The ‘SAINTS’ Of Venture Capital May Not Be So Holy For Early Stage Startups
The ‘SAINTS’ and what may be behind the funding dry-up for early stage ventures.
India’s venture capital ecosystem has seen a record rise in investments in two years. More than half of these have come from a clutch of foreign investors—mostly Chinese.
Despite driving investment growth, these venture capitalists may be, in part, responsible for the funding drought that India’s early stage ventures are facing, according to analysis by WaterBridge Ventures.
The “SAINTS”—as the authors of the analysis, Sarbvir Singh and Pulkit Mehrotra, call the group of SoftBank, Alibaba, Naspers, Walmart, and Tencent—view India as their largest open market and have rushed to invest in market leaders.
That meant much of their money is flowing towards large deals in well-established companies. And these SAINTS, particularly SoftBank with its $100-billion Vision Fund, created a “fear of missing out like never before”, the analysis said.
Their focus is on less-risk later stage deals. These bigger players understandably only look at larger deals as investing a few million in early stage startups won’t move the needle for them.WaterBridge Ventures
But that has a fallout.
Their influx has led to global investors rushing to fund established companies before the ‘SAINTS’ show up. “Founders who are concerned about handing over control to SoftBank are also spending long hours crisscrossing the globe to find other heavyweights to balance them.”
So while mega deals are “holding up the sky”, seed and pre-series A investments in early stage startups have seen a sharp decline over the last three years, the WaterBridge analysis shows. The number of venture capital deals of less than $6 million have declined since 2015, while those over $6 million have been rising since 2016. “The data is clear that there is indeed a boom in larger deals, while smaller deals are struggling.”
That’s surprising because India’s underlying metrics for startup growth are strong, the analysis said. The country’s consumer class is “growing strongly”. It has the second-largest internet user base and active internet users are expected to double in the next five years as data in India is the most affordable than anywhere in the world.
The reasons why investors are not opening their cheque books for smaller deals are more “technical factors” rather than fundamental, the analysis said. And the influx of the ‘SAINTS’ is just one of those.
Big Demands Big
WaterBridge’s analysis found that the average fund in Indian venture capital grew significantly from around $100 million to over $300 million in the last decade. “This is partly due the interest in India as explained by the improving fundamentals as well as due to the better economics of running larger funds.”
And larger fund sizes lead to a natural interest in larger deals “as it is difficult to deploy these funds in smaller, sub-$6 million, deals.”
This funding gap has been traditionally filled by angels and family offices. However, they, too, have stayed away due to the angel tax issue, lack of capital and “extended horizons needed to get their capital back”.
Lack Of Exits
In the decade from 2008-2017, venture capital firms have invested about $32 billion in early stage companies. However, there have been exits worth $11 billion only.
"The elephant in the venture capital room has been the lack of exits from the first wave of investments made in the mid 2000’s,” WaterBridge said. “Lack of exits has had a dampening effect on early stage deals as investors feel that it will take them a long time to get their money back.”
But things have shown signs of improvement. “More promising is the trend of secondary sales which have been over $2 billion in the last two years, wherein funds which have invested early sell to later stage investors.”
Better Days Ahead?
WaterBridge expects things to improve with time. “Our conclusion is that reasons for the fall off in early stage deals are technical rather than fundamental. As they get addressed (angel tax being one of them), early stage funding will make a strong comeback.”
The venture capital firm expects a new class of funds to emerge and fill the early stage funding gap. Even later stage deals will continue to grow, it said. Early stage funding is also expected to see a “renaissance” as technology disrupts sectors and becomes an integral part of consumer businesses.
Fundamentals are strong and are expected to keep growing, it said. Besides, the rise of new technologies like artificial intelligence, internet of things and blockchain will create more opportunities for early stage ventures.
“The current aversion to early stage deals seems like a classic case of navigating using the rear view mirror rather than anticipating what is coming ahead,” it said. “After all, the unicorns of tomorrow have to be funded today.”