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The Second Wave of Startups - Investing In Disruption

一月, 2017

CFO Insights on Strategy

Ganapathy Venugopal, Co-founder and CEO, Axilor Ventures, shares his perspective on what do investors look for while investing in startups.

There is a famous adage in advertising. Only 50% of what you spend really works but the trouble is you do not know which half. It is an adage equally apt to describe investing in startups. The share of successful investments is far less, often in single digits. And rarely can one predict with accuracy which ones will succeed. So, the question of what do investors look for while investing in startups is an interesting place to start. The short answer is that it depends. The longer one is what I have attempted below.

In my view, what we have seen in the startup scene in India in the last five years are largely the first order effects. We have seen an explosion in the number of startups, many of them restricted to a few sectors, a few winners and a lot of failures.

From an investing perspective, late stage investors follow large market opportunities and good teams that can address them. In the last few years, the investment bets focused on sectors with large markets (read e-commerce, consumer internet or mobile). In 2016, more than 80% of the investments have been into these and related sectors. In these sectors the preferred business models were those proven in other markets like the US and China with the predominant theme of 'organising the unorganised'. In these areas, the number of bets they could make was limited by the quality of the founding teams. The final investment decisions have been focused on finding the best teams who could execute on the opportunity to emerge as the category leaders. Given the nascent stage, the search for these category leaders have also meant that the business models have been highly capital intensive, discount driven and consumer acquisition led. This is in marked contrast to the models that have evolved in more mature entrepreneurial ecosystems. They are a lot more diverse in terms of the ideas being pursued, startups being invested in. They also have much more institutional capacity available to support startups in very early stages.

I believe that the next five years will be different. We will begin to see the second order effects of this entrepreneurial revolution. And this will be disruptive. There are three clear triggers. One, we have a sizeable number of startups who have been through their first entire cycle of their business models and funding - many winners, lots of losers but most of them wiser. The investors now have indigenous portfolio data and performance benchmarks on business models and sectors - what works, where and with whom. Second, the first wave of startups has created a large talent pool of folks with entrepreneurial aspirations - with experience of building something useful and a good understanding of the problems they want to work on. This number will only grow. Third, there are several external shifts like ubiquitous data connectivity, improving access to electricity, financial inclusion driven by Aadhaar and inclusion of large number of SMEs in the cashless economy. These are creating huge opportunities and new addressable markets which till now were either not accessible or profitable. 

But this change cannot be taken for granted. To accelerate this, we need two things. One, more disruptive ideas. Second, we need a deeper investment ecosystem that can nurture and support startups, both in numbers and diversity, in their early stages.

On having more disruptive ideas, we can follow the advice of the great inventor Thomas Edison - to have one great idea, start with a lot of them. And disruptive ideas rarely look disruptive at the beginning. Try looking at the early pitch decks of many successful startups or listening to the founders' vision for their startup in their early days. The most disruptive ideas start as deceptively simple ideas. They start with a kernel of an idea. They build proprietary insights around the problem, test needs and adoption. Based on this, they end up building something users love (and willing to pay for) and rapidly expand their user base and addressable market. Many of them acquire the patina of disruption because of their impact - execution, scale and delivering on the promise of their idea. Seemingly simple ideas executed flawlessly can build large, scalable businesses. The list of disruptive ideas that have seen an early end due to poor execution is much longer. So a good way to have more disruptive ideas is to begin with a lot of good ones and ensure that they get on to the trajectory of becoming scalable businesses.

To do this well, we need a deeper investment ecosystem to support startups in their early stages.  In the last 12 months VCs have announced raising more than US$ 2 billion India focused funds. So there is ample capital available for funding late stage deals. But the capacity at the seed level is still lagging. The angel funding investment capacity in India is one-hundredth of the capacity in the US. Early stage funding needs to be complemented by institutional programs that allow early discovery of disruptive ideas and create a capital efficient model for funding them at the right stage. In the US for instance, while only one out of 10 startups go through an accelerator program, one out of three getting funded is from an accelerator program. These programs allow early discovery and systemically improve the signals available for VCs to pick the best teams. We are quite far from that.

We have all the right conditions - a growing pool of entrepreneurs, triggers for disruption and adequate risk capital to support these. With a few enablers, I am confident that the second wave will see startup activity in more diverse sectors, with more disruptive ideas and larger ambition. It will also signify our startup ecosystem's march to maturity. 

Opinions expressed in this article are the author’s own.