In today's uncertain financial and economic landscape, you might wonder why it makes sense to invest in Indian startups. With the cost of capital rising, interest rates going up and inflation exceeding targets, it's natural to question this suggestion.
To understand why it's worthwhile to invest in startups in the current scenario, let's examine a few macro-economic indicators.
Post Every Crisis: A Glimpse Into the Past
According to the startup growth index from the Global Startup Ecosystem Report 2022 by Startup Genome, startup growth follows a pattern: it declines significantly during a financial crisis and rises in the subsequent years until the next pivotal event or crisis.
The startup growth index is like a scorecard that measures how well a startup ecosystem is doing. It looks at how much value the ecosystem creates, how successful startups are at growing money and how quickly they can sell or go public. It helps us understand the overall health and performance of the startup world.
During the 2008 financial crisis, there was a significant decline in the startup growth index for both the US and India. Startups faced challenges raising capital and growing their businesses, leading to a decline in the overall startup ecosystem.
In the subsequent years, the startup growth index gradually rose for both countries indicating a recovery from the financial crisis and renewed growth in the startup ecosystem.
These numbers highlight the cyclical nature of startup growth, which declines after a crisis and rises in the following years until the next pivotal event or crisis.
Historical Returns Data
An interesting pattern emerged when the markets collapsed during the 2008 financial crisis. Let's explore the historical returns data of the US venture capital during that period.
Post the financial collapse, there was a remarkable surge in the median MOIC (Multiples On Invested Capital), which measures the value generated by an investment. This surge reached unprecedented levels and while the MOIC never returned to the same heights, it shaped the investment landscape in subsequent years.
In 2023, we find ourselves on the brink of history repeating itself. The trajectory of startup investment returns seems poised to follow a similar pattern in future years. Investors who embark on investing in startups today will have the opportunity to replicate these remarkable results.
Born in Crises: Examples
Here are a few notable examples of startups that weathered the crisis storms and gave significant returns to their early investors:
- PayPal (US): PayPal emerged during the dot-com bubble and weathered the crisis, becoming a leading online payment platform
- Flipkart (India): After the 2008 financial crisis, Flipkart expanded from an online bookstore to a dominant e-commerce platform challenging Amazon's dominance in India
- Airbnb (US): Founded in 2008 during the aftermath of the financial crisis, Airbnb revolutionized the travel industry with its online marketplace for vacation rentals
- Ola (India): Launched after the 2012 financial turmoil, Ola quickly gained popularity as a leading ride-hailing platform and diversified into various services
- Tesla (US): Despite challenges, Tesla grew significantly after the 2008 financial crisis, revolutionizing the electric vehicle market with innovative technology
- Netflix (US): Netflix adapted from DVD-by-mail to online streaming after the dot-com bubble, becoming a global entertainment powerhouse
These examples illustrate how companies in the US and India have faced challenges and uncertainties but managed to grow and succeed, demonstrating the resilience and potential for growth in the startup ecosystem.
Opportunity in Correction
In the current market, an ongoing correction has resulted in the revaluation of many Indian unicorns. Prominent names like BYJU, Swiggy, Ola, Meesho and OYO have already experienced multiple markdowns. While these markdowns primarily affect investors' books, they also have ripple effect on valuations at all stages.
During a bullish market, investing in a startup may lead to higher valuations and a smaller stake in the company. On the other hand, in the current market scenario, investing means encountering lower valuations and having the opportunity to acquire a larger stake with the same investment amount.
To understand this, let's consider an example: suppose a startup was valued at $10 million last year but is now valued at $7.5 million due to the correction. So, if an investor purchases the company's $1 million worth of equity now, their ownership stake increases from 10% to 13.33% after the correction.
Now Could Be the Time for Investment
Due to the uncertain state of the economy, many top investors have reduced their investments. As a result, more than $16 billion is currently waiting to be invested in venture capital funds.
When these top investors hold back, it creates an excellent opportunity for emerging investors. Even though the economy is not doing well, innovation doesn't stop and entrepreneurs keep creating impressive products. This means emerging investors can find better investment chances and buy lower-priced assets.
Despite the difficult funding situation, 2022 was a great year for Indian venture capital. A total of 126 new funds, worth $18 billion, were started during that year. Additionally, in the first quarter of 2023, an extra $3 billion was invested. This shows that there is still activity and potential growth in the sector.
There are a lot of good opportunities available and the competition is not as fierce as it would be in a more favorable economic environment.
Secondary Sales Present New Avenues for Investors
As the funding winter continues, investors seek new ways to get involved in the Indian startup ecosystem. Secondary sales, where existing investors sell their shares to new investors, are one way to do this.
For investors, secondary sales offer several advantages. First, they can provide access to high-quality startups that may not be available through primary funding. Second, they can be a way to get involved in the Indian startup ecosystem at a lower cost than through primary funding. Third, they can offer investors the potential for significant returns if the startup is successful.
Startups with sufficient funds to weather the funding freeze opt not to raise new capital, as they may not obtain the desired value. Instead, they explore options to facilitate partial exits for their investors.
On Thursday, Lenskart saw a $100 million investment by private equity major ChrysCapital. This brought the curtain down on a $600 million investment in Lenskart, around $450 million in secondary share sales.
Other startups like Xpressbees, FirstCry and Flipkart have also witnessed similar secondary sales and transactions.
Investors like ADIA, Temasek, Khazanah Nasional, GIC and Qatar Investment Authority are in active talks to double down on their existing and new bets through a combination of secondary and primary share sales.
The Indian startup ecosystem is a dynamic and exciting market that offers investors a great opportunity to get involved. The current landscape presents a compelling case for investors to bet on Indian startups.
Considering investing in Indian startups, you should research and understand the risks involved.
Here are some tips for investors who are considering investing in Indian startups:
- Do your research. Make sure you understand the risks involved in investing in startups
- Diversify your portfolio. Don't put all your eggs in one basket
- Be patient. It takes time for startups to grow and become successful
- Build relationships with founders. This can help you get early access to good deals and make more money in the long run