Start-up ecosystem: A goldmine of investment opportunities

The word start-up was added to the layman’s dictionary in January 2016 when the Government of India launched the Start-up India initiative. It transformed the way markets, potential entrepreneurs, and investors viewed startups. It allows young people to take risks with their ideas and become job creators instead of job seekers.

Not once in the history of India have so many prominent figures come together to support start-ups and help them succeed globally. After all, it’s not just about an idea and a lot of enthusiasm, but also about leadership potential, industry knowledge, practical communication skills, and flexibility to deal with various circumstances. According to some reports, many high-profile CEOs leave their positions to create or work for new companies.

All of these efforts came to fruition as India emerged as the third largest startup ecosystem in the world, with more than 60,000 startups and 73 unicorns (those reaching $1 billion in valuation) across multiple industries.

The 2022 economic survey highlighted that at least 14,000 start-ups were recognized by the department of internal trade and industry promotion in India as having at least one new start-up. The icing on the cake is that a record 44 Indian startups achieved unicorn status in 2021.

There is no fixed definition of start-up. In general terms, it can be understood as a newly formed business with a viable economic model that addresses the demands of society by generating a positive feedback loop. In an emerging economy like India, inclusive and efficient startups play a vital role in increasing economic development and reducing income inequality by discovering new solutions to industry-wide challenges.

Our nation’s burgeoning startup ecosystem can be aptly described as thriving, booming, and progressive. It is evident from the record 3.8x growth in venture capital (VC) funding in India in 2021 over 2020 (faster than China’s 1.3x) and the number of VC investments minted in 44 unicorns, surpassing the 42 unicorns of China in the year. The main reason is a positive macroeconomic outlook for India and capital flight due to increased regulation of technology companies (fintech and edtech) in China.

The convergence of several factors is driving this investment in India: a perfect storm of educated young talent, digital infrastructure including Unified Payment Interface (UPI) and Aadhar-based KYC, availability of economic data, increased financial and digital awareness; depth of demand and capital, among other enablers, is brewing. An added bonus is relaxed IPO rules by India’s capital market regulator SEBI, which has revitalized investor confidence. At least five high-profile IPOs in 2021 were venture capital-backed companies.

Although more than two-thirds of venture capital investments by value go into sectors such as consumer technology, fintech and software as a service (SaaS), business-to-business (B2B) online marketplaces, consumer and digital health, healthcare Technology-enabled medical Lifelong learning technology and skills upgrading services, cross-border trade, Web 3.0, and crypto-based startups are seeing increased traction. Additionally, Indian unicorns became category-defining leaders globally, such as Postman in API management or BrowserStack in automated testing.

Industry 4.0, with robotics, data transfer, networking, artificial intelligence and machine learning as its main segments, is an opportunity for a start-up in India. Enables companies to better understand their processes and gain access to real-time data to increase efficiency, streamline processes and drive innovation

Given this exciting Indian start-up landscape, India’s active investor base has expanded significantly, reaching over 660 from 516 in 2020. Early-stage rounds, from seed funding to Series A , saw increased participation from various seed funds and family offices. New investors such as global tier 1 VCs and cross funds, emerging domestic VCs and international sovereign wealth funds (Abu Dhabi Developmental Holding Company [ADQ]Qatar Investment Authority [QIA]), made investments.

The pandemic period proved to be a catalyst for many companies, both established and new, to reimagine, redesign, and refocus. Start-ups in particular faced the unforeseen consequences of the pandemic, survived and thrived in uncertainty, showing their anti-fragility.

When companies are unlocking substantial economic value and shooting for the stars, why should we as investors miss this bus? Investors have already begun to consider these alternative investments when making portfolio decisions. It seems unlikely that the amount and momentum of funding will slow as the private market has remained reasonably stable amid recent foreign capital flight from India. Rather, as investors’ comfort level increases, in light of the strong regulatory framework, the total funds available to startups would increase exponentially. The Indian business ecosystem offers an attractive investment opportunity, with a potential annual return of around 20% if done right.

Focus on quality instead of mere popularity. Examine the operational efficiency and corporate governance aspects of the company. Understand unitary economics and don’t fall victim to familiarity bias. If finance is not your area of ​​expertise, it is better to invest in a venture capital fund managed by an expert, which will have a higher chance of success.

As you look for higher returns, don’t overlook the costs. Globally, 95% of venture capital funds underperform after fees. Therefore, it is essential to invest in a low-cost venture capital fund. Most funds charge 2+20 (2% per annum and 20% profit sharing). The 20% profit sharing fees eventually eat up all the returns, with investors getting nifty or even lower returns.

Global capital markets are under pressure, and this situation is expected to continue, affecting initial valuations. Watch for rationalized valuations in the emerging sectors of your satellite portfolio to the tune of 5% to 10% of the portfolio.

Never ignore the fundamental rule of diversification when investing, regardless of asset class. Preferably, invest in at least five companies spread over sectors. Chances are, out of 5 companies, two will go to zero, two will give average returns and one will provide super returns. After all, starting a business is challenging and one witnesses more failures than successes. One must be prepared to face setbacks and tremendous adversity.

In short, being part of the revolution and building long-term solutions for various sectors (such as health care, education, tourism, clean energy, poverty, financial services, security, agriculture, etc.) by fostering a business ecosystem, which it is also an economic imperative for you as an investor.

The article has been written by Mukesh Jindal, co-founder of Alpha Capital.

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