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PE & VC Firms On A Limp To Raise Funds

While 2017 proved the best year for investments and exits in India, fund raising proved — and continues to be — a challenge for risk capital investors

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Success for venture capitalists is not just about cracking investments. Rather, it’s about completing a full investment cycle, cashing out of portfolio companies with hefty profits and then raising the next round of corpus.

Ask Pranav Pai, who has recently closed a second fund at Rs 250 crore for his early-stage venture capital (VC) firm 3one4 Capital, surpassing a target he set for himself a year ago. Pai hit the road to raise his second fund in January 2017 with a target corpus of Rs 150 crore that was fully subscribed within a quarter of  his initiating the process.

Pai, however, is among the fortunate few.
Data available with research firm Venture Intelligence, shows that funds raised by venture capitalists in 2017 stood at $1,217 million — the lowest in six years. This is despite growing investor interest in the burgeoning startup ecosystem in the country.

To break down the numbers further, as many as 19 VC firms raised capital in India in 2017. In 2016, the number stood at 27 and in the year before, it was 15 (the funds raised during those two years were $2,750 million and $2,048 million, respectively).  In terms of total funds raised by risk capital investors — both private equity (PE) and VC firms — the number stood at $5,082 million across 34 firms in 2017.  Of that $464 million comprised domestic money, $2,239 million consisted of foreign capital and the remaining chunk was a mix of domestic and foreign capital. In the domestic market, the GOI SIDBI Fund of Funds has kickstarted a great flow of investments, but that alone is not enough. The Indian startup ecosystem needs to have funds flowing in from large insurance companies.
Fund raising continues to remain a challenge for PE and VC firms in India. Even as limited partners, or LPs, as they are commonly called, are warming up to the country, they are still taking a cautious approach to deploying fresh capital into the investor fraternity.

“The industry has matured to a certain level, but we need to see very good VC fund return,” says K. Ganesh, serial entrepreneur and partner, GrowthStory. “Lack of demonstrated exits, very few IPOs, handful of M&A (merger and acquisition) deals, lack of big cash exits are damping the party,” he adds.

The year 2017 was the best year ever for PE and VC exits in terms of both value and volume. But that was just one year. In the larger context, “investments made over the years haven’t given the kind of returns LPs expect,” says Sunit Mehra, Founder and Managing Partner at executive search firm, Hunt Partners. The risk reward ratio of investments in the US (and China) is significantly better than that of  India. Across the VC and PE spectrum, there is a contraction in India. “At least eight to ten senior people have left their existing companies in the last 12 months. Most haven’t found a landing ground in another firm,” says Mehra.

For the uninitiated, LPs are the source of capital for PE/VC firms, while General Partners or GPs manage them. “Exits and returns in India seem dwarf when compared to markets such as the US,” says Ganesh. “Quicker exits, larger exits, and clean returns for cash make all the difference. Given these parameters, global LPs often allocate their risk capital somewhere else with only a small portion kept for India.”

According to Ernst & Young data, the aggregate deal value for PE exits in 2017 at $13 billion was almost twice that of the previous high of $6.7 billion achieved in 2016. The momentum needs to continue over the next few years for the PE and VC industry to come of age.  

“Fundraising is never an easy process. It’s a test of an investor track record,” says Pai, founding partner at 3one4 Capital. Established in 2016 by Pai and his brother Siddarth Mohan Pai (sons of ace angel investor T.V. Mohandas Pai) with a total corpus of Rs 100 crore, 3one4 Capital has so far invested in over 40 startups in sectors such as enterprise automation, media and content, fintech, education, healthcare and artificial intelligence.

“The first fund for us was all GP money,” says Pai. Perhaps, that too has helped the firm raise its second tranche of capital rather seamlessly. Besides, the VC firm has already seen two exits from its portfolio within the short span of operation.

“There is greater interest amongst Indian LPs for interesting funds. By interesting, I mean those who have a proven track record and different approach,” says Mohandas Pai, one of the LPs in 3one4 Capital. Among other LPs, there are prominent names such as Infosys co-founders Narayana Murthy and Kris Gopalakrishnan, and Anil Rai Gupta, CMD, Havells.

Typically, a single private equity capital investment cycle lasts for about four years. After that, PE firms normally exit by way of trade sale, public listing, recapitalisation and secondary sale. Trade sale is the most common exit method for private equity investments as trade buyers from the same industry are often more likely to realise synergies with the business and are therefore, the most natural buyers of the business. Typically, public listing takes place during positive market conditions. Venture capital investment cycles generally last five to seven years.

The current startup landscape is aflush with “opportunities given that there are some big pain points waiting to be solved in India at the moment,” says Ganesh. “It is perhaps the best time to build new businesses,” he adds. Lack of brands in most sectors, lower data bandwidth rates in the world, huge penetration of mobiles and mobile Internet access have opened up a plethora of options for entrepreneurs today.

However, what’s plaguing the growth of startups is the absence of profits. Take e-commerce for example. The sector has attracted capital in slews in the past three or four years. But since most ventures do not have a strong business model in place backed by calculated unit economics, their constant chase of capital has become a prerequisite for their survival. In such a scenario, LPs are actually adopting a ‘wait and watch policy’ to see what unfolds in the years to come.
Startups today face similar issues.  How to get enough margins, how to be price competitive and how to keep customer acquisition costs low. In the past, a lot of  investments in the fledgling startup industry were driven more by speculation than the  fundamentals of the companies.

Towards the end of 2014 and beginning of 2015, there was an unusual euphoria on the part of entrepreneurs and investors. “People forayed into entrepreneurship without solid thinking. When things started getting tough they decided to run away,” says Ganesh.

Echoing the same sentiment, Hunt Partner’s Mehra adds, “Moving from series A to B requires different abilities in the founders.” Organisational building, hiring and retaining a stellar team, building a repeat customer base that can provide genuine revenues, the ability to manage large amounts of capital are key to a startup’s success. “This is not in everyone’s capability set,” says Mehra, adding, “Smarter entrepreneurs should understand this challenge and (swallow their pride if needed), dilute their stakes in favour of the right people who can take the company forward, or merge into a large entity, rather than letting the company die.”

All in all, it’s time for the survival of the fittest.  Venture Capital is a different asset class from private equity. There will be fewer success stories, but they will be major ones as we have seen in the case of Flipkart , Ola, Bigbasket, Portea Medical, among others. Limited partners are waiting for exactly that moment.

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private equity venture capital Magazine 3 March 2018