavior in many segments apart from offering convenience and cost savings. The acceptance of the start-ups can also be gauged from their scale of reach and how quickly they have been able to reach that scale. Many of the start-ups, however, are bound to fail, prompting many to ask the question on the judiciousness of such large investment flows and whether it would have been more beneficial for the economy if the investment flows had happened in other sectors. The start-up survival rates and economic benefits of the start-ups could be a potential topic for the subsequent reports.
Notes 1
From “I Wandered Lonely as a Cloud” by William Wordsworth.
© Indian Institute of Technology Madras
9
10
PERSPECTIVE 1
Fintech Start-ups: Making the Elephants Dance Amit Garg, Dhritiman Borkakoti, and Havisha Reddy
What is Fintech? Financial services providers, with huge demands for computation and record keeping, have always embraced technology. IBM 650, the first mass produced computer in the 1950s, which was marketed at the scientific and engineering firms, also found interests from financial companies such as the Mellon National Bank. For most parts, however, technology has been used by financial institutions to facilitate their internal operations, and in enabling some customer interactions. The institutions themselves retained their central role. Over the past few years, startups have started turning this relationship on its head. The rise of the connected world, with the smartphone at its center, is enabling new linkages across and between customers and service providers. This is increasing accessibility and inclusion, and putting the customer in the driver's seat. This has been referred as the Fintech revolution, where technology has allowed startups to upend traditional business models with 24x7 customer connections, unbundled services, big data, artificial intelligence and a dramatic simplification of the banking experience. Innovators have been able to take the technology and data first approach and are leveraging them far beyond the traditional players. This has allowed for innovation in risk assessment, reduction in costs, and deeper penetration of financial services (Exhibit P1.1). Exhibit P1.1: Technology and delivery of financial services Insurance
Payments
Remittance
Traditional Model
Loans
Investments
Innovation
Technology ₹
₹
Institution
• Access to internet • Penetration of mobiles • Trust in technology • Personalization of solutions • Speed of delivery • Reduced cost • Open architecture
Institution
Technology
Customers
Customers
11
However, the definition of Fintech does not include the traditional technology solutions used by financial institutions: core banking solutions for banks, internet banking solutions for customers, digital money transfer that requires knowledge of payee's bank account, card based POS solutions, vanilla share trading services, and so on.1 The differentiated approach of Fintech startups has allowed them to grow rapidly in segments such as payment solutions (peer-to-peer payments, wallets, and mobile payments), remittances, and consumer and small business loans. This has led to increased investor interest - $22 billion2 of investment went into the Fintech sector in 2015, of which India received $1.65 billion, the second largest after China in APAC.
Upsetting the cart: reimagining financial service delivery Traditional financial service providers tend to provide a broad range of services across multiple business lines. They carry legacy infrastructure, a historical burden of loans already made, and processes that were optimized for a different era. On the other hand, startups, not similarly burdened, are free to explore new ways to serve segments that are uneconomical for incumbents, explore new processes of evaluating risk or closing a transaction, and to rethink how a service can be provided profitably. These startups have changed the landscape in three key ways: With advantages such as a lower cost of servicing a client (because of greater use of technology), better assessment of risk (because of use of alternate data in data sparse situations), they have often been able to reach customers that are not profitable for incumbents, thus expanding the market. Even incumbents like Bank of Baroda are tying up with alternate lenders like CreditMantri to service first time borrowers. 3 Advanced technology enables more efficient processes (for example, by matching people who are looking to deposit money to those looking for a loan), leading to disintermediation in the multi-step processes. This and other such simplification leads to reduced service times and costs. Capital Float, for example, believes that one of their differentiators is speed in loan disbursement, which is possible within a day.4 By packaging multiple solutions (for example, a number of different credit cards into a single wallet), startups have given users the convenience of a single simpler interface while inserting themselves as an additional intermediary in the traditional service delivery process. Paytm started out with a focus on prepaid recharge solutions, expanding their portfolio to payment gateway, mobile wallet, online marketplace, and payment bank.
JAM: the sauce for Fintech growth in India The growth opportunity for Fintech in India can be traced down to two factors: the low penetration of formal financial services in the country, and the JAM (Jan Dhan, Aadhaar and Mobile) strategy pushed by the Government of India for financial inclusion. Sixty percent of Indians have traditionally had no access to any banking solution. 5 Ninety percent of SMEs have no access to formal credit.6 Thus, a significant pool of business and individuals only had access to informal channels - a large pool that can now be addressed by Fintech solution providers because of the three-pronged JAM initiative. The Pradhan Mantri Jan Dhan Yojana was launched in August 2014. In two years, it had led to the opening of 236 million bank accounts, and the issuance of 188 million debit cards.7 When the program started, about 45 percent of the accounts opened under the scheme had zero balance, which has since the reduced to 24 percent. This pool of people with functioning bank accounts provides a large target market for Fintech companies.
12
Aadhaar, the national identification number of the Indian government, also provides for biometric identification and online verification - both of which will facilitate digital transactions. At 1.04 billion registrations, it currently covers 85 percent of the population of the country.8 While banking penetration has been low, 75 percent of the Indians own mobile phones and over 25 percent are expected to have a smart phone by 2017. About a third of Indians were expected to be online by 2016, most of them through mobile phones. Mobile banking has been growing faster than web banking. Albeit on a low base, the value of mobile transactions in Dec 2015 was more than four times the amount it was a year ago. 9 Digital transactions are expected to account for a quarter of all banking transactions by 2020, with close to 50 percent of the people accessing digital banking by 2022.10 The year 2016 also saw the announcement of the Unified Payment Interface (UPI), a set of standards that will help integrate different payment systems in India. This will further enable the adoption of mobile and digital transactions in India, opening new use cases for Fintech startups.11, 12 Exhibit P1.2: Penetration of digital banking in India 50% UK 77%
45%
Germany 50%
China 57%
Japan 83%
USA 75%
40%
35%
Penetration of Digital Banking (%)
Smartphones to exceed number of active bank account holders
India 18%
30%
25%
Internet penetration to cross 30%: generally a tipping point for mass adoption of digital banking
20%
15%
Mobile transactions gains momentum: 2x transactions and 3x value over previous year
10%
5%
0% 2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
The way India leapfrogged the fixed line telephone phase and moved to mobile telephony, a similar model may be imminent in the Indian financial sector. It is possible that a large part of the population may never open a conventional bank account and straight away use mobile phones to do financial transactions 13 – whether for payments, lending,14 borrowing or investing. Nandan Nilekani, the former Chairman of UIDAI that implemented the Aadhaar programme has said that the mobile phone will be the bank account for many Indians and it could be a "WhatsApp moment in Indian financial services."
The emerging landscape In India, over 70 percent of the total Fintech investment in 2015 was received by companies in the Payments sector – led by Paytm which received over $500 million from ANT Financial, followed by BillDesk who got $150 million from General Atlantic. MobiKwik received $75 million led by TreeLine Asia and Citrus received $25 million from Ascent and Sequoia Capital to boost investments in the Wallets sector. BankBazaar received $60 million from Amazon India, Fidelity Growth and Mousse Partners to top investments in the Credit Cards & Loans, a
13
category that received the third highest investment. Exhibit P1.3 gives the start-up investment activity in Fintech companies during 2015. Exhibit P1.3: Investment activity in Fintech, 2015
Payments 4.5%
2.9%
Wallets Credit Cards & Loans
3.8%
Insurance
3.9%
72.5%
4.9%
mPoS Business Lending
7.5%
Others
While some sectors are still in early stages of adoption, others have gained wide acceptance. Payments, remittances and wallets are growing rapidly with cashless payments projected to account for over 50 percent of transactions in India by 2020. 15,16 Tech-enabled asset management firms also known as robo-advisory firms, such as ArthaYantra, have now opened up the market to millennials and low-value investors by using algorithms to reduce the cost of investing17. Fintech lenders like Capital Float in India, are able to cater to SME’s rapidly and more effectively. In India, lenders like KredX add value by assisting SME’s to become creditworthy, and are building a data repository to better their credit assessment algorithms. Incumbents are seeing this effect and are developing this technology or collaborating with Fintech champions to cut the cost of lending to SME’s. With new companies launched every day, the market is seeing solutions emerge across each sector. For example:
mSwipe is an mPoS solution that uses a card reader connected to a mobile device to allow small business merchants to accept card payments. mSwipe sends the user’s payment to an escrow account, from where it gets connected to the payment gateways. Thus, it does not require a bank to complete the transaction. As of July 2016, they claimed to have 85,000 merchants onboard and were on track to increase this to 200,000 by December 2016.18
Faircent is a Peer-To-Peer lending marketplace where borrowers and lenders can connect. Borrowers are assigned a loan based on Faircent’s underwriting algorithm. Lenders can then make offers at interest rates that are similar or lower than specified by Faircent for a borrower. Faircent charges an upfront fee and an administrative fee on finalized deals.
Neogrowth is an NBFC that provides loans to small businesses off its own book that has brought in an innovation in collections. Neogrowth provides loans to retailers who have EDC/POS machines or online sellers, where instead of a fixed monthly payment the repayment is a fixed percentage of each day's sale through the EDC/POS machine or e-commerce platform. Since launched in 2013, they have disbursed over ₹6000 million in loans. In 2016, they received a funding of ₹1080 million from IIFL.19
14
Scripbox has tried to make investment easy, by automating and simplifying the process of selecting mutual funds for investment. The platform provides three streams of investment (tax saving, equity and debt) and provides the user with 2-4 funds in each category. The shortlisted funds are automatically reviewed, and single click options are provided to switch from an old fund to a new one. Seventy percent of their customers are first time investors with investment ranging from ₹500 to ₹400,000 p.m.
ArthaYantra uses a simple questionnaire to capture the investor’s financial goals and risk appetite. The algorithm then runs this information and funds are recommended for investment. Artha Yantra’s mixed model allows the investor to pay for investment advice alone and buy the funds separately or buy the funds through the platform and receive free advice as the funds pay a commission to the platform.
Exhibit P1.4 below provides a quick segmentation of the Indian Fintech ecosystem. 20 Exhibit P1.4: Ecosystem of Fintech Firms in India Services Remittances
Payments
Insurance
Equity/Debt
Financial Management
Crowdfunding
Personal Finance Management
Business Lending
Credit Scoring
Wallets Credit Cards and Loans Asset Management
P2P Payments
Consumer Lending
The technology revolution i.e. penetration of internet and mobile devices will only further the cause of Fintech in the years to come. For example, the Unified Payments Interface (UPI) infrastructure facilitates a less-cash society. Government is also taking initiatives like the MUDRA Yojana that will provide small businesses loans of up to one million rupees at low interest rates. We have projected that online financial services (not including payments, share trading and remittances) will be a ₹150 billion market by 2020. The market size calculations in Exhibit P1.5 are represented by net revenue accrued to service providers and not the gross value of transactions.21
15
Exhibit P1.5: Sector-wise 2014 vs 2020 Market Opportunity Opportunity Size of Online Financial Services (₹ million)
Wallets 57,934
Insurance
Loans
Mutual Funds
45,972
28,372
18,902
Others
1,810
1,787
4,845
2,046
1,504
450
79%
46%
49%
32%
26%
Over 14x the 2014 Market Opportunity CAGR (2014-20) 32% Market size represented by net revenue accrued to service providers and not the gross value of transactions
Total
152,990
Total
2020 10,628
2014
The challenges ahead 1.
Fintech regulations are still evolving in India. The principal regulator, Reserve Bank of India, has commissioned studies on certain aspects of the emerging Fintech landscape, with a 13-member panel in July 2016 to "look into and report on the granular aspects of Fin Tech and its implications". In general, the RBI has advocated a wait and watch strategy. An April 2016 consultation paper on P2P lending expressed the opinion that “Regulating an exempt or nascent sector” could create the perception of legitimacy, which, in the context of P2P lending, could attract vulnerable lenders who do not understand the risks involved. While the focus of the regulator is usually on borrower protection, in these segments, assuming that "the lenders may include uninformed individuals", the regulator has also emphasized the need to protect the individual lenders.
2.
While there are many Fintech companies that have been operating in India for three or more years, most of them are still sub-scale. Wallets are an exception, where Paytm has driven dramatic growth of the segment. In others, such as lending, there are multiple players of similar (and relatively small) size. The value of transactions is still small compared to the potential, or even compared to the incumbents. With companies being at such an early stage of development, it is hard to identify one as a leader – there are many rounds of competitive churn ahead of us. Even companies like PolicyBazaar, who have built a reasonable position, continue to face new competitors. 22
3.
Fintech startups generally have a technology first mandate, but many Indian operations can best be described as technology-enabled. Some companies, specifically those in P2P payments, are restricted due to regulations. In other segments such as SME lending, customers require significant amounts of handholding, and the delivery of the services depends on having feet on the ground. The challenge is exacerbated for Indian startups because key elements of the ecosystem are not yet available. For example, SMERA, the largest credit-scoring bureau for small business, covers less than 1 in 10,000 businesses. 23 In other cases, data is not available, or is of poor quality. For example, credit card history, a key source of data for personal credit scores in the West, is not very useful in India because less than 2 percent of the population have a credit card. Of course, this is also an opportunity area for entrepreneurs. Finomena, for
16
example, is trying to use alternate data and algorithms to evaluate the credit worthiness of college students and working professionals.24 4.
Incumbents in India have been forewarned by the explosive growth of Fintech in other countries. They are aggressively trying to learn from startups and from the response of their peers in other markets. The banks have either tried to adopt the techniques from the startups, or tried to collaborate with them. The first approach has been demonstrated by Citibank, which started ‘Citi Fintech’ 25, a small team with a mix of former technology and banking employees, to drive innovation and counter challenges from Fintech startups. The goal is to mirror the speed and agility of the startups by replicating their processes, such as by having shorter release cycles for new versions of the mobile app. On the other hand, JP Morgan Chase has partnered with the lending startup, OnDeck Capital, where JP Morgan will use the platform from OnDeck to provide loans to their small business customers, with OnDeck providing processing support and faster turnaround time26. In India, SBI has started experimenting with several initiatives that replicate the game plan of startups – such as B2C lending partnerships with ecommerce platforms. 27 HDFC bank has established a 'Digital Innovation Summit' to "reach out and source ideas from Fintech companies". Tata Capital is partnering with Fintech companies like Biz2Credit, an SME lending startup with an international presence. 28
The overall impact of Fintech start-ups Startups in the Fintech space have helped redefine the financial services landscape – both directly and indirectly. Although, many of the current firms are still relatively small, we can see several ways in which they are helping to reshape financial services in India. The most obvious impact is in the area of payments – where millions of Indians are now using digital wallets as a matter of course. This has eased transactions immeasurably, especially in the mobile commerce space and has enabled the dramatic growth of taxi-hailing services like Uber and Ola. Importantly, it is leading to a reduction of the cash economy, evidenced already in the slow-down of ATM growth. In June 2016, Paytm also announced a soon-to-be-launched feature of making offline payments using an app, bringing digital payments to low connectivity users. The second area of impact is in terms of inclusion. Digital models can scale rapidly and at low cost – removing the limitation that traditional brick-and-mortar institutions have had. Once the models are developed, we will see rapid improvements in the penetration of financial services – reducing the role of the informal economy. Further, Fintech models are improving the efficiency of the financial services space. With improved data and analytics engines, it is now possible to do segment-of-one pricing. Averages will no longer be relevant and firms will be able to distinguish between good and bad customers in a much better way. This will result in better pricing and efficiencies. We expect that this will reduce the overall cost of credit in the system, which has a major GDP multiplier. Finally, the threat of Fintech startups has galvanized the incumbents into action, bringing in more efficiencies in the system. Many of the incumbebt institutions are developing their own digital plays and are collaborating with Fintech companies. In June 2016, Axis Bank set up an innovation lab in Bangalore to develop startups with the intention of absorbing their technology. SBI, in the same month, launched a ₹2 billion startup fund and earlier in the year, launched a specialized branch catering to startups, realizing the value of collaborating with Fintech companies to cross-sell their products. All-in-all, the startups are shaking up the establishment, and are leading to a new order.
17
Notes 1
“Fintech India”, MXV Consulting and MAPE Advisory, June 2016
2
“Fintech and the evolving landscape: landing points for the industry”, Accenture, 2016
3
“Bank of Baroda ties up with CreditMantri to first-time borrowers, SMEs”, The Economic Times, July 25, 2016
4
“Hold on, my wallet's in my phone: Fintech firms are a blessing for small entrepreneurs”, Forbes India, July 15, 2016
“Jan Dhan Yojana: Government loads up RuPay with Rs 30K LIC cover plus Rs 1 lakh accident insurance,” The Economic Times, August 28, 2014 5
“Fourth All India Census of Micro, Small and Medium Enterprises”, Ministry of Micro, Small and Medium Enterprise, September, 2009 6
7
Pradhan Mantri Jan-Dhan Yojana, Department of Financial Services, Government of India, August 10, 2016
8
“Aadhaar – Voluntarily Mandatory?”, The Times of India, August 4, 2016
9
“Mobile banking sees dramatic surge in India”, Mint, March 28, 2016
10
“Fintech India Genesis”, MXV Consulting, July 2015
11
“Which Indian financial sector is UPI really going after?”, Yourstory, March 23, 2016
12
“Unified payments system to make mobile wallets redundant: Report”, Business Standard, May 8, 2016
13
“India's first 'mobile-only' bank is here!”, Rediff, April 26, 2016
14
“This New Kind Of Credit Score Is All Based On How You Use Your Cell Phone”, Fastcoexist, April 27, 2016
15
“Fin startups take cashless economy to bottom of pyramid”, The Economic Times, July 12, 2016
16
“Rise of digital transactions forces ATM firms to put IPO plans on ice”, Mint, March 28, 2016
17
“’Robo-advice’ approved by FCA ut axes 220 jobs at RBS”, BBC News, March 14, 2016
18
“Mswipe eyes 2 lakh merchants by Dec 2016”, Deccan Herald, July 14,2016
19
“NeoGrowth gets Rs 108 crore funding from IIFL Wealth Management’s Seed Venture Fund”, The Economic Times,
July 4,2016 20
“Fintech India”, MXV Consulting and MAPE Advisory, June 2016
21
“Fintech India”, MXV Consulting and MAPE Advisory, June 2016
22
“Backed by Ronnie Screwvala, Easy Policy aims to make insurance easy in India”, Yourstory, April 12, 2016
SMERA has assigned 40,451 ratings, against an estimated 510 Mn MSME enterprises (2014-15, Ministry of MSME estimate) 23
24
“Matrix Partners, others back fin-tech startup Finomena”, The Economic Times, March 8, 2016
25
“Citi Does Fintech”, Fortune, July 1, 2016
26
“Inside J.P. Morgan’s Deal with On Deck Capital”, WSJ, December 30, 2015
27
“Launch of SBI (e-Smart SME) e-commerce loans”, Press release, SBI, January 15, 2016
28
“Tata Capital partners with SME lending platform Biz2Credit”, Yourstory, April 11, 2016
18
REFLECTION 1
The Equitas Journey: A Conversation with P.N.Vasudevan Thillai Rajan A. What was the starting entrepreneurial journey?
point
for
general, and there is a lot of sensitivity because of their social and economic backgrounds. Since many of the women are uneducated, the perception is that the well-dressed lender would be taking them for a ride. MFI loans are also unsecured loans. With such high risks, one would expect the risk of default to be higher than that of normal retail lending. But in reality, the NPA in the MFI is under 1%, making it a very different kettle of fish. It was not like any other form of lending. Even though I did come with lot of experience on retail lending I had to go through a lot of learning on microfinance such as the process, the business, the products, the customer segments, the psychology of the customers, before we could actually say that this is something we could probably attempt.
your
Before starting Equitas, I had worked been working in Cholamandalam Finance for about 20 years. In 2005, because of a reshuffling in the top management as a result of a joint venture, I had to quit my job. Subsequently, I moved to Mumbai where I joined the DCB Bank. However, since my daughter developed health problems, I had to return to Chennai on the advice of the doctors. Opportunities for finance professionals were difficult in Chennai, as there were no private bank headquartered in Chennai and I was not in a position to go back to the NBFC’s. The idea of starting Equitas came up then, and some of the people I knew encouraged me to start this and that’s how the venture began.
As a new entrant when you started, what were the changes that you brought to the industry?
How did your experience in the financial services industry prepare you for the microfinance venture?
The whole approach was to create an organisation that can sustain by itself without being associated with the founders of the organization. When we started Equitas, I took a two month journey across the country to find out how the MFI actually worked. What I found during those trips was that customers were really thankful to the MFI for the services, because in addition to loan, they also got a lot of respect from the loan officers dealing with them.
My professional career was centered on retail lending. But the Micro Finance Industry (MFI) was definitely very different than other forms of retail lending because the amount is very small and we deal with borrowers in groups. Normally retail lending means loan sizes of ₹500,000 going up to about ₹50 million. But in microfinance we talk of a loan amount of ₹5000 – 20000, which is less than the EMI of the lowest retail lending. And we would be dealing with a segment of customers such as the rural and low income people and in large numbers. Since the quantum of loan is so small in MFI, there is nothing that can be done if there is a default, because it would be too costly to proceed legally. In addition, the loans would be made to women in
…to create an organization that can sustain by itself without being associated with the founders…
But the rate at which they were actually barrowing was around 40 percent, which they didn’t know. The customers thought they were borrowing around 12 – 14 percent, but in reality it was about 40 percent. While the microfinance companies were more concerned about providing quick access to money to the borrowers, they were not pushing enough about reducing the cost. So at the end of my field
19
visits, when we sat together about creating an organization, we decided that we should create an organization that is fair and transparent. We found that in many cases the MFI’s were not being transparent. An example was the insurance premium that the MFI’s charged the borrowers to recover the loan amount in case of the death of the borrower. I observed that they were charging around ₹200 as premium from the borrowers, but they were paying only ₹75 to the insurance company, thus netting a commission of ₹125 rupees. Our aim was to create the most fair and the most transparent MFI in the world and Equitas in Latin meant equitable which means being fair and transparent.
customers felt that we were charging double that of others, but in reality, others were charging 40 percent, whereas, we were charging only 25.5 percent. So even when there was resistance to printing the rate in the passbook, we stuck to our decision and made a lot of efforts to explain to the customers. Similarly, from day one till today, we have never earned a commission on the insurance, both life and property/vehicle that we ask our customers to take in order for the insurance company to pay us in the case of the death of the borrower or damage to the property or vehicle which is secured to our loan. We are probably the only NBFC or Bank in the country who doesn’t earn commission on such insurance.
So, when we fixed our lending rate for our first loan in Dec 2007, we took a different approach. We assumed a steep growth in the first five years, and a steady state growth after that. We then determined what is our likely operating cost at such steady state growth stage. We then factored in this operating cost into our pricing calculation. Our philosophy was that the cost of growth should be borne by the investors, and the steady state operating cost should be borne by customers. On that basis, we calculated our lending rate should be 25.5 percent, as we estimated our steady state operating cost as 7.5 percent, borrowing cost to be 13.5 percent, delinquency to be 2 percent, and a spread of 2.5 percent. So, we gave our first loan at 25.5 percent when the market rate was around 40 percent. Four years later when the RBI stepped into regulate the MFI sector, they fixed the lending rate cap at 26 percent. Everybody had to drop down their interest rates, but we were exactly where the RBI wanted it to be. In a way, the Regulations followed our business practices.
How did you raise capital for the business to start with?
Even before I started, I set an objective that we should start only what we can scale up…
Even before I started, I set an objective that we should start only what we can scale up. So having made that promise, I needed to translate it into action. At that point in time, the highest paid-up capital for an MFI at the time of starting up was ₹25 million. So, I wanted to start my enterprise with paid up capital four times of that, i.e., ₹100 million. I told myself that if I am not able to raise that capital, then I am not going start the company – that much was clear to me. I did not want to start with ₹20 million and slowly grow I met several people with the objective of raising capital. They were known to me for several years professionally. Coming from a middle class salaried family I had not accumulated much in terms of savings or wealth. As my contribution, I had to mortgage my house for ₹2 million. People such as Mr M. A. Alagappan, former Chairman of Murugappa Gorup, Mr M. Anandan, former MD of Cholamandalam, Mr V. P. Nandakumar, Chairman & Managing Director of Manappuram Finance and others contributed to the initial capital and we were able to raise a total of ₹135 million. To be able to raise that amount in those days was a big event for us.
In addition we also wanted to be transparent by communicating the real lending rate to the customer by printing the all-inclusive reducing balance interest in the passbook and explaining it to the customer. We did face resistance on this because everybody else was communicating a flat interest rate of 13 – 14 percent, but we were going ahead and telling the rate as 25.5 percent. So
20
What about the subsequent growth capital from venture funds?
What has been the contribution of venture funds to Equitas?
I started approaching the venture funds immediately after raising the initial round because growth was paramount importance for us. We were about 10 days into our operations, when I met Aavishkaar, one of the venture firms. When they had expressed an interest in investing in us, I had two requests to them: one was to have the investment quickly and the second was to have a simple agreement that does not run more than a few pages. They actually did it. They funded us within a week, and gave probably a historic term sheet that was very simple. Even though the investment they made was very small, about ₹60 million, the agreement was very critical for us because it became the basis for all future agreements.
Each investor contributed differently. The contribution of Aavishkaar was the agreement that they gave us, which formed the benchmark for all the subsequent agreements with other investors. That was a significant contribution. Then we had investors such as IFC and CDC. Both of them provided us Tier 2 capital as well as non-convertible debentures. We also had FMO as an investor, who provided tier 2 capital, at a time when the MFI industry in India was in a crisis in 2010 and no investor or lender were willing to put their money on the MFIs. We also had CLSA as an investor. They supported some of our social activities, and were very closely involved with us in the IPO process. Many of our investors such as Sequoia Capital, CDC, and Aquarius had significant experience in taking their companies public and they rallied around us at the time of the IPO. They helped us in managing the entire IPO process, and the relationship with the bankers and brokers. We were thus able to capitalize on the strengths of the different investors, but none of the investors were involved in the operational activities.
We were able to capitalize on the strengths of the different investors, but none of the investors were involved in operational activities.
Investors in the company never played a managerial role. The board has always been independent, with a majority of the members being independent directors. The investors had representation in the board if they had 10 percent stake in the company and we always had an independent Chairman. In our 13 member board, we had only 3 investor nominees at any point in time, clearly indicating that independent directors had majority position in the board. Our agreement with Aavishkaar was also worded in such a way that the investors had a role at the policy level at the Board but no specific or special rights in any of the organisational or operational matters.
Wasn’t it a difficult task to manage so many investors? Actually we never had any issue. Our information sharing was of a very high order. We provided a standard set of data for all the investors, which they could directly access from the intranet. If any of the investors wanted information in addition to what we provided, then we added that to our information pack, so that it reached all the investors. Frankly nobody has ever came back asking for anything more so far, because we have given as much information as would be normally required by them. We take transparency very seriously. Our philosophy is that by being transparent, we are also forced to be fair in all our actions. We also told our customers that if they felt that any of our staff were doing something that was
From the beginning, I was clear that there will be no single individual who will own the company. So we had a philosophy that no investor will own more than 15 percent of the company. In every round we had a new investor and we never took follow-on investment from an existing investor. With every investment round, all the existing investors were getting diluted. By the time we went public, we had about 13-14 investors in the company and I have heard people telling me that it was probably a record in India.
21
not looking fair or transparent, they could call back and tell us so that we can correct it. In all our activities whether it was the regulators, government, public, press, customer, employees, banker, rating agency, or to anybody, we should be able to stand-up publicly and tell them clearly what we were doing. If we can do that, then what we were doing was fair, but if we can’t then what we were doing was not fair. So we are very particular about being transparent. Is there a cost to being fair and transparent?
framework for the MFI sector. This Committee’s report states in verbatim what our philosophy has been from day one, which is that the cost of growth should be borne by investors and the steady state operating cost should be borne by customers. Similarly, the RBI fixed the lending cap rate for MFI at 26 percent, when we were at 25.5 percent. This gives us a lot of pride and satisfaction. This is a binding element in our organisation and the entire staff are aligned to these values.
...by being transparent, we are also forced to be fair in all our actions.
May be. It could affect the returns, because had we charged 40 percent instead of 26 percent, we could have earned more. If we I had charged commission on insurance, we would have got an additional profit which could have been almost 20% of each annual PAT. But we don’t see it in this manner. We look at it as the building blocks or reinforcement of our values and belief which will sustain this organization. For example, when the MFI industry went through a crisis a few years ago, it gave us the moral high ground. We were one of the few organizations who could stand up and talk openly about our transparent practices from day one. This created a good opinion amongst the Regulator and the Governments about our organisation and helped us deal with the crisis situation in an appropriate manner. It is a different issue that people may still consider that 25.5 percent is a high interest rate, but at least there is a rational manner in which it can be justified.
How is the ecosystem for aspiring entrepreneurs today?
It is truly wonderful because today you don’t have to be from a wealthy background to start a company and I think that’s makes all the difference. The urge to innovate, being creative, strong work ethic, and the desire to create is there in everybody at varied degrees, irrespective of the background. But for several decades, money was just not available to 99 percent of the population. Only one percent of the population had access to capital and only they could do what they wanted. Today’s environment is fantastic in the sense that it has opened up opportunities for everybody. The only drawback in today’s environment is that the opportunity for venture funding is heavily skewed to technological start-ups. While that is all for the good, I hope that the next wave of revolution should be to create an ecosystem that supports non-technology start-ups also and if that happens, the percentage of entrepreneurs benefitting will further increase.
We interacted with the Malegam Committee, which was set up by RBI to suggest a regulatory
P.N. Vasudevan was the Managing Director of Equitas Microfinance Limited. He started Equitas Microfinance in 2007, which subsequently went public in 2016. After having obtained a banking license in 2015, Equitas Microfinance has since converted to Equitas Small Finance Bank.
22
India Venture Capital and Private Equity Report 2016
2.
The Spatial Diffusion of the Start-up Ecosystem “We have a million problems, but at the same time we have over a billion minds”1 “Competitive federalism brings economic prosperity to the country”2
Overview The ecosystem for start-ups comprises of various components that help in providing a conducive growth environment for the growth of start-ups. Examples of the different components of the ecosystem include, among others, (i) availability of financing sources to support start-ups such as venture, seed, and angel funds; (ii) facilities that provide hard and soft infrastructure support such as incubators and accelerators; (iii) a favorable policy framework that facilitates creation of start-ups. Given the broad canvas of the start-up ecosystem, we specifically focus on the trends in the following components in this chapter: incubators and accelerators, angel investments, and venture investments.
Incubators Incubators are institutions that provide various forms of support and nurture start-ups in their initial days. Typically, the services provided by incubators include – workspace, shared facilities like laboratories, certain amount of funding, professional services like accounting and legal support, and so on. Typically, incubators are located as a part of the larger institution such as universities or research laboratories. Stand-alone incubators, not affiliated to any institution, are a more recent phenomenon.
No. of incubators in the sample: 339
Figure 2.1: Host institution of the incubators Figure 2.1 provides an illustration of the proportion of the incubators with respect to the type of host institution. It can be seen that about 56 percent of the incubators are located in universities, indicating the important role played by universities in supporting entrepreneurship and start-ups. However, with more than 700 degree granting institutions and more than 35000 affiliated colleges to these institutions, the number of institutions that have incubators are only a small fraction of the total educational institutions in the country. The role of
© Indian Institute of Technology Madras
23
India Venture Capital and Private Equity Report 2016 state government funded universities in promoting incubators has also been marginal. Less than 10 percent of the incubators are supported by state government universities, whereas more than 15 percent of the incubators are located in centrally funded universities. However, the number of public state universities are about three times that of the number of central government funded universities and institutes of national importance. Though entrepreneurship is a private sector activity, the government plays an important role in nurturing and supporting it. More than 35 percent of the incubators are located in government institutions. Private sector however accounts for bulk of the incubators, with about 65 percent of the incubators hosted in the private sector.
Central Univ Govt. Non. Univ. Private Univ Private Non Univ. State Univ.
Figure 2.2: Geographical spread of incubators Figure 2.2 presents the location of the incubators across the country. The incubators were classified on the basis of their host institution. It can be seen that the highest concentration of incubators are in the southern states, specifically, Tamil Nadu, Kerala, and Karnataka. The concentration of the incubators are also a little higher in the states of Maharashtra, Telengana, Gujarat, and the National Capital Region, comprising Delhi and nearby areas like Gurgaon, Noida, and so on. A significant difference between the southern states and other states like Maharashtra is that, in the former, the incubators are present even in the interior regions of the state, whereas in the latter, it is mainly concentrated in and around the state capital. Overall, the central region and the North Eastern region have very few incubators. Even in some of the Northern states like Rajasthan or Himachal Pradesh the presence of incubators is sparse. Targeted interventions have to be made to encourage the setting up of incubators in these locations as a way to encourage start-ups. An interesting trend to be noted is that government institutions have played an important role in locating incubators even in locations that are not commercial centres, whereas private incubators are mostly located in large cities or those that have a significant amount of commercial activity. This also underlines the initiatives of the public sector to support entrepreneurship in far flung areas of the country.
© Indian Institute of Technology Madras
24
India Venture Capital and Private Equity Report 2016 Figure 2.3 presents an illustration of the number of incubators by type of city. Type of city has been divided into three categories based on population, Tier 1, 2, and 3. The area of the circle gives a relative indication of the number of incubators in that category. At the overall level, it can be seen that Tier 1 (comprising the six metro cities) cities have the most number of incubators, as compared to that of Tier 2 or 3. Classification of the incubators by city type and host institution shows interesting trends. While private nonuniversities hosted the largest number of incubators in Tier I cities, private universities hosted the largest number of incubators in Tier 2 and 3 cities. This showed that private sector incubators, which are not based in universities, continued to favor the metro cities (Tier 1). Secondly, the largest number of incubators in Tier 3 cities are hosted by private universities, indicating the important role played by these organizations in spreading the message of entrepreneurship. The number of incubators in state government universities Tier 2 and 3 cities has been relatively low.
Tier 1 city Tier 2 city Tier 3 city Legend: 1 – Central University; 2 – Government Non-University; 3 – Private University; 4 – Private Non-university; 5 – State university
Figure 2.3: Type of city and incubator host Figure 2.4 and 2.5 provides a pictorial representation of the various industry sectors supported by the incubators. In many instances, incubators supported more than one sector – in which case, it was counted in all the sectors. Technology sector is supported by the largest number of incubators. This is as expected, since most the incubators (at least those in universities) have been set up with the objective of commercializing the research and development conducted in the laboratories. After technology, the healthcare sector occupies the second position in terms of the number of the incubators supporting it. Telecommunications, industrials, and consumer goods come close, in terms of the third spot. The number of incubators supporting the other sectors are very limited. This shows that incubation is not seen as the preferred approach in commercializing innovations such as in utilities or in the oil and gas sector. Figure 2.5 indicates that incubators hosted by private non-universities show greater diversity and support incubations across a wide range of sectors. On the other hand, incubators hosted in other institutions support only a handful of sectors. Setting up of incubators by private non-universities can thus help to support incubations across a wide variety of sectors, such as financials or utilities. Not only are the incubators supported
© Indian Institute of Technology Madras
25
India Venture Capital and Private Equity Report 2016 by state universities lower, the number of sectors that these incubators support is also few. Only six of the 10 sectors are supported by these incubators. In the case of central universities or private universities, eight of the 10 sectors are supported. However, in the case of government non-universities or private non-universities, there is least one incubator exists that provides incubation support for every sector.
Figure 2.4: Sectors supported by incubators (representation 1)
Central Univ Govt. Non. Univ. Private Univ Private Non Univ. State Univ. Legend: 1 – Oil and gas; 2 – Basic materials; 3 – Industrials; 4 – Consumer goods; 5 – Healthcare; 6 – Consumer services; 7 – Telecommunication; 8 – Utilities; 9 – Financials; 10 - Technology
Figure 2.5: Sectors supported by incubators (representation 2)
© Indian Institute of Technology Madras
26
India Venture Capital and Private Equity Report 2016
Incubatees supported by the incubators The start-ups supported by the incubators are called incubatees. Despite the common use of the term, the word incubatees is still not defined in most dictionaries. Different incubators have different process of selecting the incubatees. While some university based incubators provide incubation support only to the start-ups founded by members of the university community, certain others have a more open policy of supporting start-ups. An example of the former is the Incubation cell at IIT Madras which predominantly supports start-ups founded by faculty, students, researchers, and alumni of the institute. An example of the latter is the Technology Business Incubator at Vellore Institute of Technology, which is open to support founders from different institutions. Typically, the incubators provide support for a period of about 2-3 years, by which time the start-ups are expected to develop the capacity to stand on their own. At that point, the incubatees move out of the incubator facility (or graduated as it is typically called) and set up offices elsewhere.
Figure 2.6: Incubatees in different sectors Figure 2.6 presents the proportion of incubatees incubated in different sectors. The sample of 1970 incubatees are supported by different incubators. The trend by and large mirrors the different sectors supported by the incubators. Technology sector, which is supported by most of the incubators, accounts for the highest number of incubatees. Healthcare sector, supported by the second highest number of incubators, features second in the number of incubatees. Industrials and consumer services also account for a significant number of incubatees. Possible explanations to the trend could be as follows. Firstly, the possibility of commercialization and the time frame for moving from lab to market is shorter in these sectors, which explains the higher number of incubatees. Secondly, incubators have the capacity to support start-ups in these sectors. For example, technology, consumer services, healthcare, or industrials are not as capital intensive as that of oil and gas or utilities. Since the facilities and quantum of financial support provided by incubators is limited, they might not be able to support start-ups that need significant capital.
© Indian Institute of Technology Madras
27
India Venture Capital and Private Equity Report 2016 Figure 2.7 provides an illustration of the incubatees and the incubators that support them, when classified by their host organization. The total area under the circles gives an indication of the number of incubatees supported by different type of incubators. It can be seen that the central universities support the most number of incubatees and the state universities support the least number of incubatees. However, in all the categories, the highest number of incubatees are in the technology sector. The only deviation to this trend was seen in the case of incubators supported by private non-universities - who supported 84 and 75 incubatees in healthcare and technology respectively. For most other incubators, healthcare occupied the second position, followed by the industrial sector. While private non-universities hosted the most number of incubators, the number of incubatees supported by them were the second lowest. Since most of the private non-incubators were situated in Tier 1 cities (Figure 2.3), the issue could not be the number of proposals received by them. A possible explanation on the lower number of incubatees could then be attributed to their possible stringent selection as compared to that of incubators supported by other host organizations. Central universities and private universities emerged dominant supporting a total of 693 and 451 incubatees respectively. These two categories supported 58 percent of the incubatees and covered every industry sector. Government non-universities also took a prominent spot supporting 440 incubatees. Both private non-universities and state universities accounted for only 18 percent of the total supporting 266 and 87 incubatees respectively.
Central Univ. Govt. Non. Univ. Private Univ. Private Non Univ. State Univ. Legend: 1 – Oil and gas; 2 – Basic materials; 3 – Industrials; 4 – Consumer goods; 5 – Healthcare; 6 – Consumer services; 7 – Telecommunication; 8 – Utilities; 9 – Financials; 10 - Technology
Figure 2.7: Incubatees classified by sectors based on the incubator host organizations Average number of incubatees supported in the different type of incubators vary widely and are as follows: Incubators in central government funded universities: 40; Incubators in government non-universities: 89; Incubators in private universities: 32; Private non-universities: 13; and State government universities: 24. This leads us to infer that incubators supported by different host organizations could have different investment
© Indian Institute of Technology Madras
28
India Venture Capital and Private Equity Report 2016 thesis. Private non-universities might have more stringent criteria because the financial sustainability of the incubators could depend on the success of the incubatees. On the other hand, incubators supported by the government could have the primary objective of encouraging start-ups rather than the financial success of the incubatees, and thus they are prepared to support more number of incubatees. The low number of incubatees supported by state universities could be attributed to their capacity rather than other factors. Given the wide geographical spread of the state universities, setting up more incubators in the state universities and strengthening their capabilities can significantly contribute to the cause of entrepreneurship.
Accelerators The concept of accelerators is a fairly recent phenomenon, at least in the Indian context. Essentially, a private sector initiative, accelerators help the start-ups to quickly move from the concept stage to the next stages. A key difference between incubators and accelerators is the duration of support provided to the start-ups. While the support provided by accelerators, in general, does not extend beyond four months, the incubators support the start-ups for about 2-3 years. In addition, since accelerators are private sector initiatives, there is a higher degree of intensity in the engagement with the start-ups.
Figure 2.8: Geographical spread of accelerators Figure 2.8 provides a snapshot of the geographical spread of accelerators in India. It can be seen that accelerators are essentially an urban phenomenon, and except for a couple, virtually almost all of the accelerators are located in the main cities – Chennai, Bengaluru, Hyderabad, Mumbai, Ahmedabad, and New Delhi. The highest number of accelerators are found in Bengaluru, followed by the NCR region and Mumbai. The geographical spread of accelerators to smaller cities would help in bringing to start-ups the discipline and knowhow to scale up from the concept stage.
© Indian Institute of Technology Madras
29
India Venture Capital and Private Equity Report 2016 Figure 2.9 gives an illustration of the number of start-ups supported by a sample of accelerators. It can be seen that 17 accelerators have supported a total number of 1816 start-ups. Though some of the accelerators like 500 start-ups, Kyron, TiE Bootcamp have been associated with a large start-ups, in general, it is found that accelerators are able to guide more number of start-ups as compared to that of incubators. Hence setting up of more accelerator-type institutions can strengthen the start-up ecosystem in the country.
Figure 2.9: Start-ups supported by a sample of accelerators
Angel and Venture Funding Angel and venture funding plays an important role in the start-up ecosystem. The primary form of external capital to most start-ups is provided by angel and venture funds. While incubators and accelerators provide some amount of financial support, it is not very large (typically in the range of ₹1 – 5 million) and would rarely suffice to meet the growth capital requirements. While there are many start-ups that have boot-strapped and have been managed to grow without any significant amounts of external capital, they are few and far between. By and large, the dominant paradigm that prevails today is to use venture and angel funding for growing the start-up. While angel funding can provide around ₹30 million, venture funds can provide several times of that. Figure 2.10 provides the number of companies that have obtained angel and venture funding in the different states of India. The colour codes indicate the relative position of different states in terms of attracting venture funding. It can be observed that companies that have received angel and venture funding are concentrated in a handful of states. For example, three states in India, viz., Karnataka, Maharashtra, and Delhi account for a large number of start-ups. States like Tamil Nadu, Telengana, and Haryana come next in terms of the number of funded start-ups. Barring these states, venture funding to companies in the reminder of the states in India have been very limited. It is interesting to note the differences in the presence of incubators and the start-up funding activity. While Tamil Nadu has the highest number of incubators, it does not rank high in terms of start-up funding. Possible explanations behind this trend could be: (i) only very few of the start-ups from the incubators are successful in attracting funding; or (ii) companies shift to other states when they graduate from the incubators. The venture funding industry has been active for about 15 years now. Even after such a long period, much of the venture funded start-ups are located in a couple of states. This indicates that targeted interventions are needed to democratize venture funding in the country. More geographical spread of venture funding in the country
© Indian Institute of Technology Madras
30
India Venture Capital and Private Equity Report 2016 would help to prevent start-up agglomeration to a few states and cities. It will help to bridge a key component of the entrepreneurial ecosystem – which is the availability of growth capital to incubatees and other start-ups.
Figure 2.10: Geographical spread of funded Start-ups www.indzara.com Jammu and Kashmir Himachal Pradesh Punjab
Chandigarh
Uttarakhand Haryana Delhi
Arunachal Pradesh Sikkim
Uttar Pradesh
Rajasthan
Assam Bihar Jharkhand
Gujarat
Madhya Pradesh
Daman and Diu
Dadra and Nagar Haveli
Tripura
West Bengal
Nagaland Manipur
Mizoram
Odisha
Maharashtra
Bay of Bengal
Telangana
Arabian Sea
Meghalaya
Goa
Lakshadweep
Andhra Pradesh
Tamil Nadu
Andaman and Nicobar Islands
Puducherry
Lowest (Red) to Highest (Green)
Indian Ocean
Figure 2.11: Geographical spread of SMEs
© Indian Institute of Technology Madras
31
India Venture Capital and Private Equity Report 2016 The contours of start-ups in India seems very different from that of the SME sector. Figure 2.11 presents the geographical spread of SMEs in the various Indian states. Though there are lot of similarities with the trends with that of Figure 2.10, an interesting contrast can be seen in the top states. Tamil Nadu and Gujarat has the highest number of SMEs, but they do not account for the top states in terms of venture funded start-ups. On the other hand, Karnataka and Maharashtra, which account for the highest number of venture funded start-ups do not occupy the top slot in terms of number of SMEs. This could be attributed to the differences in the ecosystem that exists in the development of SMEs or Start-ups in these states. Start-ups need a different kind of ecosystem, which is provided in a better fashion by Karnataka and Maharashtra whereas states like Tamil Nadu and Gujarat provide a better ecosystem for SMEs.
Figure 2.12: Angel and venture investments in start-ups classified by city type Figure 2.12 presents the break-up of angel and VC investments in start-ups based on the type of cities. The 6 Tier 1 cities of India received the largest chunk of investment of ₹661.29 billion, accounting for about two-thirds of the angel and venture funding. Tier 2 cities received 31% of the total investment (about ₹306 billion) and start-ups in Tier 3 cities accounted for only ₹19.74 billion, which is about 2 percent of the total investment. This indicated a big gulf between start-ups in Tier 1 cities and the other two tiers. It is also possible that start-ups in smaller cities, shift to a larger city for various reasons when they reach a certain scale. Any which way, the results show that eco-system for start-ups is stronger and more robust in Tier 1 cities as compared to that of Tier 2 and 3 cities. To maximize the trickle down benefits of entrepreneurship, it is important to create geographically widespread engines of entrepreneurship. Figure 2.13 provides a representation of the start-ups funded in different sectors in some of the states. This helped to identify whether there are differences in the pattern between different states. However, our results showed fairly homogeneous trends across different states (to our surprise). In a sense, this also presents an opportunity to create sector specific targeted ecosystems to develop competitive advantages. Figure 2.13 also shows wide variation between states. For example, the ratio of start-ups funded in Maharashtra to those funded in Gujarat is more than 9. Similarly, ratio of start-ups funded in Karnataka and Tamil Nadu is more than 3. The ratio of Maharashtra to Kerala is more than 42! On the whole, it was seen that the three states of Karnataka, Maharashtra and Delhi accounted for 68% of the start-ups in India contributing a total of 2175 startups. Tamil Nadu, Haryana and Telangana together accounted
© Indian Institute of Technology Madras
32
India Venture Capital and Private Equity Report 2016 for 689 start-ups, which was less than the number of start-ups in either Karnataka or Maharashtra alone. States like West Bengal, which houses the Tier I city of Kolkata, had only 45 start-ups comparable to the state of Rajasthan. Thus, some states are having a superior ecosystem that enables them to host start-ups that can attract venture funding. If components of these ecosystem are identified and replicated in other states it can significantly contribute to the cause of entrepreneurship.
Figure 2.13: Patterns in start-ups funded in different states Start-up Classification
Figure 2.14: Patterns in start-ups funded in different cities The number of start-ups funded in different categories also indicates an interesting trend. Figure 2.13 indicates that start-ups in the software and internet services account for more than one-third of the companies that have received angel and venture funding. The next was Fintech and payments, which had 592 funded companies, accounting for 18.4 percent of the total. Figure 2.14 presents the patterns in specific cities. NCR of Delhi, Bengaluru, and Mumbai account for the largest number of start-ups. Then there is a big gulf between the second
© Indian Institute of Technology Madras
33
India Venture Capital and Private Equity Report 2016 level cities, which includes Chennai, Hyderabad, and Pune. The number of funded start-ups in other cities, such as Vadodara, Ahmedabad, or Kolkata is relatively very small. This shows that by virtue of being present in a city like NCR, Bengaluru, or Mumbai, a start-up has a better chance of getting funded. Alternatively, the quality of start-ups that originate in the above three cities could be better than those seen in the other cities or the initial movers in any category originate in these 3 cities. There are some components of the entrepreneurial ecosystem that the three cities have, which help them to create start-ups that are more successful in getting funded. Identifying and replicating those factors would be important from a public policy perspective, as it would help to create more hubs of entrepreneurship across the country. There are differences in the kind of start-ups that gets funded across the cities, but they seem to be marginal and are along expected lines. For example, Bengaluru is considered to be the information technology capital, and therefore the city having the highest number of funded start-ups in software and internet services comes as no surprise. Similarly, Mumbai, considered to be the commercial capital of the country, has the most number of funded start-ups in Fintech and payments. Apart from such minor variances, the trends in the start-ups funded in different cities has been more or less the same. We specifically analyzed the age of the start-up at the time of receiving angel funding in different cities. Our sample consisted of 563 start-ups in these cities, founded during the period 2006-15. The results are shown in Figure 2.15. It was interesting to note that, among all the major cities, the age of the start-up at the time of receiving angel funding is the highest in Chennai. The start-ups in Mumbai and NCR have the lowest average age, while that of start-ups in Bengaluru or Hyderabad are not far behind. If we assume that the quality of startups that originate in the cities are by and large no different (since these are large cities), then the differences in the age could be attributed to the differences in the start-up ecosystem.
Figure 2.15: Average age of start-up in different cities at the time of receiving angel funding Figure 2.16 shows the average angel investment received by the start-ups in different cities. The start-ups in Bengaluru has received the highest average investment followed by those in Mumbai. Similarly, the start-ups in Pune and Chennai have received the lowest average investment. The quantum of funding is a function of several factors such as the start-up sector, growth possibilities, and operating costs. The sector-wise patterns in the start-ups that get funded in different cities does not show large variations. If we also assume that since most of the start-ups target the pan-India market (except those in the hyper-local segment), then the growth
© Indian Institute of Technology Madras
34
India Venture Capital and Private Equity Report 2016 opportunities should not be very different between start-ups. Therefore, we interpret that operating costs play an important role in the fund requirement. Start-ups in Bangalore and Mumbai are probably operating in an environment of high costs, whereas those in Chennai and Pune are having the benefit of lower operating costs. In a sense, it is probably a trade-off. Bangalore and Mumbai, presumably have a better ecosystem as compared to that of Chennai or Pune, which offer a comparatively low cost environment for the start-ups.
Figure 2.16: Average angel investment received by start-ups in different cities Table 2.1: Comparison of angel investments in Tier 1 and Tier 2 cities
Tier 1 City
Tier 2 City
Percentage of deals
83%
10%
Percent of investment amount
86%
6%
Average deal amount (₹ Million)
16.12
9.95
Average round amount (₹ Million)
27.26
19.28
Average age at first funding (Years)
2.12
2.28
Average no. of angels per round
1.69
1.94
Table 2.1 provides an interesting comparison of trends in angel investments in Tier 1 and 2 cities. This is based on a sample of 3791 angel deals. Details on investment amount were available only for 799 deals. More than 80 percent of the angel investment (both in terms of number of deals as well as investment amount) have been in the six Tier 1 cities. Companies in Tier 1 cities are getting funded earlier and obtaining larger amounts of funding. Average deal sizes for companies in Tier 1 cities are about 62 percent higher than that of deals in Tier 2 cities. Investment rounds are more than 40 percent higher in Tier 1 cities as compared to that of Tier 2 cities.
Summary The turn of the millennium has been literally a coming of age for the Indian start-up and venture funding industry. The Internet and the dot-com phenomena that characterized those years was the first major wave of technology based start-ups that was witnessed in the country. While entrepreneurship in itself was not new in the country, as seen in the statistics of the number of SME segment, a large number of professionals and first generation entrepreneurs venturing on their own was witnessed only after the 2000s. In the last 15 years or so,
© Indian Institute of Technology Madras
35
India Venture Capital and Private Equity Report 2016 there has been significant acceptance to entrepreneurship in the Indian society, which in turn has resulted in a boom in the number of start-ups being created. Our results in this chapter show that this growth in the number of start-ups has been restricted to a handful of the cities, leading to a phenomenon of start-up agglomeration. Bengaluru, Mumbai and NCR are the top three cities in terms of the number of funded start-ups, by virtue of which the states of Karnataka, Maharashtra and Delhi have emerged as the top three states. The contours of growth for the SME sector seem to be different as compared to that of the start-ups, as evidenced by the ranking of Tamil Nadu and Gujarat in the SME sector and Karnataka and Maharashtra in the start-up segment. This indicates that the ecosystem that supports SME’s and Start-ups could comprise of different components. In this chapter, we specifically looked at the following components of the start-up ecosystem: incubators, accelerators, and angel and venture funding. While all of them are widely prevalent only in large cities, incubators have a relatively higher presence even in smaller cities. On the other hand, accelerators and startups that receive angel and venture funding are significantly seen only in the Tier 1 cities. There is a strong case to replicate the favorable ecosystem in the cities of Bengaluru and Mumbai in other tier 1 and smaller cities to democratize the benefits from the start-up boom to different parts of the country. This would also provide increased opportunities to prospective and deserving entrepreneurs, since many of them from smaller cities do not have access to in the current milieu. The “power of the hidden hand in the market” would ensure that capital would flow to most profitable opportunities. As it stands, the market perceives companies in Tier 1 to be more attractive than those in other locations. But if entrepreneurship is considered as a public good, going beyond just financial returns, then appropriate interventions are needed to develop the start-up ecosystem in smaller cities.
Notes 1
A tweet by Shri. Narendra Modi, Prime Minister of India.
2
Attributed to Shri. Arun Jaitley, Finance Minister, Government of India.
© Indian Institute of Technology Madras
36
PERSPECTIVE 2
Should incubators romance the equity share? G.Sabarinathan1 There appears to be a renewed interest in setting up incubators and accelerators 2 with the emphasis on entrepreneurship coming all the way down from the Prime Minister of the country himself. This is a positive development for the ecosystem as a whole even if one were to accept for a moment that all of them are not well thought out or that not all the sponsors do appear to be organizationally prepared and so many of them might potentially fail. Incubators are a fairly time tested phenomenon by now. Universities and research institutions have tried setting up incubators as a mechanism for taking their technologies to the marketplace. Traditionally incubators were conceived as a common facility that allowed the entrepreneur who was a scientist or technologist to focus on what she was good at, namely building great products, while the incubator supported her with a number of complementary services such as providing lab or workshop and office facilities, legal and accounting services, and referrals to providers of equity capital that were essential to building an enterprise. Over time as our understanding of the process of evolution of enterprises developed, incubation centres also grew into being full-fledged ecosystems by themselves, creating an entire community of entrepreneurs among themselves and connecting them to a host of other agents such as customers, talent for staffing, consultants, academic experts and so on, in addition to providing all the other resources mentioned earlier.
Organisational and financial model of incubators Incubators originated as an institutional mechanism to help move scientific innovations out of the laboratory to the marketplace. The thesis was that by providing many of the collateral resources required to start and grow an enterprise many innovators could be persuaded to commercialise those innovations. Not surprisingly most incubators in the initial days, and to a significant extent even today, were captive facilities meant for researchers in the university. These origins and their institutional raison d etre defined their financial model. Conceived as a developmental initiative they were never meant to be financially self reliant, let alone be profitable enterprises. However, as academic and research institutions began to feel the need for greater fiscal self reliance, incubators began to realise the need to support themselves financially. There was also a growing realization that universities in general and incubators in particular, because of their proximity to the enterprises they helped grow, should also benefit from the wealth created by those enterprises. The case of Stanford University not benefiting from the phenomenal commercial and financial success of enterprises such as SUN Microsystems 3 is often cited as a telling example of how academic institutions needed to think of ways by which they could benefit from the knowledge and entrepreneurial wealth that they helped create. When it comes to thinking of a financial model incubators have often been viewed as a real estate or infrastructure play. As such the charges that the incubatee pays have often been treated as “rent”, with the rate of the rent being “loaded” depending on the level and kind of infrastructure available. Much of the financial innovation in the incubator space over the past few decades has been around developing flexible rental plans that make it affordable for early stage enterprises. Thus a seed stage enterprise which has just the founder(s) working on developing the idea could start with as low an expense as it could afford. As the enterprise grows it
37
could hire larger facilities and pay an increasing rental in return. 4 Incubators have also extended this model of “pay per use” to more sophisticated and expensive facilities such as the wet lab in a bio-sciences or engineering workshop.5 There is however a fundamental tension between the idea of an incubator and the philosophy of self-reliance. On the one hand, incubators are essentially meant to be a public good to help innovators overcome the difficulty in getting support from a financial marketplace that is driven by considerations of commercial return. On the other, the incubatee does not have the cash flow to afford commercial charges on space and other critical infrastructure that a startup might need. The scientist or innovator typically does not have personal resources and at that stage of evolution it is not easy to raise capital from investors. Thus there is a financial case for a service that will allow him access to these critical resources without having to pay market-rate charges for the same. Conceptually incubators are thus relevant or important at that stage of the evolution of an enterprise where the risks are so high that providers of capital and other resources, who are expected to earn a risk adjusted rate of return on their resources, 6 shy away from providing that resource because of their inability to assess the risk in the enterprise.7 This fundamental financial or economic conundrum is behind the inference that researchers have come to; namely, incubators have not been a financially viable proposition in the past five or six decades, let alone be profitable. It is important for us to point this aspect out at this juncture, given the number of new incubators that seem to be coming up with the hope of becoming profitable investments.
The emerging preference for equity shares as compensation for incubation Even as incubators evolved in terms of their engagement with entrepreneurs and enterprises they always found themselves struggling to find a viable financial model for themselves. One of the innovations that they came up with was that of acquiring an equity stake in the incubatee. 8 The idea seems to be that like a venture capital investor there would be this rare extraordinary success of an enterprise whose equity when sold would top up the incubator’s corpus and then there would be a few other not so spectacular successes that would from time to time bring in a few tidy dollops of cash. This is a financially appealing proposition. It recognizes at one level that fundamentally an incubator cannot generate enough revenue to be profitable, recurring year on year, given that it works with highly risky enterprises. But then it would bring out the occasional star that can then make up for the many other poor performers in the incubator and thus wean the incubator away from perennial financial reliance on its sponsors, whoever they may be – universities, governments, research or educational institutions. Acquiring equity shareholding in the incubatee was not very common among Indian incubators until recently. Early beginnings were made when some of the public incubators such as the one in the NS Raghavan Centre for Entrepreneurial Learning (NSRCEL) at Indian Institute of Management Bangalore popularized the idea of acquiring an equity stake in the incubatee as part of the compensation for the incubation services that they rendered. Soon enough, with the transformation of the kind of enterprises that were being established in the information and communication technology space a number of private incubators like Morpheus and GSF emerged to support these new product or technology development startups. These appear to be highly focused institutions specializing in some technology area or vertical to be able to add sector or technology specific mentoring and other forms of value addition.
38
Encouraged by these developments in India and elsewhere in the world perhaps, one common interesting feature among many of the incubators in the public as well as the private sectors is that many of them plan to seek equity shareholding in the incubatee enterprise. That is a laudable idea for two reasons. One, when an incubator holds equity in the incubatee its own financial rewards are more closely linked to the success of the latter enterprise. Thus acquiring an equity stake will presumably motivate the incubator to select their incubatees more rigorously. It will further make it worth the incubator’s while to engage with the incubatees more actively to make the enterprise more valuable. Some observers tend to opine though that early stage investors and institutional stakeholders tend to occasionally act in their self-interests which may diverge from that of the entrepreneur. Secondly, from the incubatee’s perspective an incubator might typically be expected to charge lower than market rates for its incubation services since it is taking an equity stake in the enterprise. This helps the early stage enterprise save on cash outflow towards rental and other services. This is in addition to the community and networks that the incubatee gets to enjoy in a good quality incubator. However, there could be a flip side to this argument. An entrepreneur who is sure of the value of the enterprise that she is building would be reluctant to part with equity unless she absolutely has to. The standard five percent that many incubators in India seem to charge would be viewed by such an entrepreneur as too high a price to pay for the lower cash outflow towards the services provided by the incubator. Similarly control oriented entrepreneurs would also be reluctant to part with their equity, unless they have no choice whatsoever. Thus a share based compensation arrangement might render the incubation programme unattractive to some entrepreneurs at least and might prove to be a source of competitive disadvantage to the incubator in attracting high quality incubatees.
Caveats in seeking equity as compensation The positive aspects of equity based compensation aside, it may be worthwhile to keep in mind the following points of caution while designing equity shareholding as a part of the compensation payable to the incubator. Managing equity investments requires a great degree of financial and legal sophistication. It is well-recognised that investing in the equity of early stage enterprises requires specialized skills at every stage of the investment management process: from sourcing investment opportunities to screening and evaluation, structuring and valuation, post financing engagement with the investee and exiting from the investment. These activities are even more challenging in the case of acquiring equity shares in incubatees, given that very often these enterprises do not even have the proof of concept at the time they seek incubation support. In the same manner they may not have raised any equity or debt funding. Hence they would not have been subject to a critical evaluation of the idea from a sophisticated investor that the incubator may free-ride on. Most incubators are not in a position to provide continued funding to the enterprise. At some point in their evolution therefore incubatees that require continued funding will need to approach professional providers of equity funding such as angel investors or venture capital investors. The process of acquiring equity shares in an enterprise and disposal of the same are affected in a number of ways by Indian laws that govern the purchase and sale of shares. Chief among these are the law governing companies, tax laws and regulations governing cross border purchase and sale of shares. 9 Non-compliance with some of these laws can have serious consequences ranging from the incubator acquiring shares that have not been properly allotted (and so ending up as worthless pieces of paper even though the enterprise is doing well) to falling foul of the tax laws and finally getting on the wrong side of the enforcement directorate being the most dangerous of these infractions. At the same time ensuring compliance with these
39
laws requires having the requisite knowledge of these laws in house or outsourcing the compliance work to professionals.10 It also means that the management of the incubator would spend a non-trivial amount of effort in filings and other statutory activities, no matter whether the work is outsourced or not. If the incubator management seeks seats on the board of the incubatee enterprise that throws a challenge of a different level and dimension altogether. Under the provisions of Companies Act 2013, one needs nerves of steel to be on the board of any company, given the disproportionately draconian nature of the punitive provisions and the acts of non-compliance that could trigger those provisions. While many of the deterrent provisions might appear theoretical, if the authorities chose to invoke them there are several grounds for imprisonment of directors or, at the minimum, disqualifying them for a period of five years. 11 The cost of ensuring that the activity of acquiring, managing, and disposing of equity investments can be far higher than most people who are not familiar with this activity might imagine. Quite apart from the observable financial cost, when one factors the unobservable emotional cost of coping with the stress of things going wrong due to legal non-compliance, it makes one want to reconsider the proposition of equity based compensation.
The additional challenges of a public incubator In the case of incubators in the public sector there is the additional layer of accountability expected of the officials managing a public institution. The added complexity arises out of holding equity shares as opposed to providing loan financing. In order to understand better the nature of this problem it is useful to draw a comparison between an equity investment and a lending transaction. When an official sanctions a loan, the number of variables over which she can exercise discretion can be significantly restricted through prudential norms or guidelines that may be laid down by an internal supervisory body like the board of directors of the institution providing the loan. 12 In a bureaucratic environment, both the decision maker, who would typically be a risk-averse bureaucrat as well as the supervisory regime, would like to limit the extent of discretionary authority that the decision maker has. This in turn would minimize the concerns that the decision maker might pursue private gains by providing loans on terms attractive to the borrower and unfavourable to the lender. In the case of equity investments there are a number of terms for which a prudential body cannot provide similar guidelines. These can relate to the purchase of shares, sale of shares, terms of purchase as incorporated in the shareholders’ agreement, many decisions that can affect the welfare of the shareholder such as terms of issuance of additional equity capital, changes in the shareholder’s rights and protective provisions and so on. Given the difficulty in enumerating all the instances where the shareholder’s welfare can be affected, professional equity investors therefore seek rights to approve a wide-ranging set of decisions by the management of the enterprise. And they enforce these rights either through either a seat on the board or an observer status with special privileges. Each of these aspects can potentially call for a decision to be made that has implications for the financial welfare of the shareholder. At the same time each of such decisions however is open to debate on whether the decision maker acted in the best interests of the incubator. 13 Private investment funds address this potential concern by aligning the interests of the manager of the fund who exercises these decisions on behalf of the investors in a fund (as a shareholder in an enterprise) by tying the financial incentive of the fund manager to the returns provided to the investor. The importance of this incentive compensation structure in addressing agency and other related issues that are known to prevail in the early stage equity investment business have been known to practitioners for a long time and have been
40
acknowledged in academic literature too. Public institutions and, to a certain extent, corporates often cannot provide such incentives. And their inability to provide such incentives have been identified as one of the main reasons for the relatively low success rate in public and corporate venture capital programmes. The alternate solution to this problem lies in creating an elaborate governance and decision making structure. That said, it is not clear if merely setting up an elaborate oversight structure would address all the likely issues related to governance. Assuming it can, there are problems with setting up such a structure. One, such an elaborate structure adds to what economists would refer to as the transaction cost of equity investing. Second, a specific manifestation of that cost is that it slows down the ability of the shareholder to respond to offers to buy or sell shares and the many approvals that the incubator has to accord as a shareholder to decisions to be made by the incubatee enterprise. These delays in decision making would render the incubator an unattractive incubation alternative. Public incubators that are established as a part of an educational institution often also have to set up a separate entity to hold the equity in the incubatee because the university’s charter does not permit them to engage in the purchase and sale of shares. In some instances such activities can potentially affect their taxation status. The practice that has been followed in those instances is to set up a company under Section 8 of the Companies Act, 2013 or Section 25 of Companies Act 1956. Managing the regulatory compliance of these enterprises set up for the purpose of holding shares adds to the effort and cost of equity investment for the incubator. Ideally speaking, taking into account the canons of good governance the educational institution that is setting up the Section 8 enterprise will also need to establish a formal relationship with the latter. The terms of the relationship will need to address important issues such as the disposal of the income and gains of the latter, keeping in view the restrictions relating to the distribution of gains and income of a Section 8 (or Section 25) enterprise.
The risk of premature exits for the incubator In the unlikely event that the incubator management has the bandwidth to embark on this rather tumultuous ride here is a final caveat. Incubators take equity stakes in the hope that one of those many enterprises that they incubate will be the proverbial home run that every VC investor dreams of. Two important questions are pertinent in this regard. One, what is the likelihood that the incubator will remain invested till the incubatee turns out to be the home run that it has the potential to be? Second, in the event that it does what will be the likely financial gains after accounting for the low rates of success among start-ups? To answer the first question incubators must realise that successful incubatees will need to raise equity funding from professional early stage equity investors like angel investors and VC funds to meet their growth financing needs. In fact the ability of the incubatee enterprise to raise professional equity funding from unrelated or arm’s length investors is often treated as a measure of the success of the incubator. 14 Most of the time, the public incubator does not participate in that round of financing either because it does not have the funds or more fundamentally because it is not a part of the mandate of the incubator. Given the relatively low level of shareholding that incubators have and given further their inability to participate in subsequent rounds of funding, the incubator has little negotiating power with the investors on the terms of the subsequent funding rounds. Often professional investors insist that many of the smaller shareholders sell their holding to them as a precondition to their funding the enterprise. Their reasons for such a precondition are sometimes genuine and sometimes not so genuine. Incubators thus end up selling their shareholding prematurely and against their wishes. 15 While this does not happen all the time, it does occur often enough to
41
stack the odds of realizing a financial upside against the incubator who did all the hard work in the first twelve or twenty four months of the formation of the enterprise. Incubators acquire equity shareholding with aspirations of a grand sale of their holdings in an initial public offering (IPO) or as part of an acquisition of the incubatee enterprise at a huge valuation and realizing significant financial gains. Their aspirations are put paid to by such premature exits. Having discussed all of those pros and cons we come to the second question above: What can all this potentially amount to for the incubator in terms of cash realization? We ran some back of the envelope workings as part of a discussion at a committee recently. We made some generous assumptions as part of these workings. While our inferences are preliminary and they would need to be understood more thoroughly the rough sense we get is that on a risk-adjusted basis the present value of the exit realisations from these shareholdings do not justify all the institutional overheads and the typical angst that accompanies the business of acquiring and selling shares in an early stage enterprise. It could be as little as a tiny fraction of the fee income of a public higher education institution in India.
NS Raghavan Centre for Entrepreneurial Learning16 The NS Raghavan Centre for Entrepreneurial Learning (NSRCEL or the Centre, hereafter) was established at Indian Institute of Management Bangalore (IIMB), circa 2000 AD, with the help of an endowment from Mr NS Raghavan, co-founder of Infosys Ltd., a leading information technology service provider. Apart from offering a variety of courses and promoting academic research relating to entrepreneurship, the Centre is known for its incubation centre which is the centerpiece of its numerous developmental initiatives to foster entrepreneurship in India. When NSRCEL set up its incubation Centre in 2000 with funding from Bill Melton promoted Global Internet Ventures it was among the first business incubation centres to be set up by a management school. Most, if not all other, incubation centres had been set up as an initiative supported by the Department of Science and Technology, Government of India (DST, hereafter). NSRCEL was perhaps one of the first incubators to come up in an academic institution that did not seek financial support from DST for its operations. This was possible thanks to the income from the endowment as well as the institutional support from IIMB in the form of allocation of land for the physical infrastructure and access to the many facilities on the campus for the Centre and its incubatees without being charged a fee. This is in contrast to many other academic institutions that seem to levy the entrepreneurship Centre a fee for use of their infrastructure. As part of its incubation activity the Centre supports its incubatees by providing mentoring, referrals to its networks for acquiring customers, developing strategic affiliations and above for all for funding attractions. Incubatees receive a fair amount of media coverage through the Centre. They have also said that they benefit from the reputation of having incubated at NSRCEL. Apart from incubation the Centre runs an open mentoring programme and variety of events. Both the events as well as the mentoring programme are run on a pro bono basis. The mentoring programme is run on the second and fourth Friday of every month. The Centre has a panel of nine mentors who are all either former executives or entrepreneurs. Unlike many other ad hoc mentoring initiatives NSRCEL’s mentoring is institutionalized in the sense that it works with a constant set of mentors as opposed to mentors who come for one off engagements. Over the past five years the number of mentoring sessions has grown steadily from 72 in the calendar year 2011 to 113 in 2012, to 177 in 2013, 292 in 2014 and 490 in 2015. In calendar year 2015 the Centre ran over thirty events related to entrepreneurship.
42
Apart from charging rent from the incubatees, which is well below market rates and cost of running the incubation and related operations, the Centre also takes an equity stake in all the incubated enterprises. The Centre also provides funding out of grants received from the DST as well as Department of Electronics and Information Technology, Government of India (DeITY). The Centre receives equity in return for this funding as well. Given the restrictions on IIMB holding equity in enterprises, a company by the name IIMB Innovations (IIMB-I, hereafter) was incorporated under Section 25 of Companies Act 1956. As per data as on March 31, 2015, filed with the Registrar of Companies, IIMB-I’s meagre share capital, which suggests that it does not have much of an operational mandate, is held entirely by the officials of IIMB. This is further borne out by a casual perusal of the profit and loss account of the IIMB-I. The balance sheet indicates that IIMB-I held equity investments in 19 enterprises as on March 31, 2015, while the website indicates that NSRCEL had supported 45 enterprises as of that date through its incubation activity. The difference is perhaps due to the fact that for a brief period the Centre had chosen not to take equity stake in its incubatees. Press releases from NSRCEL indicate that the Centre has sold its stake in four enterprises, all through acquisitions. Looking at the range of activities of the Centre, the staff complement that the Centre has and the fact it is all done pro bono, it would appear that the cost of the operations cannot possibly be supported from the rental income from incubation alone. This is so nearly fifteen years after the Centre commenced operations. This inference has an important lesson for all those who plan to set up incubators – it is difficult to sustain an incubation Centre on rental or services income. It is important to emphasize this aspect for another reason: The DST and other government agencies such as the Department of Bio Technology, Government of India (DBT, hereafter) expect that the supported incubators will become financially self-reliant in the first five years. The case of CIC referred to in this article appears to be an exception that has not been replicated successfully anywhere else yet. The other often cited example these days is that of Y Combinator, 500 startups and so on. These are essentially accelerators. The stage at which these new accelerators on-board enterprises and the gestation period of the enterprises are fundamentally different from that of the incubatees in a public incubator in India. What is the way forward then? Academics who have looked at this problem realize that a fundamental lack of viability is an inevitable reality of the incubation space. Practitioners agree that it is a difficult, if not intractable, problem. The silver lining is the far sighted move of Indian corporate law in the form of a provision that has been ironically considered unwelcome for many reasons, namely, to mandate that two percent of corporate profit after tax will be set aside for initiatives under the banner corporate social responsibility (CSR). The silver lining is that funding of recognized academic incubators is among the permissible activities. Incubators could use the DST funded period as a runway for establishing a track record based on which they could approach corporates to endow their incubation activity. That approach has some potential positive spillovers too. It would make both the academic institution as well as the supporting corporate to ask each other, how they could be relevant to each other’s needs. The answer to that question in turn will have many other positive knock-on effects, which could be the topic for another article.
Notes The author is Associate Professor, Finance and Accounting at Indian Institute of Management Bangalore (IIMB). Views expressed are his own. 1
43
The incubation industry and academics draw sharp distinctions between incubators and accelerators. In this article we use the two terms to refer to the idea of supporting startups at their very early stage of evolution, institutionally, in a structured way. That said, this article refers mainly to those institutions that support enterprises for at least twelve months, may be even longer and bring on board enterprises as early as even prior to their developing proof of concept. In contrast, accelerators are known to host enterprises for as little as four months and are known to engage with enterprises that have acquired paying customers. 2
Now that it is many years since SUN Microsystems fell off its zenith it is probably worth reminding readers of the current generation that even the name SUN stands for Stanford University Network. 3
4
The incubation centre in Cambridge University in the UK is a classic example of a university incubator that provides this
kind of an arrangement that could scale with the growth of the enterprise, starting with as little as a deskspace on a shared basis, now fashionably known as “co-working space”. The Cambridge Innovation Centre (CIC) outside the Massachusetts Institute of Technology (MIT), in Cambridge, on the outskirts of Boston, USA, is an example of a similar initiative in the private sector. Located right on the perimeter of MIT, tenants of CIC can benefit from the social, physical and intellectual infrastructure even though they are not located inside the university or the even though enterprise was not conceived there. An interesting example of such innovation in sharing facilities is the case of Artisan’s Asylum (AA) at Somerville, Massachsuetts, USA (www.artisansasylum.com). AA has created a makerspace with a wide range of equipment, each of which has been brought in by one of the occupants of the community at AA. Apart from creating a shared infrastructure it has also helped build a community of like-minded innovator and product developers who also benefit from the collective creative and problem solving capabilities of the community. It has led to the creation of interesting products such as the first programmable watch (Pebble Watch) which received the largest crowdfunding from Kickstarter. 5
The idea here is that an enterprise is an assembly of various forms of capital such as financial, intellectual and other types of capital. Economic theory would postulate that each of these forms of capital should earn a competitive rate of return. Opportunities that cannot provide such a return would fail to attract such capital. 6
Enterprises at that stage of the evolution are believed to be subject to Knightian uncertainty as opposed to the standard risks of an on-going enterprise. The idea of Knightian uncertainty, named after Alfred Knight, refers to “unknowable unknowns” or sources of risk that cannot even be identified or known upfront. In terms of the language of risk management, risks are those sources of uncertainty that can be identified upfront and a probability assigned to its likelihood of occurrence. 7
We use the term incubatee to refer to enterprises and entrepreneurs that are based out of (in the case of physical incubation) or attached (in the case of a virtual incubator) to an incubator. It is useful to point out that although the term is commonly used in the world of incubation, the dictionary does not recognize the term. The online version of Oxford Dictionary at www.oxforddictioanries.com for example does not recognize this word. 8
If these transactions involve other entities that are domiciled outside India it is possible that they may be affected by the laws in that other country as well. A discussion on those aspects would be outside the scope of this article. 9
10
For many specialized requirements of this nature outsourcing is a very tempting option for thinly staffed organisations such as incubators. However this author’s own experience has been that the quality of service from professional agencies in the accounting, legal and compliance fields is highly variable and patchy. The incubator that this author was managing, as well as many of the incubatees in that centre, have had to deal with the poor quality of service. The poor quality was sometimes due to the demands on the service providers’ resources were more than they could manage. But worryingly enough, there were plenty of instances where the professional members of the staff at the service provider were not up to the task of coping with the complexity of these laws and /or the rate at which many of the rules under these statutes as well as the statutes themselves changed. This author is aware of at least one instance of a perfectly respectable senior professional having been declared a director in default and having been disqualified from being on the board of any company for a period of five years. The irony of it is that the poor soul did not realise the kind of situation he was in until well after he had been declared a director in default. This author therefore advises most startup entrepreneurs to form an advisory board that does not have a statutory role under the law. This would hopefully encourage eminent professionals to be associated with and advise the startup without fear of the many things that could go wrong statutorily. 11
The most important variables in a lending transaction can be categorized as (i) the decision to lend itself; (ii) the amount of funding; (iii) the tenor of the loan and the repayment terms; (iv) rate of lending; (v) collateral securing the loan, if any; and (v) other covenants protecting the interests of the lender. Each of these can potentially have a financial consequence for the lender and the borrower. The boundaries within which the official can function can be reasonably well-defined. This 12
44
assumes that it is a straight loan and does not have any exotic features such as convertibility into equity shares or other instruments. 13
An example of such a decision would perhaps illustrate this concern better. Take the case of an event that can commonly
occur in an incubatee enterprise: The founders wish to subscribe to the share capital of the enterprise a year after the enterprise has been in incubation. The founders may wish to do so because they have got access to some funds of their own and the enterprise needs funding. Founders would typically bring in these funds at par. In the normal world this would be highly welcome and seen as an instance of the founders showing increased commitment to the enterprise. The difference in the case of a startup though is that during the year it is likely that the company’s fortunes have either improved dramatically, declined drastically or have not shown any noticeable change. The price at which the founders subscribe to the share capital will need to take into account the changed circumstances and prospects for the company. That is the basis on which an incoming investor will price his subscription to the share capital. If the fortunes of the enterprise have improved and the founders still subscribe to share capital at par value there is a transfer of wealth from the incubator (and other shareholders, if any) to the founder. In fact an institutional VC investor or an angel investor would treat the founder’s right to subscribe to share capital at a price lower than the intrinsic value of the shares as a mechanism to incentivize the founders. 14
Raising equity from an equity investor who has no prior relationship to the founders of an enterprise or pre-existing investors is considered to be one of the ideal validation of the investment-worthiness and the value of an enterprise. This is in contrast to raising capital from investors who have a prior relationship who could potentially provide funding for various considerations other than relating to the investment merit of the enterprise. Legally speaking, a shareholder cannot be compelled to sell her shares in an enterprise unless there is a pre-existing contractual obligation to do so. However, practically speaking the incubator could be constrained to do so in order to enable the incubatee raise the much needed funding. 15
Disclosure: The author was Chairperson NSRCEL from 2012 to 2016. The discussion here is based entirely on information that is available in the public domain and is being presented as an illustration of a public incubator. 16
45
46
REFLECTION 2
Contours of Venture Investing in India: A Conversation with Samir Kumar Thillai Rajan A. when I got into the venture industry, entrepreneurs had a deep technology background but a limited understanding of what the customer needed. They were clear about what they could build or develop, but did not have great clarity on what the customers’ problem was, how they were going to solve that problem, and who else was solving it. That has now changed significantly and the entrepreneurs we now see have a much sharper sense of customers’ requirements as well as competition.
Has the characteristics of successful start-ups changed over the years? Not really. The basic requirement of a successful start-up is a solid entrepreneurial team. Most startups go through tough times in their initial years, and the distinction between successful and failed startups is usually the quality of the entrepreneurial team. This requirement remains just as critical today, as it was in the past. Some other traits that make for successful start-ups are focus on large, fast-growing markets, lesser competition, unique differentiation in the product or service offering, and an intimate knowledge of customer requirements. In sum, I don’t think much has changed from the past in terms of the characteristics of successful start-ups.
Over the years, the maturation of the technology sector is also getting reflected in the entrepreneurial teams.
What has been the driver behind this change?
I can talk only with reference to technology entrepreneurs because I’m more familiar with them. We can clearly see that the technology industry has deepened over the last 20 – 25 years. In 2001, I would say the technology industry in India was really only about 8-10 years old. Multinational companies like Microsoft, Oracle, SAP and so on had just set up their offices and domestic companies like Infosys, TCS or Wipro, who had grown significantly in the previous ten years, had just started focusing on building IP. Over the years, the maturation of the technology sector is also getting reflected in the entrepreneurial teams. In addition, the ability and willingness to take risk has changed significantly from earlier. Society is now more tolerant in terms of accepting failure and more people are willing to take risks.
Then, what has changed? In a dynamic environment such as the start-ups can the saying, plus ça change, plus
c'est la même be true? While the criteria for a start-up to be successful have largely remained constant, the quality of entrepreneurial teams has significantly improved without a doubt. Also, if you ask me, markets in India have become bigger, entrepreneurial teams now have a better understanding of these markets, and their knowledge of customer requirements has become sharper. Entrepreneurial teams today are more mature, even though they may be younger in age. With markets having become large enough in India, one doesn’t necessarily have to go overseas to build a successful start-up. Understanding of customer requirements has been a big improvement area. If I look back 15 years, which is
Venture funds have funded very limited number of deep innovations in India. What needs to be done to change this trend?
47
It will change on its own, and in fact we can already see the green shoots of this change. In the beginning of my career, the proportion of deep innovations that were getting funded was close to zero. Today there is a better understanding of the culture of deep innovation in India, in part because of people who have done such start-ups abroad and have migrated back. Customer attitudes towards start-ups have also begun to change, albeit a tad slower than one would have liked. And global markets for such start-ups are more accessible today, lowering the risks of customer adoption.
up. Then there are incubators, accelerators and many new venture funds. However, given that the number of new entrepreneurs has risen significantly, and the capital available has not increased at a similar pace, it is likely that entrepreneurs may feel that fund-raising is still very hard. Would better intermediation help? Honestly I don’t think intermediation would help. The point is we will not do 15-20 deals per year, given that we seek time diversity in our portfolio. We want to build a portfolio across 4-5 years, which means we cannot do more than 4-8 investments a year. If we take the entire pool of early stage capital across the country and if this is not sufficient to fund the capital requirements, then I’m not sure whether any type intermediation would make a difference, more so since founders today have much better direct access to investors.
Deep innovation start-ups are certainly more risky, and therefore the probability of failure is also much higher. On the other hand, rewards are also higher in a deep innovation start-up. The Indian venture industry is also really just about a decade old, which is when most of the current venture firms started. In their initial years, venture firms need to show returns and establish themselves, in order to be able to raise their next funds. Therefore, it is possible that many funds did not want to make very risky investments that could impair their chances of raising future funds. In the US, many venture funds are over 30–35 years old, and are in their seventh, eighth or even later funds. Since they have proved, over time, their capabilities to generate returns and obtained the confidence of their investors, their willingness and ability to take higher risks has also gone up. My belief is that as Indian venture firms get more and more established, their ability to take risks will also increase and more deep innovation type start-ups would get funded.
...as Indian venture firms get more and more established, their ability to take risks will also increase and more deep innovation type startups would get funded.
What have been the common mistakes made by the founders that has led to start-up failures?
To my mind, indiscipline on cash management has been a big worry. Capital was too freely available in the last 2 years, though, luckily, that has stopped now. But I think the pain that we see today of companies shutting down and so on was because they didn’t respect cash. The second common mistake is me-too business models. There were too many such start-ups. Many businesses were started with the assumption that if it worked in the US and worked in China, it will work here. Entrepreneurs will have to understand the unique requirements of the Indian market / customer, and create unique products or services to meet these requirements. Even companies like Uber are modifying their global practices in India (like taking cash payments, allowing pre-booking of cars, having people at airports to guide customers to the cabs)!
Have the chances of securing funding by entrepreneurs increased in recent years? How?
Syndication with other investors is a very commonly observed practice in venture investing. How does it benefit the investor or the entrepreneur?
Yes, definitely. There are a lot more avenues to raise capital today. For example, we have more angel investors and angel networks that have come
48
enough deals are getting done. Sure, they are fewer than what was done in 2014 & 2015, but what we saw during those years was an aberration. The slowdown is only when compared to the previous year. The key for the entrepreneur is being careful about cash. Since capital is not as easily available, entrepreneurs should make sure that the money they have lasts longer. For example, the practice of stapling rupees with every order that some ecommerce companies followed is untenable. The good thing is that entrepreneurs have recognised this and are trying to cut down on that practice. However, investors also have to accept blame for this. If they demand that the entrepreneur quadruple revenues every month, then the only way it can be met is by bribing the consumer to buy more.
Yes, syndication is a common strategy in early stage venture investing. Start-ups usually need a lot of help, and multiple investors can mean additive networks to aid customer access, hiring, and even next round financing. Sometimes start-ups need some kind of bridge financing, to reach a certain milestone. If there is more than one investor, it is possible for the entrepreneur to cover the gap a little more easily. On the downside, the entrepreneur carries an additional burden of dealing with more investors. But, I think the benefits of syndication outweigh the costs.
The key for the entrepreneur is being careful about cash...should make sure that the money they have lasts longer.
We tend to syndicate with like-minded investors. For example, if we have a 5-7 year investment horizon, we would rarely syndicate an initial round with somebody who has a 2-3 year horizon. For an investor like us, syndication is a strategy to not just get the money, but bring complementary skills to the table. While many say that it’s a lonely journey for the entrepreneur, it is also a similar experience for the investor. Having another investor alongside helps to clarify thoughts for everybody.
Angel investment in ventures have been very robust these days. How has it impacted investment by venture funds? The growth in angel investments has had a huge positive impact for funds like us, and also for entrepreneurs. Having access to angel investments helps start-ups show some progress (like building a product, having a few customers, etc.), before approaching VCs. Angel capital has certainly given a boost to the entrepreneurial ecosystem. As a result, today we meet start-ups that are already along on their journey. Founders who have raised angel capital and built something, have a much better understanding of their customers, technology, and competition. Today, less than 20% of the deals we see are at a stage that requires angel investment (where Inventus doesn’t play) compared to 50-60% in the past. The growth in angel capital has resulted in start-ups that are better prepared to receive venture funding.
What is the role of the entrepreneur in the syndication process? Let's say for example we’ve decided to invest $1.5 million in a company, leading a $2 million round. We work alongside the entrepreneurs to syndicate the remaining $0.5m. The syndication process is a joint effort of both the lead investor and the entrepreneur. If the entrepreneur does not cooperate, it might be difficult to find a syndication partner. Thus, the entrepreneur puts in the effort, and the lead investor usually makes the connects with other investors. How should entrepreneurs equip themselves to handle deal winter that people are talking about?
What factors have resulted in the emergence of Bengaluru as a leading destination for venture investments in the country?
I wouldn’t characterize today’s environment as a deal winter – to me, it’s more like a return to normal. I would say 2009 was a deal winter when very few deals were done, but in 2016, I think
Certainly not the traffic! On a more serious note, a virtuous cycle of entrepreneurship has been created. Many investors who previously did not
49
I must also add that the Government of Karnataka has also been contributing its bit to encourage start-ups. The State Government has multiple policies for start-ups. For example, there is this Electronic System Design and Manufacturing (ESDM) policy, which provides good incentives for start-ups in that space. Under this policy, for e.g., there is an incentive which covers up to 50% of the R&D costs. Marketing expenses are also covered to an extent. If the start-up is exporting, then state taxes are also offset. In addition, they also have a start-up policy, where they work closely with organizations such as NASSCOM Startup Warehouse in providing facilities for start-ups. Such measures have encouraged start-up activity. Successive governments in Karnataka have shown a progressive approach towards start-ups, which has clearly also been a factor in the growth of start-ups in Bangalore.
have an office in Bengaluru are now setting up shop here because of the presence of good entrepreneurs and talent. Large multinational companies such as Google, Microsoft, and Oracle have set up their R&D centres here. Virtually, all the semiconductor companies in the nation are headquartered here. When employees working in these organizations get the confidence to start on their own, they start their venture in Bengaluru because that’s where they’ve been living. So talent availability fuels more start-ups; more startups fuel more investors; and more investors in turn fuel more start-ups. While there are investors in Mumbai also, most of them are growth investors. On the contrary, most of the venture investors are in Bengaluru.
The growth in angel capital has resulted in start-ups that are better prepared to receive venture funding.
Samir Kumar has been associated with the Indian venture industry since 2001, and is currently a Managing Director at Inventus. Previously he was with Acer Technology Ventures, and before venturing into venture, had a 15 year career in the IT industry, in various sales, marketing and product management roles, including a 10+ year stint with Wipro. Inventus is a technology focused venture firm with over 40 investments to date, across the US and India, in both consumer and enterprise sectors. Inventus also has many successful exits under its belt, including Redbus.
50
3.
Trends in the Sands of Time “History never repeats itself, but it rhymes”
“Those who cannot remember the past are condemned to repeat it."
Overview An important feature of the India VCPE report series has been to track the contours of the evolution of this industry using longitudinal data. While the data accuracy becomes limited as we go too far back in years, since there were limited data providers back then, we believe the data available since 2000 is representative, though it is far from complete. The completeness of the data availability has increased in more recent years as the industry has flourished and more service providers who are tracking the industry have emerged. With these developments, we believe we are in a position to be able to identify the trends with lot more clarity than what has been possible before. In this chapter, we present the time trends observed in the different components of the start-up ecosystem in India. A single line summary of the overall trend would be to say that the start-up ecosystem in India has significantly developed in recent years. But, it is as obvious as saying roses are beautiful. Our objective here is not just to look at the flower as a whole but also appreciate the shades of colors that exist within it. So, here we go.
Incubators Figure 3.1 provides the growth in the number of incubators set up in different time periods. We chose a five year time period because of the lumpiness associated in the setting up of incubators and to moderate the effect of year to year short term swings. Year of setting up was available for 255 of the 339 incubators in the sample. The upward sloping trend clearly indicates the growth in the number of incubators set up in recent years. According to our estimates, more than 50 percent of the incubators were set up in the last five years. This shows that the policy thrust for creating an enabling environment for start-ups has had visible impact – with more number of incubators being set up.
Figure 3.1: Growth in the number of incubators
51
Number of Incubators
Figure 3.2 provides the contours of the number of incubators, depending on the city in which they were set up. A cross section during the years 1996-2000 would reveal that the number of incubators in each of the three types of cities were more or less equal. The trend persisted in equal measure even till 2006-10. However, since then there has been a dramatic increase in the number of incubators set up in Tier 1 cities. While there are just a handful of Tier 1 cities (the six metropolitan cities), the number of Tier 2 and Tier 3 cities are much higher. Despite the higher number of cities, the total number of incubators set up in Tier 2 or 3 cities is lower than that of Tier 1 cities. This shows that the trickle-down effect of start-up ecosystem to smaller cities has been meagre.
2011-2016
Tier 1 city
Tier 2 city
Tier 3 city
Figure 3.2: Year of founding of incubators by type of city
Technology
Others
Industrials
Healthcare
Consumer services
Figure 3.3: Incubatees classified by sectors
52
Figure 3.3 shows the trend in the incubatee companies supported by the incubators, analyzed based on a sample of 1970 incubatee companies. More than half of the companies are in the technology sector. This is but natural, because most of the incubators are hosted in universities and research laboratories and the incubatees that these organizations support basically explore the possibility of commercializing technology spin-offs from the laboratories. The illustration also shows the dramatic increase in the number of incubatees during the five year period 2006-10. Other sectors that account for a significant number of incubatees are healthcare, industrials, and consumer services.
2011-2016
State University
Private Non-University
Government Non-University
Private University
Central University
Figure 3.4: Incubatees classified by the host organization In Figure 3.4, we capture the trend in the number of incubatees supported by incubators that were classified by their host organization. In recent years, much of the incubatees have been supported by the central universities. Central universities include institutes of national importance such as the Indian Institute of Technologies (IIT). Our results indicate the important role played by these universities in promoting entrepreneurhip and start-ups. On the other hand, the number of incubatees supported by state universities has been much lower, indicating that the states in general have not accorded the importance to incubation and supporting start-ups in the same way as that of the central government. While some states like Karnataka have given priority in creating a framework and have set up institutions, many other states have lagged. More importantly, the state governments have not been leveraging the vast network of the educational institutions supported by them to promote start-ups. The share of incubatees supported by the private sector, has been increasing – though not in the same manner as seen in the case of central universities. The share of incubatees supported by private sector non-university incubators in itself is small, indicating that the segment has not been very active in setting up in incubators. We also found that incubatees supported by private universities have grown in recent years. However, a striking trend has been the role of the central universities and government research institutions and laboratories in supporting the case of entrepreneurship. While entrepreneurship is essentially a private sector activity, the policy of the central government to back startups in the institutions suported by them indicates the policy thinking of the government – that promoting entrepreneurship can lead to positive externalities in the economy. It would have been ideal to find how
53
effective the support has been in creating scalable and sustainable start-ups, but that can be a subject of one of the future reports.
2011-2016
West
South
North
East
Number of Incubatees
Figure 3.5: Incubatees classified by geographical region
2011-2016
Tier 3 city
Tier 2 city
Tier 1 city
Figure 3.6: Incubatees classified by type of city In order to track the spatial trends over time, we plotted the incubatees supported by the different incubators in each of the four regions. Figure 3.5 shows the results. The southern region accounts for a very large share of the incubatees, followed by the West. While the number of incubatees from the West has been steadily increasing, there has been slight decrease in the number of incubatees from the South during 2011-16. What is interesting to note is the contrast in the development of start-ups in different regions of the country. While the
54
trend for Eastern region is as expected (since the proportion of start-ups has traditionally been less from the region), additional studies may be needed to understand the reasons behind the differences in the prevalance of incubation model between the North, West, and South regions. Figure 3.6 classifies the trend in incubatees based on the city in which the incubator is located. Incubatees supported by incubators in Tier 2 cities have been noticeably higher, and this is a trend that has been consistent across time. While the incubatees supported by incubators in Tier 1 cities have grown since 2000, Tier 2 cities account for close to three-fourths of the total share of the incubatees. This shows the important role played by the incubators in taking the culture of entrepreneurship and start-up to some of the smaller cities. As we will see later, start-ups in Tier 1 cities account for a major share of the funding from angel and VC investors. Seen in that sense, incubators form a key part of the support ecosystem for start-ups in the country – as they are able to nurture entrepreneurs in smaller cities, where the penetration of angel and VC investors has traditionally been weak.
Angel investments We specifically studied angel investments, given the significant growth in this segment in recent years. Figure 3.7 provides the number of angel deals over the years. A deal refers to an individual angel investors’ investment in a start-up. If there was more than one angel making an investment, then investment made by each angel was counted as a separate deal. Here we do not include angel networks, which have been analyzed separately in the next section.
Figure 3.7: Angel deals over the years Figure 3.7 is based on a total of 3791 deals during the period 2008 – 15. A striking observation is the significant growth in angel deals during the period. Year-wise analysis shows an annual average growth rate of 124 percent. While year-to-year count of deals shows mildly fluctuating trends, a three year window as indicated in Figure 3.7 shows a steady increase in the number of deals. The fact that so many angels are making investments in start-ups has been one of the biggest changes in the entrepreneurial ecosystem in recent years.
55
Figure 3.8 provides an estimate of investment amount made by angel investors. Similar to the trend seen in the number of deals, the total estimated investment amount has seen significant growth, with an average annual growth rate of 205 percent during 2008-15.
Figure 3.8: Estimated amount invested by angel investors
Figure 3.9: Number of angel investors in different years Figure 3.9 gives the number of angel investors investing in different years and Figure 3.10 gives the number of angel investors reinvesting in different years. Similar to the number of deals as well as investment amount, the number of investors also show an increasing trend. The number of angel investors, despite the occasional downtrends, has grown at an annual average of 107 percent during 2008 – 15. The number of first time angel
56
investors, during the same period has grown at an annual average rate of 98 percent. The growth rate of investors who are reinvesting has grown at a rate of 105 percent. Thus, there has been a secular growth trend in the angel investor segment. The growth in the rate of repeat investors (i.e., who have made at least one investment previously) indicate that many don’t view angel investments just as a one-off investment activity.
Figure 3.10: Number of angel investors who are reinvesting in different years
Figure 3.11: Average investment in an angel round Figure 3.11 gives the average investment received from an angel round. In a round, there could be more than one angel investor investing, and therefore the round investment refers to the total investment made by all the investors together. During 2009-15, the average round investment has grown about four times, at an annual
57
growth rate of 27 percent. Figure 3.12 gives the average investment made by an individual angel investor. It can be seen that this has grown about eight times during 2009-15, indicating an annual growth rate of 34 percent.
Figure 3.12: Average investment made by an angel investor
Figure 3.13: Number of angel investors in a round Figure 3.13 indicates a declining trend in the number of angel investors in a round. This is as expected, since the average investment made by angel investors have been growing at a faster rate (Figure 3.12, 34 percent) as compared to that of the average investment received by the start-up in an angel round (Figure 3.11, 27 percent). An inference to this trend is that angel investors are increasingly comfortable in making larger investments. Angel investors are today making investments as high as what early stage venture funds used to invest in the 2000s, thus providing a significant source of capital for start-ups.
58
Figure 3.14: Average age of start-ups at the time of receiving angel investment Figure 3.14 shows the average age of the start-ups at the time of receiving angel investment. Our analysis is based on a sample of 873 start-ups during the years 2006-15. The trend is striking. There has been a steady decrease in the average age of the start-up at the time of receiving angel investment. During 2008-15, the annual average investment age has reduced by 27 percent. The finding becomes all the more remarkable, when we consider the increasing trend in the average investment amount. Possible reasons could be attributed to both the demand and supply side. On the demand side, entrepreneurs have been able to create robust start-ups, which are “ready for funding”. Given the knowledge of what the investors expect becoming widely available, entrepreneurs are able to incorporate those elements in their business plan to give the investors more comfort while making their investment decisions. On the supply side, more and more investors are getting the comfort to make angel investments – through a better appreciation and appetite of risk that exists in such ventures. Needless to say, the entrepreneurial ecosystem has played an important role in this convergence. Figure 3.15 traces the number of angel deals in different start-up categories. We traced the number of deals rather than the investment amount because the quantum of investment was not available for a large number of start-ups. Our results show that software and internet services account for the largest number of deals, and the trend has remained consistent over the years. Coming up next was Internet marketplace and e-commerce, the share of which has shown an increasing trend more recently. The remainder of the sectors do not account for a significant share. In a sense, the trends in angel investment are consistent with those seen in incubators and accelerators – where technology and technology enabled sectors accounts for the bulk of the investment. Software and internet services are considered as a part of technology sector in the ICB classification.
59
Figure 3.15: Number of angel deals in different sectors
Figure 3.16: Trends for quartile classification of angel investors Figure 3.16 gives the deal trends for angel investors classified by quartiles based on the number of deals they have invested. The sample was 3791 deals during 2008-15 and quartile classification of investors were done as
60
follows: Quartile 1 – investors who have made only one investment; Quartile 2- investors who have invested up to 4 deals; Quartile 3 – investors who have invested up to 12 deals; and Quartile 4 – who have invested in more than 12 deals. The total deals in the different quartiles are: Quartile 1 – 927; Quartile 2 – 1088; Quartile 3 – 927; and Quartile 4 – 849. The trends are quite interesting. The top 3 sectors for all the four categories are software and internet services, internet marketplace and ecommerce, and consumer products and services. However, occasional investors, i.e., Quartile 1 and 2 investors are characterized by a higher degree of diversity in terms of the number of deals in different sectors, whereas Quartile 4 investors are characterized by a higher degree of concentration. Bulk of the investments made by Quartile 4 investors are in the top 3 sectors indicated above, with very little in the remaining sectors. A possible explanation could be that most active angel investors (Quartile 4) have prior experience in the technology sector and are therefore making a majority of the investments in the sectors they are familiar with.
Figure 3.17: Trends in investment amount for quartile classification of angel investors Figure 3.17 illustrates the average deal investment amount and the total investment made by different angel investor quartile. This was based on a sample of 799 deals for which investment amount was available. Quartile 1 comprised of investors who have invested only once; Quartile 2 comprised of investors who have invested twice; Quartile 3 comprised of investors who have invested up to 5 deals; and Quartile 4 comprised of investors who have invested in six or more deals. Average deal investment amount is considerably higher for investors in Quartile 1 and the total investment made by investors in this category is also the highest. As the number of investments increase, the average deal investment amount also reduces and so is the total investment made by the category of investors. More active investors are thus diversifying their risk by spreading their investment across more companies, as seen for Quartile 4. Our results highlight the important role played by the occasional investors – not only are their average investment higher, as a group, their investment amounts are also higher.
Angel networks A noteworthy development in the last few years has been the evolution of the angel networks. While many of the angel networks are organized around cities (such as The Chennai Angels, Mumbai Angels, and so on), there are other forms of networks as well. A prominent example is the Indian Angel Network, which is the pan-India network of angel investors. Some of the features of the angel network are as follows:
61
In an angel network, a group of members come together to make an investment. Therefore, individual investments made by each angel investor is lower. While the average investment amounts for an angel and angel network investment does not vary significantly, the number of investors vary considerably. In angel funding, typically about 3-4 investors come together, whereas in an investment facilitated by an angel network, the number of investors are typically about 5-10.
A potential investment opportunity is analyzed and discussed by many interested investors. This helps the investors to reduce potential mistakes in decision making. By bringing in like-minded angel investors, the networks helps to enable interaction between fellow angel investors.
The angel network facilitates the entire selection process, starting from receiving applications to arranging screening committee meetings, doing due diligence, and the final documentation for investment. Since there is a dedicated operational team to manage the activities, the processes are streamlined and there is often good online process for submission of proposals by the entrepreneurs. The angel network office acts as a single point of contact for the founder.
An investment director is usually appointed to represent the investors who have invested in the deal. This ensures a single point of contact between the investors and the company. However, in practice, the entrepreneurs would have to take into account that there could be occasions where the views of the individual investors could diverge.
Since the individual investment amount made by each member is not very large, some feel that the commitment of the investor could also be lower as compared to instances where the angels invest directly and the investment amounts are larger.
Figure 3.18: Number of investments made by angel networks Figure 3.18 shows the growth in the number of investments made by angel networks over the years. As it can be seen, there has been a steady growth over the years. The annual growth rate of the number of investments by angel networks made during the 2009-15 period has been about 75 percent. However, a significant part of
62
the growth can be attributed to the year 2015, when the number of investments increased more than threefold from 33 in 2014 to 116 in 2015. While year-on-year trends can show growth spikes, a moving window aggregate as seen in Figure 3.18 shows a fairly steady growth in the number of investments.
Figure 3.19: Number of angel networks that have made investments in different years
Figure 3.20: Average number of investments made by angel networks Figure 3.19 shows the number of angel networks that have made at least one investment in different years. In the span of 7 years, the number of networks have increased 20 times. Though there is a slight decrease in the number of networks that made an investment in 2014, the overall trend is that of positive growth in the number
63
of angel networks. However, there has been a big jump in the number of networks in the year 2015. Figure 3.20 shows the average number of investments made by different angel networks. Overall average works out to be approximately 3.5 investments per year.
Venture investments Figure 3.21 and 3.22 presents the trends in start-up funding from all sources - angels, angel networks, and venture funds. Figure 3.21 shows the pattern in funding by sector. Interesting trends could be noticed in most of the sectors – the investment picks up slowly (possibly a period of learning and understanding for both the investor and the entrepreneur), reaches a peak, and then gradually tapers down. It is clearly evident that entrepreneurs have a better chance of getting funded during the growth period of the sector. The sector that has bucked the trend has been software and internet services sector. The number of start-ups getting funded in this sector has been steadily increasing over the years. An implication of our finding is that the probability of getting funded from angels and venture funds, in addition to so many factors, also depends on the sector as well as the timing in approaching the investors.
Figure 3.21: Start-up funding classified by sector Figure 3.22 presents an illustration of funded start-ups in different cities, based on the year in which the startups were incorporated. Trends are very similar to the ones seen in Chapter 2. Bengaluru, Mumbai, and Delhi show an increasing trend. However, for cities such as Chennai, Hyderabad, and Pune the trend is more or less stationary. In the case of Chennai, the number of start-ups incorporated in recent years that have been funded have actually reduced. Figure 3.23 gives the number of start-ups funded in different cities during the period 2000-15. The prominence of Bengaluru, Mumbai, and NCR cannot be missed. In each of the three cities, there has been a sharp increase in the number of start-ups funded in 2015. Over the years, the gap between these three cities and other cities such as Chennai, Hyderabad and Jaipur has considerably increased. This has prompted many to ask the question, what makes the successful cities tick? In order to ensure that the gap does not further widen between cities, policy makers need to identify the components of the entrepreneurial ecosystem in cities such as Bengaluru that makes more number of start-ups to get funded.
64
Figure 3.22: City wise funding of start-ups by the year of incorporation
Fig. 3.23: City wise funding of start-ups
Summary A striking feature of the longitudinal analysis of the Indian entrepreneurial ecosystem has been the express growth across different components. This chapter specifically looked at incubators, angel investments, angel networks, and venture capital for different time periods. While year-to-year analysis could show fluctuations, a three year moving window shows a consistent growth trend over the years. The technology sector that comprises software and internet services has been the dominant sector in terms of the number of investments across all the components that has been studied. Two concerns remain. First, the development of the ecosystem has been restricted to a few states and within those states, only to the state capitals. The velocity of trickling down to other cities has been very slow. While the pattern of having start-up hubs is what prevails globally, the global hubs (such as the Silicon Valley in the US) are known for their start-ups in certain specific sectors. On the other hand, the start-ups in India, viz., Bangalore, Mumbai, and Delhi are more or less similar in terms of the start-up sectors. A slight exception could be Bangalore, which has a slightly higher proportion of technology and software services start-ups.
65
Second, the growth in the number of investors and the amount of investment has been significantly high, which cannot be sustainable in the long run. Such exuberance can have undesirable side effects. For example, many naïve investors could be attracted by the euphoria of investing in start-ups, without fully aware of the risks involved. While some years ago, founders and members of the industry bemoaned of lack of seed and early stage funding to ventures, today the pendulum has swung the other way. Several members indicate the “spray and pray” practice that seemed to have crept – where investors make small investments, but do not show the required commitment to provide guidance or mentoring to their investment. When such investors are disappointed by the outcome of their investments, they may move away from making such investments in the future, resulting in dwindling investments in start-ups.
66
PERSPECTIVE 3
The Acceleration of the Indian Start-up: A Brief Outline of the Regulatory Changes Aarthi Sivanandh
India has come a long way from just being an outsourcing hub. The initial outsourcers reframed their mind from perceiving India as an outsourcing hub, to see, if they could also get their strategic work executed in India. The evolution of startups began in the early 2000s when the transformation of India from an outsourcing hub to an entrepreneurial hub took seed. The look-alike entrepreneurs of the West slowly faded away and real unique ideas that were critical to the Indian economy and those companies that solved problems unique to India evolved. However, the regulatory framework that existed during the period did not adequately support the entrepreneurial surge. For example, governing the company form of structure was cumbersome. The paperwork involved in setting up and operating a business was a huge paper based exercise. It wasn’t the digital age that we are familiar with today and India was ranked 130 out of the 189 countries by the World Bank in its 2015 country report of ease of doing business. A combination of myriad factors led promoters to spend scarce energy, resources and time to incorporate companies in the Silicon Valley, New York, London, or Singapore for their favourable tax regimes and for privileges such as incorporating companies in less than a week. The flight of capital, talent, earnings and the external verdict of the World Bank and industry lobbies, led the government to realize the urgent need to stop the leakage of start-ups to other jurisdictions. Simultaneously, the political climate (and therefore the business climate) changed after a majority government took its place at the Centre in May 2014. The new government has worked on several fronts to improve the ease of doing business rankings as well as enhancing a conducive environment for industry, especially for start-ups. These efforts will remain the singular reason for India rising to the third position among all the start-up hubs in the world. And for all players in that ecosystem - founders, angel investors, incubators and young employees, India is no longer a last choice.1 This article briefly reviews the regulatory changes that have served as a stimulus to the start-ups. It examines the company form of start-up and the issues relating to the ecosystem in which the start-up operates, with specific reference during the 2014-16 period. The key developments during the period that has given a fillip to the start-up entrepreneurs include entity structures that are available to an entrepreneur to conduct business, and measures taken by the central bank to ease the procedural norms to raise investment capital from foreign investors. Given the substantial developments in the e-commerce sector, this article also traces the regulatory changes that are especially relevant for the e-commerce sector.
The legal vehicle for entrepreneurship to take form: The Company For the entrepreneurship skills of a person to manifest itself in a corporate form, there is a need for a legal entity or structure. The legal vehicle allows the person to take risks and give shape and form to business ideas without the constant concern of personal liability, while at the same time assuring legal rights to all those who do business with that entity. There are several choices available for the legal entity, such as a company, limited liability partnership (LLP), a vanilla partnership and a one man company. The typical and often preferred choice is that of a company set up under the Companies Act 1956 and its amended version in 2013. The company structure lends itself to separation of personal liability and corporate liability. Courts have rarely pierced this
67
corporate veil to say the company and the founder are one and the same. A clear sense of risk and liability propels the choice of entity structure. Further, this structure is more investment friendly as investors prefer the rigors the company is obliged to, viz., operate in a transparent manner with accountability and governance requirements pursuant to the requirements of company law. Also, the investments made in such company structure gain ‘marketability’ when the company eventually makes a public offering of its stock. In comparison, while the LLP structure allows for its partners to be liable only to the extent of their contribution to the LLP, it has scored lower in choice because of reasons related to shareholder control. Unlike the Companies Act, the Limited Liability Partnership Act, 2008 does not secure for its limited partners any protection against oppression and mismanagement by its shareholder partners. As the start-up traverses through the stages from establishment to early business and then to growth and maturity, the awareness of the regulatory aspects involved in growing companies becomes the key differentiator between outstanding entrepreneurs and sightless entrepreneurs. For instance, an entrepreneur who had headquartered her company in Singapore owing to its intellectual property friendly jurisdiction, investor appeal and tax regime had attracted an investor who was keen on making an investment in her company. The company however had an operating subsidiary company in India. A then existing law required that individuals cannot invest in shell companies or holding companies in foreign jurisdictions. In the instant fact pattern, the investor flagged the investments made by the entrepreneur in Singapore holding company as a violation of law. However, a closer reading and interpretation that clarified such investments were kosher if such holding companies or shell companies in fact held operating and functional subsidiaries, was unacceptable to the investor. The entrepreneur thus reversed his structure of companies so as to facilitate the investor at great cost of time, money and resources. A keen awareness of the market, regulatory aspects and the maturity to deal with investors in this context would have saved this entrepreneur valuable time in the early stages of growth.
Evolution of the legal landscape concerning formation of companies Single founder companies A start-up set up as a company structure, shall be governed by the Companies Act 2013 (that has replaced the Companies Act 1956). While most provisions of Companies Act, 2013 (Co. Act) have come into force, some sections such as those relating to mergers and amalgamations are still regulated by the provisions of the erstwhile Companies Act, 1956 (“Co. Act 1956”). The Registrar of Companies (“RoC”) in each state is the nodal authority for registration of companies. Under the new Co Act, a natural person who is an Indian citizen and resident in India can incorporate a one person company. This has been a welcome move to single founder companies that traditionally required two persons at the minimum to start a company. This imposed a requirement on the founder to enlist a spouse, friend or relative who could be entrusted with minimal stock so as to comply with the requirements of the Co. Act 1956. The new amendment eases this completely and permits one man companies. The singular advantage of such companies is the number of persons required to set up the company. It shall be required to convert itself into public or private company, in case the paid up share capital of such a one man company is increased beyond ₹5 million or its average annual turnover exceeds ₹20 million.
Registering as a start-up The government in 2016 announced the “Start-up India-Stand up India” action plan, which laid more stress on governance with lesser government interference. In tune with that sentiment, there was the launch of the Startup India mobile portal and website, where an entity can also directly be incorporated through the Start-up India portal and then register as a Start-up. However, in order to obtain tax and IPR related benefits, a Start-up shall be required to be certified as a business, which involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property by the
68
Inter-Ministerial Board of Certification. The members of the board comprises of the Joint Secretary, Department of Industrial Policy and Promotion, representative of Department of Science and Technology, and representative of Department of Biotechnology. The Government has defined a start up to include only those companies that satisfy the below criteria
It has been in existence for less than 5 years from the date of its incorporation/ registration (A company or other entity already in existence at the time of the Start-up India Action plan can still avail of the benefits of the plan provided it has been in existence for less than 5 years at the time it seeks the benefits), If its turnover for any of the financial years has not exceeded ₹250,000,000 (approximately USD 3,687,810) and; It is working towards innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property.
Amendments to the Companies Act The company incorporation process has now been made completely electronic making the whole process very business friendly. This is reflected in the number of companies incorporated: in 2014 around seventy thousand companies were reportedly incorporated, whereas in 2015 it was around seventy five thousand. As per the amended Companies Act, 2013:
company should receive its initial capital and shares shall be issued within 60 days of certificate of incorporation.(previously, the Co. Act 1956 required such issuance be made within 3 months) the entire process of incorporation shall be completed within 120 days there is no requirement for minimum paid up capital and notable changes were made with respect to issue of sweat equity and ESOP as given in Exhibit P3.1 Exhibit P3.1: Changes made with respect to sweat equity and ESOP in Co Act., 2013 Particulars
Position under the Co. Act 1956
Position under the Co. Act 2013
Issue of Sweat Equity Shares
Company cannot issue sweat equity shares for more than fifteen percent of the existing paid up equity share capital in a year or shares of the issue value of ₹50 million, whichever is higher.
Start-up company may issue sweat equity shares not exceeding fifty per cent of its paid up capital up to five years from the date of its incorporation or registration.
Exception to Start-up Company with respect to quantum of issue.
Provided that the issuance of sweat equity shares in the Company shall not exceed twenty five percent, of the paid up equity capital of the Company at any time. Employee Stock Option Exception to Start-up Company with respect to issue of ESOP to Promoters and Directors (directly or through relative) holding more than 10 percent
As per section 12(1)(c) Company cannot issue ESOP to (a) employee who is a promoter or person belonging to promoter group; (b) director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10 percent of the outstanding equity shares of the company.
69
In case of a start-up, the provision shall not apply up to five years from the date of its incorporation or registration.
Simplification of processes Several processes have been instituted to benefit the start-ups, some of which include:
A simplified form can be filled for registration of start-up with various government agencies. Importantly, this mobile application has been integrated with the Ministry of Corporate Affairs for seamless integration A checklist of various applicable laws, licenses and FAQs has been provided for founders to know of various compliances Filing for compliances and obtaining information on the status of various clearances and approvals has also been made possible on the app.
Measures by the RBI To complement the start-up regulations under the Co. Act, the Reserve Bank of India (RBI) has also focussed on measures to ease doing business in India and enhance a conducive ecosystem for the start-ups. Some of the key measures are as follows:
Registered Foreign Venture Capital Investors can invest in all start-ups regardless of the sector that the start-up would fall under. Previously, these investments were restricted based on sectoral limits of the RBI and the relaxation has benefitted the start-ups
A hurdle that often stalled investments in start-ups was the inability of the investor to value the company especially if it was a pre/early stage investment opportunity. In such instances, investors would propose a deferred investment structure wherein their investment was conditioned on the founders achieving certain performance milestones. The erstwhile regulations required that the permission of the RBI be obtained for such investment structures with delayed or deferred consideration to the Indian founders. This has now been eased and the RBI permits transfer of shares or ownership which allows deferred consideration structures and facilities for escrow or indemnity arrangements for a period of 18 months; and
A company receiving funds from abroad has had to report the same to the RBI and until now a delayed filing has attracted a compounding of the offence or a penalty. The RBI has now simplified the process for dealing with delayed reporting of foreign investment related transactions by building a penalty structure into the regulations itself. And all outward remittances to foreign parties can be reported online through a form based process, which is intended to provide ease in doing business. All electronic reporting of investment and subsequent transactions is now on e-Biz platform only and submission of physical forms has been discontinued with effect from February 8, 2016.
Dealing with insolvency and bankruptcy In tune with the government intent, a fast track process has been put in place for start-ups to deal with insolvency and bankruptcy. The Insolvency and Bankruptcy Bill 2016 received Presidents’ assent on 28 May 2016 wherein the Start-ups pursuant to Section 56 can apply for a fast track process that enables winding up of the company in ninety days. The Board may enable such fast track process once it determined the eligibility of the start-up as a corporate debtor.
Self-certification of compliance The start-ups have been allowed to self-certify compliance through the start-up portal with respect to certain specified labour laws and environmental laws (listed below).
70
1. 2. 3. 4. 5. 6. 7. 8. 9.
The Building and Other Construction Workers (Regulation of Employment & Conditions of Service) Act, 1996 Inter – State Migrant Workmen (Regulation of Employment & Conditions of Service) Act, 1979 Payment of Gratuity Act, 1972 Contract Labour (Regulation and Abolition) Act, 1970 Employees’ Provident Fund and Miscellaneous Provisions act, 1952 Employees’ State Insurance Act, 1948 Water (Prevention & Control of Pollution) Act, 1974 Water (Prevention & Control of Pollution) Cess (Amendment) Act, 2003 Air (Prevention & Control of Pollution) Act, 1981
The self-certification process helps the entrepreneur shrug off regulatory concerns in the initial stages and concentrate on the business. The erstwhile license raj system thrived on the entrepreneur being caught off guard by labour inspectors and such other government authorities. The provision of a self-certification process provides a trust based governance for the business ecosystem. The Start-up Action Plan has also exempted the start-ups from labour inspections for a period of 3 years except in a case of credible and verifiable complaint of violation. These relaxations are particularly beneficial for those start-ups which are engaged in the manufacturing sector. However, India has not one but 200 legislations relating to labour laws that will still need to be reviewed and a determination made as to what is applicable to the start-up. The idea of self-certification for the few crucial ones required of a start-up is bound to ease the start-up compliance anxiety and save time and resources in this regard.
Case study of the ecommerce sector India has a huge internet user base that doesn’t necessarily translate into a huge consumer base for products and services online. Flipkart and Snapdeal, the touted unicorns in the industry leave behind several thousand internet start-up companies that struggle to live past their second year and travel aggregators such as Ola, Taxi For Sure are at the centre of debates that rally arguments for and against their protection from external competition. The regulator and the government have thus had to parry and balance various interests to allow the growth of the ecommerce sector in India. The prime fuel for the growth of the ecommerce industry has been capital – how fast the companies are able to attract it both domestically and from foreign investors. As regards foreign investments the companies have been able to attract a fair share of interest from the US and China despite the absence of a clear Foreign Direct Investment (FDI) policy. And a tug of war is often witnessed between the brick-and-mortar stores and ecommerce sites, with allegations that, since the government doesn’t allow FDI in multi-brand retail companies, the latter are flouting policies to attract FDI and therefore gain an unfair advantage in the market. The deep discounts offered by the e-tailers have also been a cause of concern. This led to the filing of a case by the Retailers Association of India (RAI) in the Delhi High Court wherein the e-commerce models came under scrutiny and RAI sought parity with e-commerce companies in that they were equally entitled to attract investments as their ecommerce peers. Thus, the Department of Industrial Policy and Promotion (DIPP) released a Press Note (PN) on March 29, 2016 to bring clarity to the policies governing the e-commerce sector. The Press Note (PN3) provides definitions for terms such as e-commerce, e-commerce entity, inventory based model of e-commerce and market place based model e-commerce. The inventory based model of e-commerce (“Inventory Model”) or the Business to Consumer (“B2C”) model means an e-commerce activity where the inventory of goods and services is owned by the e-commerce entity and is sold to the customers directly. The Marketplace based model of e-commerce (“Marketplace model”) or
71
the Business-to-Business (“B2B”) model means an entity providing an information technology platform on a digital or electronic network to act as a facilitator between the buyer and the seller. However, there are ambiguities within the PN3, such as the suggestion that B2B entities may do cash and carry business, and yet, prohibiting any ownership of the inventory by them. The PN does not define ‘digital products’. The absence of such a definition might create confusion around the way the term is understood. Furthermore, it does not provide sufficient time for companies to comply with its provisions. It is hoped that in order to make the PN effective, the DIPP will soon issue clarification to ambiguities and a compliance timeline to give the ecommerce companies some breathing space and time to restructure their current models. PN3 has left open many grey areas, which might be a source of new litigation between various stakeholders. Further, given its immediate implementation from March 29, 2016 and lack of time to existing entities to restructure their business and operation model, businesses could suffer if they don’t structure their operations quickly. The necessary clarifications on marketplace model and inventory model in PN3 have acted as an impetus for investors, who want to invest in marketplace e-commerce entities. Only time will tell as to whether this PN has been an impetus or roadblock for e-commerce business, but it is a step regulation for e-commerce industry. Other than the issues relating to FDI in the e-commerce sector, the domestic e-commerce sector is governed by the Information Technology Act, 2000. This makes India only the twelfth country in the world to have such a comprehensive legislation for e-commerce. This Act has led to amendments in the Indian Penal Code, 1860 the Indian Evidence Act, 1872, and the Reserve Bank of India Act, 1934 to make them align with the requirements of a digital economy. With the hyper activity around e-commerce activities in general, it maybe noteworthy to examine what responsibility does the e-commerce player owe and to who. The minimization of the liability of the start-up on the internet largely depends on the nature of representations made by the start-up on its website, like Terms of use, privacy policies, and the usage agreements. Each of these has to be customized for the website to effectively manage the liability of a company. These would necessarily carry certain disclaimers to at least help minimize the liability of the start-up if not eliminate it. A start up should also regularly review their website to flag off potential areas of liability.
Outlook It maybe “acche din” in the days to come in the Indian start up scenario as the government has been extremely keen to boost this sector and erase any regulatory differences that foster growth between the Indian and foreign ecosystems. While this piece focusses on the government impetus given to the start-up scenario there are several other initiatives that have been undertaken in the areas of infrastructure (to build better connectivity between cities and basic amenities for growth), tax regimes (rationalising taxes for start-ups, angel investments tax and measures to spur domestic investment), and exit mechanisms for investors. While the regulator is beginning to whistle to the tune of the industry, synchronization remains the ultimate aim.
Notes 1
Start-up India 2015 report, published by NASSCOM.
72
REFLECTION 3
Bootstrapping to $500 million: A Conversation with Sridhar Vembu Thillai Rajan A. for getting introductions to the investors. They don’t simply fund otherwise. In our case, we simply had an idea and it was not even clear whether we could put together a business plan based on the idea. Our plan was to figure it out as we went along. While we had the confidence that would be able to figure it out the VCs cannot be sure whether we will be able to figure it out. Given these circumstances, there was no real possibility for us to get money from VC’s. So we just plunged into starting our venture on our own. This gave us the discipline to find out how we could generate revenues quickly, because we needed the money to survive.
When you started your venture back in 1996, the number of people starting on their own was not very large. What was the major factor that influenced your decision to be an entrepreneur? I came to the US for doing a Ph.D. after completing my under graduation at IIT Madras. My initial goal after completing my doctorate was to get into an academic job. But after completing my Ph.D. from Princeton University in 1994, I realized that I was not mentally prepared for an academic job and it was not my cup of tea. Therefore, I decided to get into the private sector. I ended up working in Qualcomm working as an engineer. It was during that time that I realized that there was so much that could be done in India. Qualcomm itself was a great company to work for and the founders of the company were actually professors before they started out on their own. This was definitely an inspiration for me. My brother was also in the US at that time, and we discussed a lot about starting on our own which finally culminated in starting our own venture.
While VC provided lot of benefits, there were undesirable side effects as well.
Fortunately, we were able to quickly start generating profits and we could sustain ourselves. We started getting the attention of the VC’s after about 3-4 years, but by then we were already profitable. We had an established product in a small market, and we knew that eventually we have to create a broader suite of products for a larger market. While the VCs saw the market for our initial product as big in itself, we wanted more time to think about what we should be doing in our business. The interest of VCs in our company coincided with the dot-com phenomenon of 19992000. By this time, I could see that VC investment had resulted in several companies spend capital unwisely thereby wasting a lot of money.
As they say, omne initium difficile est. But you have chosen a path that is different from the dominant paradigm that prevails today, which is to use venture capital to finance the business. Was it a conscious decision not to seek external funding from the beginning or was it something that kind of emerged along the way?
While VC provided lot of benefits, there were undesirable side effects as well. We decided not to take VC funding when we saw that there was so much capital floating around. Companies were spending recklessly and we decided that it was not worth taking the money and changing our culture as a result of that capital.
First of all in 1996, when we began, venture capital was not as easily available as it is now. One needed to have the right background, pedigree, or a track record. We also did not have the necessary network
73
Since Java was a new language at that time, we created this protocol and on top of it, built a platform for network management. This product interested some big printer companies whom we met in a trade show and they wanted to customize this platform to their requirement for bundling with their product. We were able to strike such deals which gave us the initial revenues. We also had a services component. For example, my brother worked in Prof. Ashok Jhunjhunwala’s lab along with 2-3 engineers on a small project. Such engagements provided the initial revenues to sustain our venture.
Why did you think that VC investment would change your culture? VCs would typically encourage their companies to grow faster and faster. It is normal behaviour because the perception is that many of the new markets are like land grab. The companies have to become big very fast or else the market will be dominated by another company. There is some rationale to this thinking, because for some companies like Facebook, the winner takes it all is true. But there are a lot of areas where that does not necessarily apply. Chasing growth and market dominance at the cost of all else in such sectors is like pumping the company full of steroids. For an athlete, taking steroids (if it is made legal) may lead to short term wins. But, in the long term there would be a breakdown of the body. Exactly the same thing can happen in businesses as well. With excessive capital, the discipline in the internal culture of the company gradually tend to fade away. The companies tend to build very flashy headquarters and corporate offices or spend a lot of money on sales and marketing. By contrast, investing in R&D, takes a long time to produce results. Companies have a flashy office or throw money on sales and marketing, because it is like making a statement that they have arrived. These things have an impact on the company’s culture.
There is a perception that VC funding provides a kind of “certification effect” to the start-up and gives more comfort to the customers? I would say the effect is marginal at best. It does not really matter to the customer which VC has funded a company. In the early stages of the venture, the customers are apprehensive whether the start-up is going to around for some time, but they are not concerned whether the startup has VC funding or which VC firm has funded. Customers are fully aware that a lot of VC funded companies fail too. There is no guarantee that just because a famous VC has funded a start-up, it absolves the risk of non-survival. For that matter, risk of nonavailability of product service and support exists even for established companies. Many large companies are rapidly changing their product portfolios, and there is a good chance that the product line may be dropped in 5 – 10 years and we may not get product support. Thus the risk exists, whether it is a large company or small company. Having a VC investment may confer a small advantage, but it is not a big deal.
Chasing growth and market dominance at the cost of all else in such sectors is like pumping the company full of steroids.
What were the initial sources of funding for your business? I come from a typical Chennai middle class background, and there was no family money. My father was working in the High Court as a Stenographer and we did not have any business background. We funded the business with whatever little we had in terms of personal capital. We went without pay for the first one and a half years, and for the next 2-3 years we took only nominal pay to meet our living expenses.
Value addition to the portfolio companies is another area VC firms are known for. The situation, in my view, is a little different in reality. The problem I see is that a lot of VCs have extended themselves, because it is in their own interest to diversify their portfolio. What they are
Whatever revenues we made, we ploughed back in the business. Our first product was a stack for Simple Network Management Protocol in Java.
74
deal making because we do not have an unending source of capital. If we are not disciplined, we would run out of business.
doing is really portfolio diversification and how much attention they can provide to individual companies is a big question. Often each VC partner could have as many as 20 companies in their portfolio. In addition, they could have seed or angel investments in their personal capacity. Moreover, the VCs are also constantly prospecting for new investments. Therefore the kind of attention that they could provide to every portfolio company becomes very limited. Occasionally, they are able to refer suitable candidates for recruitment. Many of them are often from the start-ups in which they have invested. Whether it produces a durable team is questionable, since many of these referrals stick only for about 3-4 years. Thus with multiple fires demanding their attention, the only time the VCs show up is during board meetings. Other times, we can consider lucky if they respond to our emails!
Wouldn’t a listed company bring more trust or comfort – to the customers, employees, and so on? That is the story being told in the market. But I am not sure. Customers care for a really good product, good after sales support and the durability of the company. We can convince our customers today that we have been around for 20 years in business, and that is definitely a long time. Given the dynamic conditions in the market today, there is no guarantee that a public company would continue to exist after 10-15 years. So far, no one has ever refused to buy our product because are not a public company. We may have lost a deal for some other reason such as lack of certain features in the product and so on, but not because we are a private company.
You have also stated your intention to keep Zoho private and not go for a public offering. Wouldn’t being a public company provide many benefits, say for example liquidity to the stocks that your employees could be holding?
As far as the employees are concerned, we have a good compensation, bonus, and profit sharing plan. Even while recruiting, we tell them upfront that we are an unlisted company and intend to stay that way. Therefore, when they join the company they know fully well that it would be a privately held company. People who have concerns on joining a privately owned company, don’t join us. The question is whether the employees are happy after spending 3-5 years in the organization. We are inclined to think that they are, if we look at the attrition rates. While the industry average attrition rates are 15 - 20 percent, our rates are 5 – 6 percent.
To go public or not is the issue. But why bother when we are well capitalised and are able to grow on our own internal accruals? Going public is a very complicated process and we have to subject ourselves to external oversight. There is no reason for us to subject ourselves to this complexity. A common reason given to go public is to provide some liquidity to the shareholding that the promoters have. I don’t care so much for liquidity and my modest expectations are met. We are able to generate enough capital for expansion within our firm. A second reason to go public is to raise large sums of capital that enables us to make acquisitions. But in my view, when we have large amounts of capital, we are tempted to do deals that are most likely to fail. With limited amounts of capital, we become more disciplined, we could to smaller acquisitions that are more likely to pay off. As a private company, we cannot indulge in reckless
…we cannot indulge in reckless deal making because we do not have an unending source of capital. If we are not disciplined, we would run out of business.
What message do you have for the current set of entrepreneurs? A prevailing paradigm that exists today is to quickly scale up a business and sell out after some time. I have been in the business for 20 years now, and it is my desire to be in this for as long as possible. That means, I do not have any particular advice to entrepreneurs who are thinking of a 5-6 year cycle. I am not comfortable with the short term thinking
75
investments to generate surplus returns, long term investors would tend to be more judicious with their investments.
for the following reason. Given the unpredictable nature of the business, it is very difficult to forecast what could be accomplished in six years to sell the business. So, out of sheer necessity, it would be better to take a long term orientation. Because, that enables us to constantly reinvent and adapt to the changes in the market. On the other hand, if the entrepreneur has a fixed timeframe in mind, and has not produced a good product in that timeframe, then the entrepreneur gets fidgety and worried that he has not been able to make much progress.
How would you characterise the entrepreneurship ecosystem in India today? Today a lot of investment is driven by the expectation of a quick return. Lets’ take the case of angel investments, which has seen significant growth in recent years. The prevailing thinking is that an investment of ₹0.5 – 1 million can grow to ₹10-20 million in a very short time frame, giving attractive returns. While some of the investments are going to be successful, a lot are not going to. Too many companies are being funded today with the expectation that they could sell to someone, but it is not realistic to expect that all these companies can get acquired. There is going to be a period of healthy shake out, and there will be a return to normal levels. However, I am bullish in the long term, if we look at 10-15 year growth cycle. The favourable policy environment, demographics, and development focused agenda of many governments would lead to positive results.
Today a lot of investment is driven by the expectation of a quick return…While some of the investments are going to be successful, a lot are not going to.
While there is a lot of VC available in the market today, there are not that many high quality companies that can be supported. However, we still have a long way to go because the per capita GDP of India is only $1500. There is scope for the GDP to grow another 5 – 10 fold, which means companies that take a long term view are more likely to do better, because it is the process of GDP growth that also creates more opportunities for the companies. Therefore, entrepreneurs are more likely to do better if they a long term orientation, which then precludes the very short term. While short term investors invest substantial amounts and quickly flip their
Sridhar Vembu is the founder and CEO of Zoho Corporation. Zoho Corporation are the makers of the online Zoho Office Suite as well as several business applications. The company has annual revenues of about $500 million and provide employment to close to 4000 people. Despite the increasing growth and market presence, Sridhar has focused on the boot strapped model and Zoho has remained independent without any venture funding.
76
4.
The Gladiatorial Arena of Start-ups
“I will win the crowd…I will give them something they have never seen before...”1 “Gladiators seek to best all. It is how they survive.”2 “The real gladiators of the world are so humble in their origins and unremarkable in appearance that when we stand next to them in a grocery store line, we never guess how brightly their souls can burn in the dark.” 3 Thillai Rajan and Atit Danak
Overview India has grown up to be one of the leading start-up countries in the world, in terms of the number of start-ups being founded. In this Chapter, we analyze the landscape of the start-ups that are founded, and also provide a perspective with those that have been successful in raising initial capital. An important source of initial funding to start-ups is provided by angel investors. Therefore, we also provide a brief analysis of the angel investor landscape. In the end, we also provide a short comparison of the global and Indian trends in venture financing for select sectors. The primary data source for this Chapter was obtained from LetsVenture (LV), India's largest startup funding platform. Founded in late 2013, LV is India's first and now the largest platform for startups to create their investment ready profile and connect to global, accredited investors for early stage fundraising. By mid-2016, 11000+ startups, 1800+ angel investors, and 300+ institutional investors from 21 countries were connected to the platform. The company uses technology – with focus on personalization & match-making - to build world's largest network of startup ecosystem stakeholders - startups, angels, institutional investors, family offices, policy makers, corporates, accelerators and incubators - to discover and connect with each other. Till mid-2016, 130 start-ups have been successful in raising capital through the LV platform. In its public metrics, LV only counts the deals where it helped startup close the round along with paperwork and charged a success fee.
The Start-up Landscape Table 4.1 provides the number of start-ups on the platform based on the year of founding of the start-up. It can be seen that there is a sudden jump in the number of start-ups from the year 2013. While it is also possible that fewer of the start-ups founded during the years 2010-12 have registered on the platform, we believe the number of start-ups founded in different years reflects the trend in start-up formation in the country. Table 4.1: Founding year of start-ups Founding year
Tier 1
Tier 2
Tier 3
Grand Total
2010
148
43
5
196
2011
224
65
12
301
2012
437
100
24
561
2013
770
262
37
1069
2014
1664
488
75
2227
2015
3162
875
130
4167
2016 (part year)
1118
391
59
1568
Grand Total
7523
2224
342
10089
77
Consistent with the results of the previous Chapters, a large majority of the start-ups are based in Tier 1 cities. In a sample of 10089 start-ups (for which founding year was available), about 75 percent of the them are from Tier 1 cities. Tier 2 cities accounted for about 22 percent of the sample, while the remaining 3 percent are from the other cities. Policy makers need to be cognizant of this skew in the start-up formation trends and make efforts to create conditions that democratizes the start-up formation. Table 4.2 provides details on the lifecycle stage of the start-up. Start-ups were classified into 5 categories based on the lifecycle stage, viz., ideation, proof of concept, beta launched, early revenues and steady revenues. We calculated the maturity index of the start-ups based on the number of start-ups in each stage for the different city types. The stage of the start-ups was given a value of 1 to 5 for the different stages, with a value of 1 for ideation and a value of 5 for steady revenues. Maturity index was calculated as a weighted average of the number of start-ups in each stage and the value assigned to each stage of the start-up. The maturity index of the Tier 1 cities is the highest at 3.1. This indicates that a higher proportion of the start-ups located in Tier 1 cities are at the later stages of the life cycle as compared to those in Tier 2 or 3 cities. While the results are expected, the trend could be attributed to a more conducive environment for start-ups in Tier 1 cities to progress quickly across the different stages. Table 4.2: Maturity index for start-ups in different cities Start-up stage
Tier 1
Tier 2
Tier 3
Grand Total
Ideation
1125
439
84
1648
Proof of Concept
1557
468
88
2113
Beta Launched
2166
640
89
2895
Early Revenues
2858
841
102
3801
Steady Revenues
868
191
29
1088
Grand Total
8574
2579
392
11545
3.1
3.0
2.8
3.0
Maturity index
Table 4.3 gives details on the number of start-ups and those that have been funded. Two types of funding details are available, those that have successfully raised money on the platform and those that have received commitment from other sources (as disclosed by the founders). The number of companies that have received funding is very small – just 1.07 percent of the companies successfully raised capital on the platform. The proportion of companies that have received outside commitment is higher at 7.9 percent. In total, only 8.3 percent of the total start-ups in the sample has received some form of external funding. Table 4.3: Number of start-ups founded and funded Count Total number of start-ups
Percent
12073
100%
Total funded in LV platform
130
1.07%
Total outside commitment
957
7.9%
Total funded
998
8.3%
Table 4.4 shows the percentage of companies that have got funding by city tier. Among the transactions that got closed on the platform, 90 percent of the companies that got funded were from Tier 1 cities. Overall (including other external commitments), about 83 percent of the companies that obtained some form of funding were from Tier 1 cities. The proportion of companies from Tier 1, 2, and 3 cities that got funding from the platform was 1.5 percent, 0.5 percent, and 0.25 percent. Overall, the proportion of companies that have got external funding from Tier 1, 2, and 3 cities was 10 percent, 6 percent, and 5 percent respectively. Not only has the start-up formation rates in Tier 2 and 3 cities lower, the probability of getting funding is also considerably
78
lower. Targeted interventions would be needed to augment the capabilities and access to finance for the startups in the mid and smaller cities. Table 4.4: Percentage of start-ups funded by type of city Other City type LV funded All funded commitment Tier 1 90.0 82.7 82.9 Tier 2
9.2
15.5
15.2
Tier 3
0.8 130
1.9 957
1.9 998
Total
Table 4.5 gives the proportion of companies funded in the six Tier 1 cities out of the total companies that got funded on the platform. Strikingly, the cities of Bengaluru, Delhi and Mumbai account for more than 94 percent of the companies that have got funding in the six Tier 1 cities. The remaining 3 cities, viz., Chennai, Hyderabad, and Kolkata account for only 6 percent of the share of companies that got funding. The maturity index of the start-ups in Bengaluru, Mumbai and Delhi are also higher than that of Chennai, Hyderabad, and Kolkata. Among the six cities, Bengaluru has the highest percentage of companies that got funded (39 percent), whereas the share of Chennai is just one-eighth of that of Bengaluru. Presence of LV team in Bengaluru could be a possible reason for the trend. Table 4.5: Tier I cities: Maturity index and percentage share of start-ups funded Percentage share of Maturity City start-ups funded index 3.1 Bangalore 35.50 Chennai
4.27
Delhi
24.79
Hyderabad
0.85
3.0 3.1 3.0
Kolkata
-
2.9
Mumbai
26.50 117
3.1
Total start-ups in Tier I funded on platform
3.1
A comparison of funded and non-funded start-ups Figure 4.1 presents a plot of the percentage of start-ups at different stages of their lifecycle separately for startups that got funded on the platform and those that did not get funded. It can be seen that the percentage of companies that get funded in the ideation and proof of concept stage is low. However, after the beta launch stage, the probability of getting funded dramatically increases as indicated by the cross-over point in the pathways of funded and non-funded companies. The sweet spot for funding seems to be the early revenues stage, which has the maximum number of companies. Surprisingly, the percentage of companies declines in the late revenue stage. The possible explanation that we could think of is that start-ups are not inclined to raise angel funding when they reach the late revenues stage. They could be approaching institutional sources to raise larger sums of capital leading to a reduction in angel funding. Figure 4.2 shows the pattern for the companies that have got some external funding (either funding from the LV platform or other external sources or both) and those that did not get any external funding. The trend is similar to that of Figure 4.1.
79
Figure 4.1: Proportion of start-ups at different stages (LV funded and not funded)
Figure 4.2: Proportion of start-ups at different stages (Overall funded and not funded)
80
The founders have also seemed to have realized the importance of launching and reaching early revenues stage quicker to increase the chances of getting funded. For example, in a 2016 study on State of Indian Start-ups, a sample of 532 startups were asked on what they would have done differently to accelerate their progress. The top response that was given was “launched earlier and got customer feedback.”4 Table 4.6 gives the maturity index values for different start-up groups: those that have been funded on the platform, those that have received commitments from other sources, start-ups with overall external funding, and those with no external funding. The trend conforms to a pattern. Those start-ups that have obtained commitments have a higher maturity index as compared to those that do not have any external funding. It needs to be seen whether the higher maturity index is a result of prior funding raised by startup or frugality of startup founders.
Stages Ideation
Table 4.6: Maturity index for funded and non-funded start-ups LV Other Overall No external Funded commitments funding funding 1 40 1608 39
Proof of Concept
6
121
125
1988
Beta Launched
23
222
230
2665
Early Revenues
60
437
456
3345
Steady Revenues
39
133
142
946
Grand total
129
952
993
10552
Maturity index
4.01
3.53
3.54
3.00
Effect of incubators and accelerators An important development in the start-up ecosystem in recent years is the setting up of incubators and accelerators. Start-ups on the platform have indicated whether they have been a part of any such incubation or acceleration facility. Table 4.7 gives details of the number of start-ups that have been part of an incubation or acceleration facility. Out of a total of 11,545 start-ups about 6 percent have been part of an incubation or accelerator facility. It is interesting to note that the maturity index of start-ups that have been part of an incubation or acceleration facility is higher than that of start-ups have not been part of such a facility. This indicates a possible correlation between the maturity of the start-up and the influence of incubator or accelerator. Table 4.7: Profile of start-ups that have been part of incubation or acceleration facility Start-up stage
Part of incubation or acceleration facility Yes
No
Grand Total
Ideation
4.4
14.9
14.3
Proof of Concept
14.1
18.5
18.3
Beta Launched
24.3
25.1
25.1
Early Revenues
44.3
32.3
32.9
Steady Revenues
12.9
9.2
9.4
Grand Total
637
10908
11545
Maturity index
3.4
3.0
3.0
81
Table 4.8: Funding trends for start-ups in incubators or accelerators Present in incubator or Other LV funded All funded accelerator commitment Yes 23.1 15.4 15.2 No
76.9
84.6
84.8
Grand total
130
957
998
Table 4.8 provides a cross tabulation of the start-ups that have been funded and whether they have been a part of the incubation or acceleration facility. It can be seen that about 23 percent of the start-ups that have received funding on the LV platform have been with an incubator or accelerator. At the overall level, 15 percent of all the start-ups that have received external funding have been part of an incubator or accelerator. In a way, a majority of the start-ups that do get funding have not been a part of an incubator or accelerator. A possible reason could be that start-ups that are able to get external funding on their own do not apply to incubator or accelerators. These results also suggest another interpretation. Being a part of an incubator or accelerator can increase the possibility of getting external funding. For example, only 8.3 of the start-ups are successful in getting external funding. But among those who have been a part of an incubator or accelerator, 24 percent have been able to get external funding. Thus incubators and accelerators have been able to increase the chance of getting funded by about three times. Similarly, 5 percent of those who have been with an incubator or accelerator have been able to get funding on the platform, while the proportion of those getting funded on the platform for the overall sample is only 1.1 percent. Incubators and accelerators have thus been able to increase the chances of getting funded on the platform by five times.
Landscape of angel investors Figure 4.3 gives the number of angel investors who have listed themselves on the platform. Investor location information was available for a total of 1718 investors, out of a total of 1811 investors who were present on the platform. Of that, about 80 percent of the investors are from India, while the remaining 20 percent are located abroad. The angels from India are spread over 46 cities, and investors from abroad are spread over 77 cities in 34 countries. The fact that there are 346 investors from overseas locations are interested in making investments in India is very encouraging. Getting the interest and the feasibility of sourcing investment from overseas angels would have not been possible without such online platforms created by LV. A biggest contribution of these investor platforms have been to increase the interface area between start-ups and investors.
Figure 4.3: Location of angel investors in LV platform Figure 4.4 gives the number of angel investors in the platform based on their year of joining. The numbers for 2016 is only for part of the year. Number of angel investors who joined the platform has grown since 2013. While there was a big jump in the number of investors between 2013 and 2014, the growth was also healthy during 2015. These statistics underlines the increasing interest among the angel investors to invest in start-ups. Figure 4.4 also gives the number of investors who have made at least one investment within the calendar year of
82
joining. The number of investors who make commitments as a percentage of those who express interest has continued to remain healthy. Despite the increase in the number of investors registering on the platform, the percentage of investors who make commitments have stayed above 20 percent, indicating that more than one in five who register in the platform have actually made an investment within the calendar year of joining.
Figure 4.4: Number of angel investors who joined the LV platform in different years and the number who have made their 1st investment on the LV platform in the corresponding year
Figure 4.5: Percentage of angel investors from different city categories Figure 4.5 shows the percentage of angel investors in India by the type of city in which they are located. It can be seen that the bulk of the registered investors (88 percent) are from Tier 1 cities. This probably explains the reason why most of the start-ups are also located in the Tier 1 cities. Previous academic research has also indicated that location proximity of the start-up is an important characteristic of angel investment. It is also one of the reason why city specific angel networks have been established in India and elsewhere. The number of angels in Tier 2 and 3 cities are 11 percent and one percent respectively. The reason behind this is not difficult to hazard. Most of the entrepreneurs who have become successful turn angel investors and the proportion of
83
those who become angel investors are higher in Tier 1 cities because of the ecosystem that exists in the Tier 1 cities. Figure 4.6 provides the percentage of angel investors in the six tier 1 cities. Delhi (i.e., the National Capital region that comprises of adjacent cities to Delhi such as Gurgaon, Noida, and Okhla) has the largest number of angel investors, followed by Mumbai and Bangalore. Taken together, these 3 cities account for 88 percent of the total angel investors in Tier 1 cities. The remaining cities of Chennai, Hyderabad, and Kolkata account for only 12 percent of the total. A campaign to increase the number of angel investors may be in order as increase in the number of investors would lead to an increase in the number of investments.
Figure 4.6: Percentage of Tier 1 city angels from different cities
Figure 4.7: Number of investors and average commitment amount Commitment details were available for 448 individual investors with a total commitment amount of about ₹1145 million. The total number of commitments made by the angel investors are 1018, i.e., on an average each
84
investor has invested in about 2.3 companies. The number of start-ups that has successfully raised funding is 130, indicating that on an average about 8 investors join together to make an investment. The average investment per investor was about ₹11 million. Figure 4.7 provides the profile of the investors in terms of their average investment amount. The peaks indicate that the investors seem to have a preference to invest in nice, rounded numbers. The number of investors is the highest for the average commitment amount of ₹500,000, followed by ₹1 million. Beyond that, there is a sharp fall in the number of investors, indicating that the sweet spot for investors on the platform is between ₹0.5 – 1 million. Figure 4.8 shows the cumulative investment against the number of investors. It was seen that the top 20 percent of the investors (in terms of the investment amount) accounted for 50 percent of the total investment, while the bottom 80 percent of the investors accounted for the other half. Thus, both active and occasional investors contribute significantly (in equal amounts) to the investment amount.
Figure 4.8: Cumulative investment and number of investors
Figure 4.9: Profile of angel investors Figure 4.9 gives the proportion of angel investors in terms of their experience. Investors have been classified into two categories: new, i.e., who have made fewer than five investments; and experienced, i.e., who have made five or more investments. The difference in the proportion of experienced and new investors is not very high, indicating that the mix of angel investors is well balanced. Figure 4.10 gives the profile of angel investors in terms of their professional background. Senior executives in large corporations comprise the largest segment,
85
accounting for more than half of the investors on the platform. Entrepreneurs comprise the second highest category, accounting for close to 40 percent of the investors. The traditionally wealthy, i.e., those engaged family businesses account for less than 9 percent of the investor sample. This indicates that emergence of investment platforms such as LV help to draw out professionals to make angel investments. For the entrepreneurs, getting investment from experienced industry professionals can be very beneficial given their rich corporate experience.
Figure 4.10: Professional background of angel investors
Odds of success for the entrepreneur An aspiring entrepreneur should be fully aware that the odds of success are stacked up against the venture. Similar to that of the gladiatorial arena, the entrepreneur needs to demonstrate courage and pluck in the most adverse of circumstances to emerge victorious in the marketplace. While it is difficult to get reliable data on the survival rates of start-ups, we have used the number of rounds of financing as one indicator of growth and progress made by the start-up.
Figure 4.11: Proportion of start-ups that get founded and funded at every successive round
86
Figure 4.11 shows the proportion of start-ups that get founded as compared to those that get funded at every successive round. As it can be seen, the numbers are illustrative, and the trends have been interpolated based on two independent data sets. In sum, for every 875 start-ups that get founded, only one is able to successfully raise 4 or more rounds of funding. Out of the total start-ups that get founded, about 6 percent take part in an accelerator or incubation program. 75 of the 875 are able to get first round of funding, out of which only 15 are able to get the second round of funding, and only 5 are able to secure the third round of funding. While the chances of funding are difficult, our analysis show that the Indian entrepreneurs do demonstrate a lot tenacity to survive. We used the date of last update made by the start-ups to infer about the survival and existence of the venture. Figure 4.12 gives the trends on the days elapsed since the last update made by the start-up (Panel A) and days elapsed since the start-up joined the LV platform (Panel B). Panel A shows that about 90 percent of the start-ups on the platform have made an update within the last 90 days, indicating that they are active (otherwise, they would not be making updates). Panel B shows that the days elapsed for a majority of the start-ups since they joined the platform was between 6 months to 2 years. This shows that many of the startups are quite active and are promptly updating their progress made, possibly to strengthen their chances of getting funded.
Figure 4.12: Days elapsed since the last update made by the start-up and joining the platform
Comparison of the global and Indian start-up landscape In order to get some insights on the relative standing of the Indian start-up landscape we did a comparison with the global start-up landscape. This comparison was made for three sectors – grocery tech, health tech and consumer healthcare, and home improvements and smart homes. Data for these comparison was obtained from the global and India focused reports produced by Tracxn. The results are given in Figures 4.13 – 4.15. While there are differences between the three sectors, there are commonalities too. The common trends contain both features: some comforting and some concerting. The comforting trends are broadly two. First, is the vibrancy in the Indian start-up landscape, as seen by the number of companies founded. In two of the three sectors, the number of companies founded in India is close to the number of companies founded globally. For example, in grocery tech, the number of companies founded globally was 561 whereas the number of companies founded in India was even higher at 615. In healthcare and consumer health tech, the number of companies founded globally was 1000 and the number of companies founded in India was 841. In the case of home improvement and smart homes category, the number of
87
companies founded in India was reasonably lower (259) as compared to that founded globally (628). Nevertheless, the evidence suggests a very bullish sentiment (which some may consider an exuberance, bordering on the alarming) on the founding of start-ups in India. Second, is the average investment per round. Though the average investment per round is higher globally, there is not too much of a difference from the average investment received by start-ups in India. In the case of health tech and consumer healthcare sector, the global average is significantly higher as compared to that the average for Indian start-ups, particularly in recent years. However, in the smart home and home improvement category, the average investment per round in Indian start-ups is higher than that of the global average. In general, no conclusive trends could be established on the average investment per round between global and Indian start-ups. But since most of the institutional investors who invest in India are overseas investors, the average investment size is likely to very similar. The most striking concerting trends are two. First is the low proportion of start-ups that are able to raise external funding in India. A possible reason could be the number of investors itself. For example, while India has about 1800 active angel investors overall, while US has close to 300,000.5 The percentage of global start-ups that are able to successfully raise capital in the grocery tech, healthcare and consumer healthcare, and smart home and home improvement are 41 percent, 52 percent, and 36 percent respectively. The corresponding percentage for Indian start-ups are 5 percent, 10 percent, and 11 percent. This is also reflected in the number of rounds of funding in global and Indian start-ups. The number of rounds of funding in global start-ups are several orders of magnitude higher than of Indian start-ups. Possible reasons for this could be two fold. One, capital availability for start-ups is scarce in India. Two, investment worthy start-ups that are being founded in India are fewer. If the former is the dominating cause, policy interventions that increases investment flow to start-ups should be implemented. If it is the latter, then it is more disconcerting. Creation of “me-too” start-ups is a waste of capital, which could be productively invested elsewhere in the economy. To avoid such wasteful expenditure becoming a drain on the economy, there should appropriate capacity strengthening activities to strengthen the entrepreneurial ecosystem, which would create more awareness among the founders on the need to create investment worthy start-ups. The second concerting trend is the time lag in the setting up and funding between global and Indian start-ups. The growth in the number of Indian start-ups in different sectors occurs later than what is seen for global startups. The number of Indian start-ups that are set up continues to increase even after a dip in the global growth rates (as seen in the case of home improvements and smart homes category). First movers have a definite advantage in terms of getting funding from prospective investors. If Indian start-ups come to the market later as compared to their global counterparts, not only will it affect the ability to raise funding, but also the valuations they would receive and the market share that they can garner.
88
Figure 4.13: Comparison of global and Indian trends: Grocery tech start-ups
89
Figure 4.14: Comparison of global and Indian trends: Consumer Health-care and Health-tech 90
Figure 4.15: Comparison of global and Indian trends: Home Improvements and Smart Homes
91
Summary This chapter has provided several interesting insights on the Indian start-up arena. Firstly, the start-up landscape is vibrant in India as seen by the number of start-ups that are being founded. Secondly, a majority of the startups are located in Tier 1 cities. Further, the maturity index of start-ups located in Tier 1 cities are higher than that of start-ups located in Tier 2 or 3 cities. Among the six Tier 1 cities, Bengaluru, Delhi, and Mumbai account for 94 percent of the start-ups that get funded, while Chennai, Hyderabad, and Kolkata account for only 6 percent of the start-ups that get funded. Thirdly, the proportion of start-ups that get external funding is very small. A comparison of Indian and global start-ups for some of the sectors indicate that the proportion of global start-ups that get funding are much higher. Fourthly, the investors have a preference to fund start-ups that are in the later stages of their lifecycle. The sweet spot for funding seems the early revenue stage, as the largest proportion of start-ups that have been funded are in that stage. Revenues indicate customer validation of product and services and this can be a big comforting factor to the investor. Fifthly, being part of the incubators and accelerators need not be the preferred route to get external funding. Our results show that only 15 percent of the start-ups that have been funded have been a part of an incubator or accelerator. However, being a part of an incubator or accelerator can significantly improve the chances of getting funded for a start-up. Sixthly, we find that the odds of getting funded are severely stacked against the entrepreneur. Only 75 of the 875 start-ups are able to get the first round of funding. Out of the 75, only one is able to get four or more rounds of funding. The biggest hurdle seems to be in the first round of funding, as only about 8.5 – 9 percent of the start-ups are successful in getting the initial round of funding. The proportion of companies that are able to raise subsequent rounds of funding increases considerably after the first round. Finally, the landscape of angel investors show that about 20 percent of those who are registered are from overseas cities. While this indicates the interest among the overseas investors to invest in Indian start-ups, this also underscores the impact of online platforms such as LV in overcoming geographical barriers between investors and start-ups.
Notes 1
From the movie “Gladiator”.
2
Quote attributed to Spartacus.
3
Quote attributed to James Lee Burke.
4
State of Indian Start-ups 2016, A survey by LetsVenture – Axilor, 11 March 2016.
5
India angel investing landscape 2016, LetsIgnite Presentation by Shanti Mohan, 11 March 2016
92
REFLECTION 4
Evolution of Start-ups: A Conversation with Mahesh Murthy Thillai Rajan A.
Google, and so on. Several of the founders of these start-up companies were drawing ridiculous salaries, in the range of ₹350 – 450 million. It was like a high-paid job for an IIT-IIM graduate. People started companies with the objective of taking advantage of the easy money available.
You have been through multiple cycles in the venture industry. How would you characterize the evolution of the Indian start-ups over the years? I think we have probably had 2 cycles of start-ups in India so far. The first cycle was during the period 1999-2003 – inspired by Sabeer Bhatia and the Hotmail story. It was during this phase that people were slowly warming up to the idea of starting on their own. People were very sceptical of start-ups before this and the first seeds of start-ups were sown during this cycle. Companies which originated during this period that come to my mind are Naukri and Make My Trip. Even after the dot-com crash, these companies were committed and stayed on course.
The second cycle was also associated with exuberance in valuations, which has resulted in an implosion of sorts. Many of the so called ‘Unicorns’ are now facing difficult times. For me, this downturn is a healthy development. Now we are beginning to see in 2016, the first green shoots of the 3rd generation of start-ups. This time there are fewer mercenaries – and more sincere, committed founders. And yes, there is more capital too. So this generation should produce even better companies over the long term than the first two.
The second cycle was during the period 2010-14. Start-ups came out in droves during this period, probably because of global economic trends. There was unrestrained flow of capital to India because markets elsewhere in the world: China, Europe and the US were not growing as fast. The difference I found between the two cycles was this: In the first cycle, we had many sincere start-ups, but they were not able to obtain financial commitments.
People started companies with the objective of taking advantage of the easy money available.
Does academic pedigree matter in entrepreneurship or startups? May be from a psychological point of view, but certainly not from any real experience.
For example many folks in the VC industry have studied in institutions like the IITs and IIMs and have never been entrepreneurs themselves. So, in the absence of personal knowledge of what makes for a good start-up, they instead take decisions as per their personal comfort.
In the second cycle, we had probably lots of insincere start-ups, mercenaries if you will, but which were able to attract investment. Since there was lot of capital available, many of the startups came with the attitude of going out and making hay while the sun shone. Investors also should be blamed for the situation. During this period, many of the start-ups were nothing but clones of companies in the West. We had companies that were nothing but replicas of Amazon, Facebook,
So, if they receive a proposal from a fellow alumni, they get sent to the front of the line. And, in the absence of any other indication, it is comforting to invest in your batch mates, seniors and juniors.
93
Many of them want to become wealthy quickly, in contrast to the preference for long-term wealth creation.
That’s the psychology here, and this preference to invest in your clan’s companies has nothing to do with the investee’s merit or in the plans merit themselves. You can see the result – there is no correlation (or if anything, there is a negative correlation) between the IIT / IIM credentials of a founder and the success of their start-up.
In the 54 companies that I have invested in, not one of the founders, in retrospect has had an IIT + IIM background. Which may be one reason why the fund’s performance has been industry-leading. Now, this was never a conscious decision when we started investing, but it’s really an observation after the fact.
I do not attach a lot of importance to the quality of educational institutions where the founders studied. I personally am not even a graduate, and I tend to have a lot more belief in an uneducated risktaker than an educated and risk-averse IIT/IIM graduate.
I am also surprised by the attitude of many of these 3-rd cycle VCs and entrepreneurs. They want to build a business in 3 or 4 years and then sell it, and move on to the next one, glorifying the concept of “exit”.
Students go to IIT’s to ostensibly study engineering, but as it happens almost no one ends up working in the field they studied in. This is because the youth that have come here have not come from any love of the subject – but instead arrived there from a desire to de-risk their lives and to get high-paying jobs, no matter what field they are in. Many IIT-ians also follow up with a management degree subsequently to even more underline the fact that they never intended to work in the field they studied in, but were simply optimizing for better-paying jobs. Hence the ludicrous situation that the typical student spends 4 years studying computer science followed by two years studying marketing – all to become an investment banker. These are safety players, and quite the opposite of what successful start-ups really need.
But to me, entrepreneurs who make a huge impact are those who spend a life time building the companies that they create. For example, there is Richard Branson, Bill Gates, and Steve Jobs. In India, we have business leaders like Azim Premji, Narayana Murthy and so on.
... entrepreneurs who make a huge impact are those who spend a life time building the companies that they create.
But somehow, we have let that true ideal go and instead started celebrating small-term pops by glorifying serial entrepreneurs, who aim to start and exit a business every 45 years. Not that it is necessarily a bad thing – but you need a balance of both. Does the 8 year life of venture funds encourage short term thinking among entrepreneurs?
I would tend to think so. Most funds in India today are 8 plus 2 year funds. It basically means that if I raise money in 2016, I need to return it by 2024. It takes 2-3 years to deploy the capital, which generally means, I can finish investing by 2019 and need to start getting money out by 2023 or 2024 – giving about 4 to 6 years that I can stay invested in any investee.
Start-ups on the other hand need risk takers. The founders need to show a certain amount of commitment to the venture, which, among other things could be in terms of working with little or no salary for the initial years. For those who are conditioned to aim for top dollar salaries in established organizations, this is a scary prospect.
This, especially in India, is too short a period.
IIT-IIM founders and other ‘safety players’ now draw large salaries in the initial years, thanks to venture investors who come from similar backgrounds and have as little understanding of the need for risk and commitment as the founders do.
We have somehow copy-pasted the structure of American venture capital industry in India, and it just doesn’t work. Four to six years is too short a time frame for companies to create an impact in
94
entrepreneurs investors.
India, or even to create exitability. If funds take a 45 year perspective, then they would be essentially seeking mercenaries among founders, who promise a quick hump and dump.
rightfully
shun
such
Because it’s not just about the money. An important feature of angel investing is to provide guidance, mentorship and to open doors for the entrepreneurs.
I am therefore keen to start a long term venture fund in India. I’m working towards one of my next funds being a 20+ year long term fund.
But many investors today are HNI’s such as doctors and lawyers, who do not have any entrepreneurial experience. They are thus not able to provide any mentorship to the entrepreneurs.
I’ve spent a couple of years figuring out how this is possible – it is unprecedented in India. But I know it is possible. There are investors that can do long term funding such as endowments and family offices. It is also possible to create structures that can lead to long term funding, such as having a publicly listed fund, where investors can exit whenever they want.
should
Funding is seen as something to celebrate…The point is funding is the beginning of the road.
Angels, like any other investors, need to have an investment thesis – such as the activities they would do, the sectors would like to dominate, and the type of companies they will fund and so on. The investment thesis cannot be just “fund anything that moves”.
On creation of such a vehicle, we will be able to support entrepreneurs who actually create long term value. So far, the returns that venture funds have generated in India has been generally disappointing. In our first fund, which was $15 million, we have been able to return 4.0X, cashon-cash – which, I am told is some sort of record in India. In our second fund, which was $55 million, we should return about 3x if not more – there are still 4 years to play there.
However, the positive aspect of an angel investment is the staying power. The VCs have a 5 year window, after which they say, “Ok, time’s up.” They then merge the company or sell it to one of their portfolio companies.
But anybody with a fund size in excess of $200 million is unlikely to offer any significant return to their investors. The magic is in smaller, more strategic funds.
You have seen several cycles of start-ups. What are the common mistakes made by the founders and your suggestions for avoiding them?
Some companies can grow to huge sizes just on the back of angel investment without having to touch VCs and PEs. Angels can indeed play a huge role in India.
The key aspect that the founders have to decide is whether they want a high salary or whether they want to make a difference.
In the last few years, there has been a substantial growth in angel investing. What has been the impact of this? Angel investors do not have an 8 year time period. They can even provide long term funding and the best among them do not have a time pressure to exit.
Today, many people, right from college are thinking of founding start-ups as an opportunity to get a high salary. The Start-up page from Economic Times and breathless blogs that cover start-ups are part of the problem.
But a few among them now are coming in with unnatural expectations for ridiculously high returns. A few are even asking for guarantees from Series A investors lined up before they put in angel rounds. This, of course, is ridiculous – and
Funding is seen as something to celebrate – an end in itself as in “Wow, see how much they got funded!” The point is funding is the beginning of the road. It should scare you, if you’re a good founder, when you take ₹100 million or ₹1000 million from a
95
particularly coming from me, but avoiding VC and PE can actually be a route to success.
VC. Because you are expected to return 10 times that amount in 6 years. Can you do it? If you can’t, you’re going to lose your company. Are you ready for that? What are you celebrating? You should be shit scared.
In terms of another personal learning: my biggest exit was from a company called RedBus. As a fund we made 24 times our investment back but the founder had to sell his company at the 7 year mark. The founder made some money but he lost something that he had created from scratch.
Our media is celebrating the wrong kind of heroes. People who have raised billions of dollars, bought large residences and office spaces, even turned angel investors – before returning any money to their investors and before building a viable, profitable business themselves. It is hubris.
The entire system is biased against producing enterprises that create long term value. My advice to people if they want to be long term entrepreneurs is that it takes 10 – 20 years to build a company. For this one must be careful with taking institutional venture capital at all costs.
The message going across is – “Hey – no one is here to build a lasting or profitable company. They’re being rewarded for their short-term thinking with tens of millions of rupees in salaries. Why should I also not do the same?”
I am an institutional VC myself, and I can tell that when I make an investment I want to exit from it. I would therefore encourage entrepreneurs to take investment from angels or even through loans, but stay away from institutional VC as much as possible –unless you’re certain that you can work within their timeframes.
My advice to prospective entrepreneurs is not to look at the current generation of media heroes as many of them are likely to lose out. If they truly want to make a difference, they have to understand a few things. For example, it is going to take more than 4 to 6 years to create an impact in the business.
My advice to people if they want to be long term entrepreneurs is that it takes 10 – 20 years to build a company.
Therefore, they have to be careful with taking capital from investors who have a shorter horizon. To give an example, I have invested in a microbrewery company nine years ago, and the company is now doing revenues of ₹200 million or so. Having stayed invested in the company so far, I know I have to continue to be invested for maybe five or ten more years, before it can reach a value of ₹10 – 20 billion. If I’d tried to get out at the 4 year mark, I’d have had almost nothing to show for it. But, with a longer timeframe, you radically improve your chances of creating a truly ground-breaking large and sustainable enterprise.
How should entrepreneurs handle the deal winter that is being currently talked about? I don’t think there is a deal winter in the market now. Today we have great deals at a reasonable price.
Three years ago, we had very poor deal quality and everybody running after deals and hence those were at terribly high prices. Today, we know at first glance that we would throw such deals out, and they don’t have a chance of getting one rupee of funding. But we are seeing the right kind of entrepreneurs coming back and they are talking what seems like a fair valuation. I have in fact made 6 investments in the last 12 months and it’s the best time to invest in.
We need to have patience, and the only way this company could do that was by saying no to institutional capital. We now five outlets, and have plans of scaling up organically to around one hundred outlets. Ironic, as it may sound,
However, some of the venture funds are going slow because they were victims of the explosion and their investment values are all down by about 80 – 90 percent. We have been a little lucky in the fact
96
that we never did that kind of investments at high valuation. So it’s a great time for us to buy.
We are now going through a phase where investors are exercising a lot of caution. There is lot capital available, but there are very few unique investment theses. The earlier norm investment thesis of “Jo tum karega mein bhi karoonga”, has proved to be the undoing of many large investors.
How have the venture investors in India evolved over the years? Most of the venture firms in India are employeemanagers of their funds, they are not owners of the fund.
In hindsight, how did you manage to stay clear of the exuberance?
Fund raising for them is largely done by others abroad and there are very few purely Indian funds. The partners of most funds are generally concerned about protecting their salary incomes.
We were very clear from the beginning that we would not support any deal that did not look good in terms of valuation.
The earlier norm investment thesis of “Jo tum karega mein bhi karoonga”, has proved to be the undoing of many large investors.
There are two ways to achieve that – the first is to have great performance in terms of returns, so that they are able to raise successive funds. The second way is to just follow the market trends because most investors have no entrepreneurial experience. So they want to bask in the comfort of “they all did broad e-commerce, I also did it, they all did food tech, I also did it, so please pay my salary” kind of thinking.
So, we passed on the opportunities where we had a chance to invest, such as Flipkart or Snapdeal. Jabong, which at one time was valued at $1.2 billion, was sold at a 95 percent discount.
We also carefully looked at the type of entrepreneurs that we would fund. Many entrepreneurs are not here for the long term, and they don’t care much about the investors either. They are more concerned about how much money they will make, and don’t care about anything else. Such entrepreneurs are like those who take up the jobs that are the highest paying, and not what they are actually doing. We have avoided those. We have always looked for entrepreneurs who had the drive and wanted to make a difference.
Investors also had an investment strategy of investing in the Amazon of India, Facebook of India, Google of India, and so on. So, unlike China where the model has worked well, where Alibaba is the Amazon of China, what has happened in India is that Amazon of India has been Amazon, Facebook of India has been Facebook, and the Google of India has been Google, and so on. There’s no room to be a copy paste in India.
Its’ not that I have not had losses. In this profession, losses are inevitable. But we have learnt valuable lessons from these losses. Otherwise, what is the point of losing money? The money that we lost should be helpful in educating ourselves on the mistakes that we should not be making.
Mahesh Murthy is a founder of Seed Fund, an early stage, sector agnostic venture fund. Before becoming as a venture investor, he has had a very successful stint in the advertisement industry. He started his career in active investing, in 2000, when he founded Passionfund, focused on early stage startups. Over the last 17 years, he has made 54 investments.
97
98
India Venture Capital and Private Equity Report 2016
PERSPECTIVE 4
Summary of the Case Studies “I wake up to a smoking gun. The evidence is in your head. There is no proof of guilt or innocence”1
Thillai Rajan A.
Overview A runaway Aamir Khan’s hit of the early 1990’s was the Bollywood flick, “Jo Jeeta Wohi Sikandar”. True, the world recognizes winners and also needs winners. Naturally, most of the reports on the VC industry has anchored on the winners, i.e., startups that have successfully raised venture or other forms of external capital. While this report series has been equally guilty of applauding only the winners so far, we are trying to atone for the omissions of the past editions. Therefore, starting with this report, we hope to also focus on the participants and not just the podium finishers. We believe this will help in a better understanding of the start-up landscape and also help us to understand what separates both. In this report, we feature case studies of four organizations in the start-up ecosystem and deal flow landscape in these organizations. We are thankful to the organizations who have graciously provided stripped data on the pool of applications that they receive. This is a significant step forward and taken together, these case studies help to understand the pulse of the entrepreneurial ecosystem. While we are still far away from the clinching smoking gun evidence that we all aim to, these case studies provide us with a reasonably strong evidence on what is happening on the ground. The case studies that form a part of this collection include Bengaluru based Axilor, The Chennai Angels, Keiretsu Forum Chennai, and Saffron Incubation and Acceleration2. While the case studies themselves provide descriptions and findings of the cases, I have tried to consolidate the main findings in this summary. The key findings that emerge are as follows.
1.
There are significant odds against the entrepreneur in raising external private capital
The number of proposals that the institutions receive are high and continues to grow. For example, the average batch-to-batch growth in the number of applications received by Axilor has been 57 percent (Exhibit C1.1). In the case of Chennai Angels, the annual growth in the number of proposals has been around 60 percent. A venture fund organization whom we interviewed for this report had an annual average deal flow growth rate of 28 percent during the period 2010-16. More importantly, the highest growth was seen in the early stage deals, where the probability of getting funded is the lowest. Exhibit P4.1 shows the deal flow by stage of the venture and Exhibit P4.2 shows a comparison of the deal flow snap shot in 2010 and 2015. Both of these indicate that the type of deals that flow has considerably changed over time. While the deal flow is characterized by high growth rates, the proportion of successful companies continues to be less. For example, in the case of Axilor, the proportion of applications that go to the interview stage is about 10 percent and the proportion of selected applications is only 3 percent (Exhibit C1.1). In the case of The Chennai Angels too, the ratio of successful companies is only around 3 percent of the applications received. One of the venture fund organizations that we spoke to had invested in only 0.67 percent of the deals that it assessed. Entrepreneurs thus trying to raise capital should be aware of the low success ratios. Given the low success rates in raising funding, very often the fact a start-up got funded becomes an occasion for celebration more than the success of the venture itself. However, such low success rates in India are nothing unique to the venture capital industry. For example, the acceptance rate in the Joint Entrance Examination for admission to the IITs is only 0.7 percent. Similarly, the percentage of successful candidates in the UPSC Civil Services Exam is estimated to be
© Indian Institute of Technology Madras
99
India Venture Capital and Private Equity Report 2016 between 0.1 – 0.3 percent. Having said that, a higher percentage of success rate would definitely boost the spirit of entrepreneurship. Exhibit P4.1: Deal flow by the stage of the start-up
Exhibit P4.2: Snap-shot of the deal flow in 2010 and 2015: A comparison
2.
Start-ups that demonstrated more progress at the time of approaching investors have a better chance of getting funded
This could be criticized as an obvious statement. However, this trend indicates that there is no randomness associated with the selection process. In the platter of companies that the institutions gets to assess, they select those companies that demonstrate a higher degree of commitment or have made relatively better progress. For example in the case of Axilor, none of the companies that are in the “idea” or “concept” made it to the final selection. The proportion of those having a legal entity is higher among those selected as compared to that of the application stage (Exhibit C1.2). Results from The Chennai Angels (Exhibit C2.8) show that the proportion of companies in the pre-revenue stage is considerably lower (14 percent) for invested companies as compared to that of companies that apply for funding (46 percent). The average annual revenue run rate is also higher (₹48 million vs ₹22 million) for companies that were successful in raising investment.
© Indian Institute of Technology Madras
100
India Venture Capital and Private Equity Report 2016
3.
The line of separation that distinguishes the winners from the participants can often be very thin
The data from Keiretsu Forum indicate that the average number of positives (or concerns) is just higher by a count of 2 (or lower by a count of 2) for the invested companies as compared to that of non-invested companies (Exhibits C3.10 and C3.11). Similarly, the average investment made by companies as seen from Chennai Angels (Exhibit C2.8) is not very different between the invested and applicant companies (₹7.98 vs ₹6.88 million respectively). However, the case studies also provide various pointers on increasing the probability of success. The most common causes of rejection of proposals has been limited interest among the angel network members, low traction, and scalability issues (Exhibit C2.7). Data from Keiretsu Forum indicates that the strengths of the business model, the value proposition, and market size are significant factors that influence the investment decision (Exhibit C3.8 and C3.9). The count of concerns for companies that were not successful in receiving investment was considerably higher for the following parameters: business model, customer traction, margins and profitability and market size. The entrepreneurs could bear this in mind when making their business plans.
4.
As we move up in the lifecycle stage of the start-up, the source of applications become more concentrated
Start-ups seeking incubation support are in the initial stages of their lifecycle as compared to that of start-ups applying for acceleration. Data from Saffron Incubation and Acceleration Limited (SIAL) shows that the applications for incubation come from more number of cities as compared to that of applications for acceleration (Exhibit C4.1 and C4.2). This indicates that the sustaining power of the start-up founders is not very high in the smaller cities. Much of the applications are being received from applicants in Tier 1 cities, indicating that the path to entrepreneurship still remains the untrodden path for many in the smaller cities. If the investors’ choices are anything to go by, then the start-ups from metro cities seem to have more potential for success as compared to those from non-metro locations. While the data from Axilor indicates that though a majority of the applications that they receive are from founders in non-metro locations, the final selection consists of founders only from metro locations (Exhibit C1.2). An underlying trend that was seen consistently was that metro cities accounted for a large proportion of the deal flow. Even among the metro cities, Bangalore, Delhi, and Mumbai accounted for a lion’s share of the deal flow. Exhibit P4.3 provides the pattern in deal flow provided by a venture firm interviewed for this study. It can be seen that the share of Bangalore, Mumbai, and Delhi has grown significantly in recent years. Exhibit P4.3: Deal flow from different cities
© Indian Institute of Technology Madras
101
India Venture Capital and Private Equity Report 2016 While several reasons could be attributed to this trend, it can be summed up as follows: Man is nothing but a product of the social environment. Similarly, the overall ecosystem for start-ups is of a much higher order in metro cities leading to entrepreneurs from these cities being better equipped on various dimensions. Establishing a more robust ecosystem in the smaller cities is therefore very critical in expending the frontiers of entrepreneurship beyond the metro and larger cities.
5.
The start-ups are increasingly seen using the right ingredients that prepares them for success
There is a strong dominance of technology and related sectors such as software and internet services, internet marketplace and ecommerce, consumer products and services, and so on in the application stage. This is also reflected in the investments, and a significant number of companies that have received investments are in the technology and related sectors. When the start-ups were classified into five stages based on their lifecycle (just an idea, having a landing page, prototype built, in private beta, and initial traction), the highest number of startups were in the prototype built stage (Exhibit C4.10). Data from Axilor shows that a majority of the applications that they received for the most recent batch has been in the launch phase (Exhibit C1.1). This indicates that a majority of the founders are showing progress and demonstrating seriousness at the time for applying for funding. More importantly, the strength of the average application has continued to increase with every successive batch as seen by a higher proportion of the applications in the later stages of the start-up life cycle. A single founder venture is unlikely to succeed or continue to remain as a single founder venture in today’s context. Our findings show that though there are many single founder applications, a majority of them have two or more founders (Exhibit C1.2 and C4.3). The team size seems to be correlated to the lifecycle of the start-up as seen in the number of founders for incubation and accelerator applications. The founder team size, in general, is larger in the applications for acceleration as compared to that of applications for incubation (Exhibit C4.3). It is also interesting to note that family members as co-founders form a very low proportion, indicating that founders are increasingly open to choose their business partners from outside their families. The educational backgrounds of the founders also indicate that the highest number of applications have almost equal number of people in both engineering and business backgrounds (Exhibit C4.9).
6.
Approaching the investor through a reference can improve the odds of funding
It is well known that VC investors receive several deals for consideration, but they pay more attention or respond promptly to deals that they receive from known sources. While investment bankers have played an important role in providing deals to the investors traditionally, the trend is gradually changing. In recent years, angel networks and VC firms have tried to strengthen their proprietary deal flow networks in order to be able to identify deals ahead of the competition. In addition, there is a view (and rightly so) that a “banked” deal (i.e., mediated by investment bankers) are usually fully priced. Therefore, in the fund raising process, the VC firms specifically stress on their networks and ability to achieve quality deal flow. Exhibit P4.4 provides the proportion of deal flow from different sources for one of the VC firms that we had interviewed for this report. It can be seen that personal contacts of the firms’ employees account for the largest number of deals. Therefore, it is important for the founders to develop network of contacts within the VC industry to strengthen their prospects of funding. The trends seen from Chennai Angels also support this premise. Ninety two percent of the investments made by The Chennai Angels were sourced through or had a reference from angel investors or members of the angel network (Exhibit C2.9). None of the deals that were received directly were funded. A possible explanation for this trend is that references act as gate keepers and provide a layer of selection. Since many of the individuals who have deep connection with venture investors are reputed and well known, they would like to protect their reputation and forward to investors only those deals that they think has merit.
© Indian Institute of Technology Madras
102
India Venture Capital and Private Equity Report 2016 Exhibit P4.4: Deal flow from different sources
Summary The findings highlighted above are some of the salient ones. The individual case studies themselves provides several interesting insights. We invite the readers to read each of the case studies that follow and derive their own conclusions.
Notes 1
From “The Pain” by Lacuna Coil.
2
Name changed at the request of the organization and confidential reasons.
© Indian Institute of Technology Madras
103
104
CASE STUDY 1
The Accelerator Program at Axilor Thillai Rajan A.
Axilor, based in Bengaluru, has been set up as a platform to support early-stage entrepreneurs. Founded in 2014, Axilor helps founders improve their odds of success through various programs and funding support. Improving the odds of success included one or more of the following activities: refining the idea, helping the founders build products that have value for users, reaching and connecting customers, providing funding, and helping the startups to scale up. Axilor was founded by Kris Gopalakrishnan, S D Shibulal, Tarun Khanna, Srinath Batni and Ganapathy Venugopal. Kris and Shibulal were co-founders and members of the Board of Directors at Infosys Technologies. Tarun Khanna is the Director, South Asia Institute, Harvard University and the Jorge Paulo Lemann Professor at the Harvard Business School. Srinath Batni was previously a member of the Board of Directors at Infosys Technologies. Ganapathy Venugopal, also the CEO of Axilor, was previously the head of strategy and planning at Infosys Technologies.
The Accelerator program The flagship program of Axilor is the accelerator program, which aimed to take the business from the idea to pilot stage. The program helps founders to build their products become investible faster. The expectation is that the start-ups in the program would be able to move 3 to 5 times faster than that of working independently. Many start-ups were able successfully raise funds even during the course of the program. Participating the accelerator program helps the start-ups to move quickly from market validation to business model quickly and get prospective funding from the scale-up program. Structured as a 100 day program, the participants in the program are provided free space in the Axilors’ start-up campus and also get access to an entire gamut of partner benefits and tools. In addition, those selected are also receive a nominal grant of One hundred thousand rupees. The accelerator program was aimed at founders who were in early stages of their start up (up to 6 months of their start-up journey). Axilor specifically targets companies in three specific areas: e-commerce, enterprise and healthcare. In the e-commerce segment, they specifically, target start-ups which enable e-commerce (improve consumer experience through better search, recommendations or product discovery, reduce consumer acquisition costs, categorize better, increase conversions, promote loyalty, improve fulfilment, streamline logistics or make payments easier). In the enterprise segment, they seek start-ups that are focused on large global opportunities with a low friction sales model. In healthcare, Axilor is keen on start-ups in the following areas: affordable access, achieve break-through improvements for chronic illnesses, harness the potential of preventive healthcare, and improve the efficiency of providers.
Program administration and process Normally, there are 2 batches of the accelerator program every year, which start in March and September. The company accepted applications for its second batch (Winter 2015) between July and August 2015, third batch (Summer 2016) between February and March 2016 and the fourth batch (Winter 2016) between June and August 2016. Exhibit C1.1 gives the number of applications, shortlist and final selected for Batches 2, 3 and 4.
105
Exhibit C1.1: Number of applicants at different stages of the selection process
Selected
Application Stage
Interview Stage
Selected
Application Stage
Interview Stage
Selected
Batch 4 - Winter 2016
Interview Stage
No. of applications
Batch 3 - Summer 2016
Application Stage
Batch 2 - Winter 2015
178
17
6
244
24
9
437
44
11
(Source: Axilor)
Selection to the accelerator program Given the inherent uncertainties in start-ups, assessing their potential is a difficult task. While the team and idea of the start-up, it is difficult to judge the idea in the early stages. Accordingly, Axilor has focused on things that they can validate. It was found that successful applicants had two things in common: (i) the founders had some proprietary insights about the start-up idea; and (ii) the founders have solved some tough problems previously and had smartly overcome challenges. In general, successful applications had more evidence than promise. Exhibit C1.2 shows the comparative characteristics of applications at different stage.
Interview Stage
Selected
Application Stage
Interview Stage
Selected
Application Stage
Interview Stage
Selected
Batch 4 - Winter 2016
Application Stage
Exhibit C1.2: Comparative characteristics of applications Batch 2 - Winter 2015 Batch 3 - Summer 2016
No. of founders
1.5
1.59
2
2.4
2.3
2.2
2.0
2.3
2.3
Percentage of founders from non-metro locations Sector wise split Ecommerce Healthcare Sustainability and CleanTech Others Percent having previous startup experience
13%
0
0
14%
13%
0%
20%
14%
0%
40% 14% 7% 38%
41% 18% 18% 24%
50% 17% 17% 16%
32% 11% 4% 54%
29% 4% 4% 63%
22% 11%
30% 7% 5% 59%
46%
66%
32% 11% 5% 52%
63%
78%
100%
26% 10% 28% 24% 13% -
17% 11% 22% 39% 11% -
17% 50% 17% 17% -
7% 6% 19% 25% 42% 2%
25% 25% 46% 4%
56% 22% 22% -
8% 5% 22% 26% 37% 7%
5% 30% 30% 35% -
18% 27% 55% -
76%
87%
89%
71%
73%
82%
-
-
-
16%
33%
36%
Stage of the idea Concept Mock / Scale model Prototype Beta Launched Others Percent having a registered legal entity Percent having previous external funding
7%
0%
0%
(Source: Axilor)
106
9% 46%
Benefits from the accelerator program The broad range of benefits from participating in the accelerator program are as follows:
Most start-ups get funding after the successful completion of the accelerator program from the scaleup program Dedicated access to experts and other entrepreneurs for mentoring and other help Differentiated partner benefits from AWS, Google, Microsoft and Facebook. Access to tools for market validation, prototyping and testing. Free memberships to industry bodies to help in networking Provide more visibility to the start-ups.
Scale up and Early stage funding program In addition to the accelerator program, Axilor also has the scale-up and early stage funding program. The former helps the start-up to go from pilot to launch stage, while the latter takes the start-up from the launch phase to scale. As a part of the scale-up program, Axilor provides funding of up to ₹2.5 million, in exchange for a minority stake. Even those start-ups that are not part of the accelerator program can apply for the scale-up program, provided they meet the investment criteria and sectors of interest. Early stage funding program is for those companies that have demonstrated a market fit and have had good customer traction and revenue visibility. Axilor is prepared to provide funding support in the range of ₹75 – 30 million for a significant minority shareholding.
107
108
CASE STUDY 2
The Chennai Angels Ramesh Kuruva The Chennai Angels (TCA), formerly known as Chennai Entrepreneurship Trust Fund, was established in November 2007 with a focus on nurturing and mentoring new generation entrepreneurs. Set up by a group of successful entrepreneurs, TCA provides significant mentoring in addition to funding for the selected enterprises. Since the members of TCA have had significant experience in founding ventures, growing them into successful businesses, before exiting them, they are able to provide considerable value-addition and handholding to the businesses that they invest in. As of July 2016, TCA has invested more than ₹500 million in 34 companies. In 2015-16, the total number of angel investors in its network increased to 96, from 35 in 2012-13. Exhibit C2.1 gives the number of proposals received over the years by TCA. The number of proposals received in the consumer products and services category was the highest at 258, followed by 181 in the software and internet services category. The number of proposals received in other categories are: Technology – 84; Internet marketplace and ecommerce – 83; Edu-tech – 79; Health-tech – 68; Fin-Tech and payments – 36; Hyperlocal and logistics – 33; and Media, advertisement and gaming – 31. Ninety five of the proposals could not be classified in any of the categories and were grouped under others. Exhibit C2.2 gives a visual representation of the number of proposals received in different sectors. Till July 2016, TCA has invested in 35 start-ups. Category wise break-up of the investments are as follows: Consumer products and services – 8; software and internet services – 5; Technology – 7; Internet marketplace and ecommerce – 5; Edu-tech – 4; Health-tech – 2; Fin-Tech and payments – 3; and Media, advertisement and gaming – 1. Exhibit C2.3 gives a visual representation of the investments made. Exhibit C2.1: Number of proposals received by TCA
(Source: Chennai Angels, IIT analysis)
109
Exhibit C2.2: Proposals received in different sectors
(Source: Chennai Angels, IIT analysis)
Exhibit C2.3: Investments classified by sector
(Source: Chennai Angels, IIT analysis)
The selection process The selection process at TCA starts with an application submitted by the start-up in an online system. Once the completed application is submitted the start-up, the analyst team at TCA takes it up for analysis. Based on the
110
information provided, the analyst studies the proposal carefully to get an understanding of the business idea, market potential, competition, and other details. The analyst then completes a pre-defined template with the necessary information, which is then presented in a pre-screening meeting. The pre-screening meeting, held every Thursday, is attended by three members of TCA, who have been previously identified. To ensure consistency, the members comprising the pre-screening committee does not change from meeting to meeting. All applications that are submitted till Tuesday of the respective week, is normally taken to the pre-screening committee meeting of the same week. Applications that arrive after Tuesday, are taken up for the next weeks’ meeting. Though the number of proposals taken up depends on the applications received, on an average about 6-7 proposals are discussed every week in the pre-screening meetings. The proposals that show promise are then shortlisted by the pre-screening committee and are presented in the screening committee meeting held on Friday. Members of TCA who could be potentially interested in the investment opportunity are invited to participate in the meeting. A member of the pre-screening committee then presents the short listed deals to the screening committee. On an average, about 2-3 proposals are presented to the screening committee. For those deals that generate interest among the members, the entrepreneurs are invited to have personal interaction with 2-3 members of TCA. During this interaction, called the deep-dive session, the entrepreneurs get an opportunity to have a detailed and thorough discussion on the various issues raised by the members. Proposals to TCA come through different sources. If the proposal is mentored or recommended personally by any of the member of TCA, then they are directly taken to the deep-dive stage, skipping the pre-selection and selection steps. Exhibit C2.4 provides the proportion of proposals received via different sources. Exhibit C2.4: Source of all the proposals received
(Source: Chennai Angels, IIT analysis)
Based on the experience of the deep-dive session, the entrepreneur could be invited to make a presentation to the larger group of TCA. Attended by about 25 members, these presentation sessions are held on alternate Saturdays. Normally, 3 presentations are scheduled at these meetings. After the presentation by the entrepreneurs, members are asked through a show of hands whether anyone would be interested in the
111
opportunity. If 4-5 members are keen to take it up, then the deal is taken to the next stage. One of the members who showed an interest, is identified as a deal champion and a polling mail is sent to all the 95 members of TCA to check whether they would be interested in investing in the opportunity. Among other details, the polling mail would also contain details about the valuation of the start-up as well as the amount that the entrepreneur is seeking to raise. Exhibit C2.5 gives details of the average investment asked by the entrepreneurs in different sectors. Exhibit C2.5: Average fund requirement indicated in the proposals
(Source: Chennai Angels, IIT analysis)
The investment process Once the polling mail generates commitment interests of about 60 – 70 percent of the investment requested, TCA begins the process of business, legal, and financial diligence. The due diligence activities are outsourced, and are done by reputed professional firms. To avoid conflict of interest in the due diligence process, membership to TCA is not granted to professionals who have their own legal or accounting practice. If the outcome of the due diligence process is successful TCA issues a call for money notice to investors who indicated their commitment to invest in the deal. In case of a shortfall in the commitment amount from the “ask”, the TCA team would contact prospective investors individually in an attempt to bridge the shortfall. Since the investment is made by a group of TCA members, an investment director is identified by TCA to be a single point of contact between the company and investors. Typically, the deal champion is identified as the investment director for the investment. Having a single point of contact helps the company to avoid the distraction of responding to multiple investors and focus on business operations. Typically, each investor contribute in the range of ₹1 – 2 million, though occasionally it could even be higher. The minimum expected investment from each investor is usually ₹0.5 million. However, when the commitment bids made by the members exceed the ask amount of the start-up, the commitments are gradually scaled down. Usually, the investment made by TCA in a company would range between ₹25 – 30 million. When the investment requirement is higher, TCA would attempt to syndicate the investment with other angels, angel networks, and even seed funds.
112
Exhibit C2.6 gives the average investment made in different sectors. Even at the time of submitting the proposal, the founders have invested significantly in their start-ups. Exhibit C2.7 gives details on the average investment made by the founders in the start-ups at the time of submitting the proposal. It can be seen that there is significant variation in the investment made by the founders in different sectors. Exhibit C2.6: Average investment made in companies
(Source: Chennai Angels, IIT analysis)
Exhibit C2.7: Investment made by the founders in the company till the time of proposal submission
(Source: Chennai Angels, IIT analysis)
113
Proposals vis a vis investments made TCA also documents the reasons behind the proposal not being selected. Exhibit C2.8 gives the split up between the different reasons provided behind the proposal not being selected. Exhibit C2.9 provides a comparison of proposals that received investment and those that did not receive investment. Exhibit C2.8: Reasons for proposals being rejected
(Source: Chennai Angels, IIT analysis)
Exhibit C2.9: Comparison of invested and not-invested proposals Category
Invested
Not-Invested
Company stage Post revenue: Pre revenue
86:14
54:46
Investment requested (₹ Mn)
24.00
42.29
Average annual revenue run rate in the year of investment (₹ Mn)
48
22
Average investment made by the companies at the time of application (₹ Mn)
7.98
6.88
Reference form angel investors and members of angel networks
92%
8%
No reference (direct applications)
Nil
57%
(Source: Chennai Angels, IIT analysis)
114
CASE STUDY 3
Keiretsu Forum, Chennai Ramesh Kuruva Keiretsu Forum is a global angel investor network with 2,500 accredited investor members through 46 chapters on 3 continents. The Chennai chapter of Keiretsu Forum, which was the 34th chapter for the investor network was founded in February 2015. The founders of the Chennai chapter and the leadership team comprised of Rajan Srikanth, Subra Iyer, and S.V.Krishnamurthy. Rajan Srikanth has over 20 years of experience in management consulting. He is also the Managing Director of SmartKapital, a venture advisory firm designed to facilitate rapid revenue and profit growth for Small and Medium Enterprises (SMEs). Prior to founding SmartKapital, Srikanth served as a Worldwide Partner and President of Mercer Consulting’s Asia operations. He has held senior partner-level positions at Accenture and at Mercer Delta Consulting after strategy consulting stints at Bain & Company and KPMG. Previously, he was also an Assistant Professor at the Walter A. Haas School of Business, University of California, Berkeley. Subra Iyer has over 21 years of experience in M&A advisory and transaction services, audit, restructuring and forensic investigations. He has advised and conducted due diligence services for global PE firms including KKR, Carlyle, CVC, Standard Chartered Private Equity, Southern Capital and Navis Capital. SV Krishnamurthy is a successful entrepreneur with extensive experience in serving global customers from India. He was one of the early entrants in the outsourcing sector, having entered into it as early as 1989, when he was appointed to the 1st group of Service Providers by Citibank’s credit card operations in India. His previous ventures include PMC India, a business process outsourcing company in financial services, and Asirvad Microfinance.
The Chennai chapter investment process The different global chapters of Keiretsu Forum operate in a fairly autonomous manner. While there are no restrictions that the Chennai chapter has to source deals only from Chennai, the normal practice of the different chapters is to actively source deals from the city in which the chapters are based. As indicated by the operating team of the Chennai chapter, they have about 20 – 30 new conversations with entrepreneurs every month, out of which 10 get into the deal pipeline, of which, 6 – 7 are taken to the next step of detailed screening. From those that are taken for screening, 3 – 4 are selected for a personal presentation at the monthly forum meetings. Since the time of founding, more than 50 entrepreneurs have made their presentations at the monthly forum meetings till July 2016. Exhibit C3.1 gives the number of companies in different sectors that have presented in these monthly forum meetings. In most of the monthly meetings, the list of presenters also include a foreign company that come through some of the other global chapters of Keiretsu. Thus Keiretsu forum provides entrepreneurs a platform to access the global investors in addition to the investors in their respective cities. Typically, the monthly meetings are attended by the chapter members. Each entrepreneur is given a time slot of 10 minutes to make a presentation, followed by Q&A for about 10 minutes. This initial presentation helps to gauge the level of interest for investment among the chapter members. Those companies that have generated strong interest, are subsequently provided an opportunity to engage in a “deep-dive” session with those members who had shown interest. During these “deep-dive” sessions, the prospective angel investors and the entrepreneurs discuss the investment opportunity in a more detailed fashion. If the discussions during the “deep-dive” sessions emerge fruitful, then the deal is taken for closure after the chapter undertakes the due diligence process. On an average, the chapter aims to complete the investment process in 30 – 45 days from the date of the presentation of the entrepreneur in the monthly forum. As of 115
August 2016, the Chennai chapter has invested in 19 companies. Exhibit C3.2 gives the number of companies in different sectors that have received investment through the Chennai chapter. Exhibit C3.1: Number of companies by sectors that have presented in the monthly chapter meetings 16 14
3
Number of companies
12 10
3
8 6
12
2 2
4
8 6
5
2 0
Technology
1
4
Consumer Hyperlocal and Health-Tech Products and Logistics Services
Edu-Tech
Domestic
2
2
2
2
Fin-Tech and Payments
Internet marketplace and eCommerce
Others
Software and Internet Services
Foreign
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
Exhibit C3.2: Companies that have received funding through the Keiretsu Chennai chapter
Number of companies invested
6 5
5 4
4 3
2
2
2
2
2
1 0
Technology
Health-Tech
Consumer Hyperlocal and Products and Logistics Services
Others
Software and Internet Services
1
1
Edu-Tech
Fin-Tech and Payments
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
The overall average investment has been about ₹4.7 million. Exhibit C3.3 gives the average investment size in different sectors. As it can be seen, there has been a significant variation between different sectors. Consumer
116
products and services companies have received the highest average investment, and Edu-tech has received the lowest average investment. There are also differences in the average investment received by domestic and foreign companies. The average investment in a foreign company was ₹5.45 million, whereas in a domestic company, it was ₹4.46 million. On an average, about 6 – 7 angel investors participate and invest together in a deal. As of July 2016, the Chennai chapter had 29 investors, and growing at the rate of 1 – 2 investors per month since Feb 2016. About 80 percent of the investors were successful entrepreneurs, and a majority of the investors are in the age group of 55 – 60. Exhibit C3.3: Average investment in different sectors
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
The Mind-share An important value-add for the entrepreneurs who make the presentations at the monthly chapter meetings is the feedback provided to them by the members. The members provided detailed feedback on the strengths and concerns based on the presentation made. This feedback is compiled by the Keiretsu team and shared with the entrepreneurs so that they have an opportunity to strengthen their venture. Exhibit C3.4 provides the frequency plot of the positive factors and Exhibit C3.5 provides the frequency plot of the concerns. In order to understand whether there were differences in the pattern of positives and concerns between sectors, we analyzed the mindshare separately by sectors. The results of the top 5 sectors are given in Exhibit C3.6. Though there are differences, the results indicate a great degree of commonality across sectors. Exhibit C3.7 gives the pattern in positives and concerns when companies were classified on the basis of their domicile.
Characterising the successful companies A comparison of the count of positives on various parameters for invested and non-invested companies is given in Exhibit C3.8. Similarly, a comparison of the count of concerns for invested and non-invested companies is given in Exhibit C3.9. Exhibit C3.10 and C3.11 gives the aggregate and average count of positives and concerns for invested and non-invested companies respectively. As expected, the count of positives has been higher for invested companies, whereas the count of concerns has been higher for non-invested companies.
117
Exhibit C3.4: Count of positive factors in the mindshare provided to entrepreneurs
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
Exhibit C3.5: Count of negative factors in the mindshare provided to entrepreneurs
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
118
Exhibit C3.6: Pattern of positives and concerns in different sectors
Product strengths and uniqueness / IP Market size Competency of the entrepreneur Business model / Barriers / Competitiveness Operational efficiencies Customer traction / Customer acquisition / Gestation time Segment leader / First mover / Competition Economies of scale and scope / Growth Entrepreneur commitment (Financial) Business processes Communication / Value proposition Proven market need / Market readiness for the product or size Product readiness / Testing completed Exit possibility Partnership and alliances Valuation and Fund requirement Margins and profitability Regulatory issues
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
119
Hyperlocal and Logistics
Health-Tech
Edu-Tech
Consumer products and services
Technology
Health-Tech
Concerns Hyperlocal and Logistics
Edu-Tech
Consumer Products and Services
Parameters
Technology
Positives
Exhibit C3.7: Count of positives and concerns for domestic and foreign start-ups Foreign start-up
Concerns
Domestic start-up
Foreign start-up
Domestic start-up
Positives
Product strengths and uniqueness / IP Operational efficiencies Business model / Barriers / Competitiveness Entrepreneur commitment (Financial) Business processes Market size Competency of the entrepreneur Customer traction / Customer acquisition / Gestation time Economies of scale and scope / Growth Exit possibility Segment leader / First mover / Competition Proven market need / Market readiness for the product or size Partnership and alliances Product readiness / Testing completed Margins and profitability Communication / value proposition Valuation and Fund requirement Regulatory issues (Source: Keiretsu Forum, Chennai chapter; IIT analysis)
Exhibit C3.8: Count of positives for invested and non-invested companies for key parameters
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
120
Exhibit C3.9: Count of concerns for invested and non-invested companies on key parameters
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
Exhibit C3.10: Aggregate count of positives and concerns for invested and non-invested companies
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
Exhibit C3.11: Average count of positives and concerns for invested and non-invested companies
(Source: Keiretsu Forum, Chennai chapter; IIT analysis)
121
122
CASE STUDY 4
Saffron Incubation and Acceleration 1 Ramesh Kuruva The Saffron Incubation and Acceleration Limited (SIAL) is an incubation and acceleration facility in a Tier I city in India. Founded within the last six years, the main focus of this facility is to develop an early stage technology start-up ecosystem in India.
Incubation and Accelerator Programs SIAL provides two programs, Incubation and Acceleration. Incubation program is for start-ups that are in the idea stage whereas accelerator program is for those start-ups that have a visible product and are in the process of identifying a fit in the market. Details of these program are as follows.
Incubation Program The aim of the Incubation program is to help transform a vision for a prototype and product into a viable product with Product-Market validation over a 6-month period. The teams go through a cycle of prototype building, customer development, product-market fit process and to establish the business model cycle. During the incubation period, entrepreneurs will also get professional guidance from the mentors. SIAL has a panel of mentors, many of whom are experienced entrepreneurs. Mentors are expected to provide vital inputs in various functional areas of management such as marketing, finance, strategy, product development, and so on. Peer to peer learning is one of the important components of the incubation resident program at SIAL, where many entrepreneurs come together to share their knowledge and experience, and also it gives access to the wider community to develop a professional network. Product development is a crucial process for any start-up. Getting the right product usually involves several iterations. One of the benefits of participating in the incubation program at SIAL is to help the entrepreneurs to get to the final product stage with fewer iterations. The program also helps to identify potential customers. Tangible benefits from the program participation include financial benefits from Amazon and Google respectively. Participants in the incubation resident program also get a wild card entry to the accelerator program. For the various services provided in the program, SIAL charges a fee when the incubatees graduate from the centre.
Accelerator Program The goal of the accelerator programme is to give the required momentum, over a six month period, to those start-ups that already have a defined product. Start-ups that have gone through the product-market fit process are considered for this program. The accelerator program will help with business model brainstorming, growth hacking strategies, setting up the advisory board and market validation, and funding to the tune of ₹1 million. SIAL incubated companies have priority over other start-ups in the accelerator program selection process.
Applications for the incubation and accelerator programs SIAL receives applications to participate in the incubator and accelerator program through a variety of channels – internet and web, emails, and through referrals. This case study provides an analysis of a sample of the applications that were received through the Internet for the incubation and accelerator programs. Exhibit C4.1 and C4.2 gives the applications received for incubation and accelerator program respectively from different locations.
1
Name changed at the request of the organization and for confidential reasons. 123
Exhibit C4.1: Proportion of applications received from different locations for participation in the incubation resident program
(Source: SIAL; IIT Madras analysis)
Exhibit C4.2: Proportion of applications received from different locations for participation in the accelerator program
(Source: SIAL; IIT Madras analysis)
124
SIAL received more than 60 percent of the applications from Tier I cities comprising Chennai, Bangalore, Delhi, Mumbai, Kolkata, and Hyderabad for both incubation and acceleration. Among the Tier I cities, the maximum number of applications were received from Chennai.
Analysis of incubator and accelerator applications Exhibit C4.3 gives the number of founders in start-ups applied for incubation and accelerator program. Twenty six percent of start-ups applied for accelerator program have a single founder whereas 40 percent of the startups applied for incubation have a single founder. Sixty three percent of start-ups applied for the accelerator program have two to three founders, whereas only 51 percent of the start-ups applied for incubation have two to three founders. Exhibit C4.3: Number of founders in start-ups 70
63
60
51
Percentage
50 40
40 30
26
20 9
10 0
Single founder
Two to Three founder
Applications received for incubation
12
Four or more founders
Applications received for acceleration
(Source: SIAL; IIT Madras analysis)
Exhibit C4.4: Relationship between co-founders in the start-ups 45
39
40 35
30
Percentage
30 25 20
14
15 10 5 0
6
18
14 10
5
Family members
Friends and Classmates Professional acquaintance
Applications received for incubation
Colleagues
Applications received for acceleration
(Source: SIAL; IIT Madras analysis)
125
Exhibit C4.4 gives the co-founder relation in start-ups applied for incubation and acceleration. It can be seen that for both incubation and acceleration co-founders are friends and classmates in most cases. Co-founders among family members had the lowest proportion. Exhibit C4.5 gives the sector classification of start-ups applied for incubation and acceleration program. There is a difference in the pattern of applications received for incubation and acceleration. The difference in the proportion of applications between incubation and acceleration is the highest for consumer products and services, Fintech and payments, HealthTech, Software and Internet services, and Technology sectors. Exhibit C4.5: Sector classification of start-ups 30
25 25 20
17 13
Percentage
15
13
12
12
10
12 10
10 7
5
Consumer Edu-Tech products and services
7 5
Fin-Tech Health-Tech Hyperlocal Internet Media, and and logistics marketplace advertising, Payments and and gaming eCommerce
Applications received for incubation
11
10
4
2
0
8
4
Others
4
2
Software Technology and internet services
Applications received for acceleration
(Source: SIAL; IIT Madras analysis)
Exhibit C4.6: Business models of start-ups
70
62
57
60
Percentage
50 40
43
38
30 20 10 0
B2B
B2C
Applications received for incubation (Source: SIAL; IIT Madras analysis)
126
Applications received for acceleration
Exhibit C4.6 gives the business model classification of start-ups applied for incubation and acceleration. B2C start-ups were higher in the case of incubation applications, whereas in the case of accelerator applications, B2B applications were higher. Exhibit C4.7 and C4.8 gives the expectations of start-ups from incubation program and accelerator program respectively. Mentoring, investment, and marketing constitute the top expectations from the incubation applicants, whereas investment and marketing are the dominant expectations from the accelerator applicants.
Exhibit C4.7: Expectations from the incubation program Technology
17
Scaling up
5
Recruitment/ Identifying people
11
Prototype development
34
Networking support to venture investors and othes
26
Mentoring
132
Marketing
34
Investment
49
Concept validation
27
Business model/ Revenue model
27 0
20
40
60
80
100
120
140
Number of applications (Source: SIAL; IIT Madras analysis)
Exhibit C4.8: Expectations from the acceleration program 10
Technology
6
Scalingup
11
Recruitment / Identifying people
4
Prototype development
5
Networking support to venture investors and others
14
Mentoring
25
Marketing
23
Investment
1
Concept validation
3
Business / Revenue model
0
5
10
15
20
25
Number of applications (Source: SIAL; IIT Madras analysis)
Exhibit C4.9 gives the ratio of employees with engineering to business backgrounds in the start-ups applied for incubation program. Exhibit C4.10 gives the status of the start-ups at the time of applying for incubation. The largest number of applications have stated that they have a prototype at the time of application. But then there are 83 applications in the initial stages, i.e., with just an idea or having a landing page. Exhibit C4.11 gives the profile of incubation applications based on the college graduation year of founders. It was seen that most of the applications were received from founders who had graduated recently (i.e., during 2012-16) from college.
127
30
Exhibit C4.9: Ratio of employees with engineering and business backgrounds in incubation applications
75 - 25
68
50 - 50
145
25 - 75
55 0
20
40
60
80
100
120
140
160
Number of applications (Source: SIAL; IIT Madras analysis)
Exhibit C4.10: Stage of start-ups at the time of applying for incubation 47
Just an Idea
36
Have a landing page
103
Prototype built
38
In Private beta
32
Initial traction 0
20
40
60
80
Number of applications
100
(Source: SIAL; IIT Madras analysis)
Exhibit C4.11: Number of start-ups classified by the college graduation year of founders 140
123
Number of start-ups
120
107
100 80 60 40
36
34
Before 2000
2000-2005
20 0
2006-2011
2012-2016
Founder graduation year from college (Source: SIAL; IIT Madras analysis)
128
120
Appendix 1 Definitions and Explanations This section provides an overview of the classifications and definitions used in the report.
Start-up definition Start-up phase includes the first five years of the company after incorporation. Our analysis included only the first five years of the company.
Start-up companies list The list of start-up companies and their funding details were obtained from the following database sources: Venture Intelligence, Dealcurry, Lets Venture, VCCedge, and Trak.in
Industry classification The Industry Classification Benchmark (ICB) were used for classifying industries and Sectors. The different industry and sector categories are as follows: Industry classification: Oil and Gas; Basic Materials; Industrials; Consumer goods; Healthcare; Consumer services; Telecommunication; Utilities; Financials; and Technology Sector classification: Oil and gas; Chemicals; Basic resource; Construction and materials; Industrial goods and services; Automobile and parts; Food and beverage; Personal and household goods; Healthcare; Retail; Media; Travel and Leisure; Telecommunication; Utilities; Banks; Insurance; Real estate; Financial services; Software & Computer Services; Technology Hardware & Equipment
Start-up classification Since the ICB was not found appropriate to classify the start-ups we used a separate classification for categorizing the start-ups. These classifications were adapted from several industry reports on start-ups. Accordingly, start-ups were categorized into ten categories as follows: Consumer Products & Services, Edu-Tech, Fin-Tech & Payments, Health-Tech, Hyperlocal & Logistics, Internet Marketplace and E-commerce, Media, advertising and Gaming, Software and Internet Services, Technology, and Others (to account for start-ups that could not be categorized in any of the other nine categories).
Investment amount Since the report covered a fairly long duration, 2000-2015 for most instances, all individual investment amounts were converted to 2015 base year values. The method used to convert nominal investment amounts to 2015 base year values is as follows: Suppose, the investment made in 2014 was 100 million. The average Consumer Price Index (CPI) was 138.481. The average CPI was 146.000. The 2015 equivalent of the investment of 100 Million made in in 2014 would be: = (2015 𝐶𝑃𝐼/2014 𝐶𝑃𝐼) ∗ 𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = (
146 ) ∗ 100 138.481
= 105.43 𝑚𝑖𝑙𝑙𝑖𝑜𝑛
129
City type
Cities were classified into three tiers based on the 6th pay commission recommendations, Government of India. The cities classified as Tier 1, 2, and 3 are as follows: Tier I Cities: Bangalore, Chennai, Hyderabad, Kolkata, Mumbai, NCR- Delhi. Tier II Cities: Vijayawada, Guwahati, Patna, Chandigarh, Durg-Bhilai, Ahmedabad, Faridabad, Srinagar, Jamshedpur, Belgaum Kozhikode, Gwalior, Amravati, Cuttack, Amritsar, Pondicherry, Bikaner, Salem, Moradabad, Dehradun, Asansol, Dhanbad, Hubli, Kochi, Indore, Nagpur, Warangal, Raipur, Rajkot, Jammu, Bhubaneswar, Jalandhar, Jaipur, Tiruppur, Meerut, Vishapatnam, Jamnagar, Ranchi, Mangalore, Thiruvanathpuram, Bhopal, Aurangabad, Ludhina, Jodhpur, Coimbatore, Ghaziabad, Guntur, Vadodara, Mysore, Jabalpur, Nashik, Kota, Tiruchirappalli, Aligarh, Surat, Bhiwandi, Madurai, Agra, Bareilly, Lucknow, Kanpur, Allahabad, Gorakhpur, Varanasi , Pune, Solapur, Kolhapur, Madurai. Tier III Cities: Cities not listed in Tier I and Tier II
Incubator host institutions
The institutions that hosted incubators were classified into five categories as follows: Central Universities: These included incubators set up in Central government funded universities such as the Indian Institute of Technology Madras, Indian Institute of Management Bangalore, and so on. State Universities: These included incubators set up in State government funded universities and colleges such as the Anna University, Chennai and so on. Private Universities: Incubators set up in private universities and colleges would come in this category. Example would include the incubator facility in the Birla Institute of Technology and Science, Pilani. Government Non-universities: Incubators in government research laboratories and other non-teaching institutions was classified in this category. For example, the incubator in NCL, Pune was classified in this category. Private Non-universities: Incubators set up by individuals and private institutions would come in this category. Examples include the IAN incubator, The Hatch, and so on.
130
Appendix 2 Useful Websites for Start-ups Description
Website
(A) Government, Publicly funded institutions, and Universities A great source of information on:
http://startupindia.gov.in/
India start-up action plan. Start-up hub India (Clears queries from entrepreneurs) State start-up policies. Detail information on incubators and accelerators. List of central government clearances and state government clearances. Details of support from SIDBI. Events and conferences organising by various States and industry bodies. Meeting with entrepreneurs and Venture capitalists.
http://www.venturecenter.co.in/
The Venture Center is a technology business incubator specializing in technology startups offering products and services in the areas of materials, chemicals and biological sciences & engineering.
http://meity.gov.in
Department of Electronics and Information Technology (DeitY) is implementing a scheme titled Technology Incubation and Development of Entrepreneurs (TIDE). Initially launched in 2008 the scheme has been revised and extended till March 2017. As per the scheme provision, 27 centers are being supported at academic institutions across India.
http://www.nstedb.com
The National Science & Technology Entrepreneurship Development Board (NSTEDB), established by Government of India in 1982 is an institutional mechanism, with a broad objective of promoting gainful self-employment amongst the Science and Technology (S&T) manpower in the country and to setup knowledge based and innovation driven enterprises.
http://www.iitk.ac.in
SIDBI Innovation & Incubation Centre (SIIC) at IIT Kanpur was set up in collaboration with Small Industries Development Bank of India (SIDBI) to foster innovation, research and entrepreneurial activities in technology related areas.
http://msme.gov.in
The Scheme provides opportunity to the innovators in developing and nurturing their new innovative ideas for the production of new innovative products which can be sent in to the market for commercialization.
http://www.iaccelerator.in/
iAccelerator is an initiative by Indian Institute for Management Ahmedabad’s Centre for Innovation Incubation and Entrepreneurship.
131
Description
Website
http://www.nsrcel.org/
Set up at IIM Bangalore, the Nadathur S Raghavan Centre for Entrepreneurial Learning (NSRCEL) facilitates business growth through academic research by scholars and practical learning for entrepreneurs. NSRCEL is an open incubator, it doesn’t distinguish between IIMB Alumni and non-alumni.
http://www.bits-pilani.ac.in
BITS has set up a Center for Entrepreneurial Leadership (CEL) to give a specific boost and emphasis to entrepreneurship development. The organization can house, in its office space, between 10-12 companies at a time. BITS also provides training to the startups in business communications and provides short courses on business management.
(B) Private sector initiatives and industry associations http://www.thestartupcentre.com/
TSC supports technology entrepreneurs build global startups leveraging technology to solve real world problems.
http://isba.in/
Indian STEP and Business Incubators Association (ISBA) main objective is to promote business incubation activities in the country through the exchange of information, sharing of experience, and other networking assistance among Indian Business Incubators (TBIs), Science and Technology Entrepreneurs Parks (STEPs) and other related organisations engaged in the promotion of start-up enterprises.
https://www.sv.co/
Start-up village is for ambitious students to learn how to build a real startup and experience Silicon Valley while still in college.
http://venturenursery.com/
Venture Nursery undertakes an intensive and immersive coaching and mentoring role in the chosen startups and helps each with end-to-end infrastructural and learning support.
https://chennai.starttank.com/
It is located within PayPal’s India Development Centre in Chennai. The initiative seeks to nurture and support the creation of a new generation of technology companies by offering them initial infrastructure and mentorship, direction and encouragement.
10000Startups.com
“10,000 Start-ups” is a vision, which is committed to incubate, fund and provide support to impact 10,000 technology start-ups in India, by 2023. The aim is to nurture the hatchling start-ups into full-fledged technology stalwart companies, by giving them support via access to start-up incubators, accelerators, angel investors, venture capitalists, start-up support groups, mentors, and technology corporations.
http://www.indianstartups.com/
http://www.startupentrepreneurs.org/
Indian Start-ups is a start-up ecosystem bringing together entrepreneurs, investors, partners and service providers throughout India and across the globe to help nurture, nourish and manpower new and growing start-ups. Startupentrepreneurs.org offer support to start-up entrepreneurs with self-finance, mentorship, network and workspace.
132
Description
Website
(C) Angel Networks and Investment Platforms http://www.angelprime.com/home/
AngelPrime is focused on startups in the middle that need seed capital, it invests in not more than 3-4 companies a year.
http://indianangelnetwork.com/
Indian Angel Network is a network of angel investors keen to invest in early stage businesses which have potential to create disproportionate value. The members of the Network are leaders in the Entrepreneurial Eco-System as they have had strong operational experience as CEOs or a background of creating new and successful ventures.
https://www.investmentnetwork.in/
It is an online platform connecting startups with a global network of angel investors.
http://www.hyderabadangels.in/
Hyderabad Angels (HA) is a group of seasoned angel investors who are keen to invest in promising start-ups and early stage companies to create tangible as well as intangible value.
http://www.mumbaiangels.com
Mumbai Angels is recognized as an innovative business incubator and holding company. It gives companies with a level of assistance that surpasses their highest expectations.
http://www.gsfindia.com/
The key objective of GSF is to spur innovation and entrepreneurship through angel and seed investing. Their mission is to encourage flow of informed, knowledgeable mentorship capital to the start-ups in India and beyond.
http://www.thechennaiangels.com
The Chennai Angels (TCA), formerly known as Chennai Entrepreneurship Trust Fund, was established in November 2007 with the objective of fostering Entrepreneurship with prime focus on nurturing and mentoring new generation entrepreneurs
http://angellist.com/
AngelList is a social network for start-ups. AngelList allows smaller investors to invest $1,000 or more in a start-up on the same terms as other large investors.
http://www.nextbigwhat.com
Platform for technology start-ups connecting start-ups to investors, other start-ups and they also cover the latest news and meaningful analysis of India's digital ecosystem.
https://angel.co/
AngelList is a social network for start-ups. AngelList allows smaller investors to invest $1,000 or more in a start-up on the same terms as other large investors.
https://letsventure.com/
Letsventure is a crowd funding platform for Indian entrepreneurs. Listing start-up can help raise money from groups of investors across India.
http://tracxn.com/
Traxcn is a start-up intelligence website used by angels and venture firms. Registering here helps start-ups to get an expression of interest from investors across India.
133
Description
Website (D) Start-up Ecosystem https://yourstory.com/
Your Story is a media platform for entrepreneurs, dedicated to passionately championing and promoting the entrepreneurial ecosystem in India.
http://lawrato.com/
This source provides an aggregate list of lawyers. Entrepreneurs can consult for legal advice.
http://www.dutiee.com/
Dutiee provides advice for social start-ups, non-profit success stories and on ethically manufactured goods.
http://www.ladieswholaunch.com/
An active and engaging site for women entrepreneurs that provide a resource for starting, building and running a business.
https://cofounderlab.com/
A website where you can find your co-founder or you can become a co-founder. List with start-up enthusiasts across the world. It will be quite useful too for people who wish to find their cofounders with a mandatory skill set. (E) Incubators and Early Stage Funds
http://yournest.in/
An early stage venture capital fund, investing in businesses built on vibrant and new ideas enabled by path-breaking use of technology.
http://seedfund.in/
Seedfund is an early-stage venture capital firm with about $70 million under management.
http://www.infuseventures.in/
An early stage venture capital fund and ecosystem focused on the sustainability and clean energy sector in India.
http://www.microsoftventures.com/
It is an early-to-middle-stage accelerator focused on themes such as smart cloud services, mobile applications, urban informatics and big data, Internet of Things and wearable computing.
http://tlabs.in/
TLabs is a startup accelerator-cum-early-stage seed fund for Indian Internet and mobile technology startups.
http://kyron.me/home.php
Kyron is a next-generation global accelerator for early-stage technology startups.
http://www.villgro.org/
Villgro is one of India’s oldest social enterprise incubators, supporting innovators and social entrepreneurs during their early stages of growth. Since 2001, Villgro has incubated 103 such enterprises.
http://www.khoslalabs.com/
It is a startup incubator started by Vinod Khosla, Co-founder of Sun Micro Systems and Founder of Khosla Ventures.
134
Acknowledgements We gratefully acknowledge the generous help and support by the following at different points in the preparation of the report. Akhila Rajeshwar, TiE Chennai Annie Luis, IL&FS Investment Managers Arumugam Aramvalarthanathan Arun Prabhudesai, Trak.in Arun Prakash Korati, IL&FS Investment Managers Balram Nair, The Chennai Angels Ganapathy Venugopal, Axilor Gowtham Sarvesh, Keiretsu Forum Chennai Haran Prasanna, New Horizon Media Janani Varsha, The Chennai Angels K.C. Srinivasan, TVS Capital Keshav Anantha Krishnan, Keiretsu Forum Chennai Mangala Jois, Inventus Capital Poorvi Narang, IDG Ventures India Prachi Sinha, Axilor Pratik Selarka, Ventureast Priyanka Deenadayalu, The Chennai Angels Priyanka Mohanty, IDG Ventures India R. Narayanan, TiE Chennai R. Ramachandran, TVS Capital Raghunatha Rao, IDG Ventures India Rajan Srikanth, Keiretsu Forum Chennai S. Rajan, Equitas Small Finance Bank S. Sriraman, Beehive Ventures Sangeeta Panchdhari, ICICI Securities Sasha Mirchandani, Kae Capital Shanti Mohan, Lets Venture Shubhankar Bhattacharya, Kae Capital Vijay Anand, The Start-up Centre Vijaya Pereira, ICICI Securities
135
