India Startup Report: 3 Reasons to be Excited for Indian Founders in 2016

For a US$ 2.2 trillion economy of 1.3 billion people, the role that startups are playing in India could only be summarized in one word — exciting. USA makes up 76% of deal value globally but its share has fallen from 95% in 2006. Meanwhile, the combined share of India and China’s deal value has risen from 2% to 24% over the past decade. At the macro level, there are 3 levers which make India's startup potential exceptionally exciting.

First, the Increasing Quantity of Startups

According to NASSCOM, India has moved to 3rd position in number of startups with the fastest growing base of startups worldwide. With around 2/3rd of the population under 35 and an average age of 28 for founders, there is sufficient demographic dividend to sustain (if not boost) the growth momentum. NASSCOM predicts that the pace of startup launches will increase from 3-4 every day in 2015 to 6-7 every day by 2020. Potential can be judged from the fact that there is 1 entrepreneur for every 150,000 Indians (assuming average 2 founders per startup) compared to 1 in 3,500 Americans and 1 in every 7,000 British.

Next, Strengthening Economic Growth

India has reached an inflexion point in 2015 with the growth rate overtaking that of China’s. Lower commodity prices, better governance & reform agenda, and digitization will be the key drivers of growth going forward. IMF predicts that India will outpace China for the foreseeable future and be one of the engines of world growth along with Africa. Keeping the GDP/ start-up constant at 2015 levels, India will need to double the number of start-ups by 2020 just to keep pace with economic growth.

Last, A Stabilizing Population

While the potential of large population and consequent market size has been oft-quoted, the slowing pace of population growth and the trajectory towards replacement fertility rate by 2020 presents India with an entirely new opportunity. A stable and increasingly urban population will bring predictability to planning and allow startups to target consumers in a more focused manner as more data becomes available.

Today, if the population pie was split equally between startups, every business would have a target population of 300,000 all to itself. That is almost 50X of USA’s level and shows that there is room for more competition to serve the population as India moves from volume driven to value driven market.

Table 1: Comparison of top 5 startup Nations

Source: NASSCOM, International Monetary Fund (IMF)

Note: We believe China is not directly comparable to India because of its centralized government controlled economy dependent on public finances.

To capture this potential, the VC industry has also grown by leaps and bounds. According to Preqin, the number of VC deals and total funding has doubled and quadrupled respectively over the last 5 years in India. There are over 150 active VCs, 300 active angels, and 100 active incubators/accelerators along with startups who form the Indian start-up ecosystem. Despite this growth, the ecosystem remains nascent when compared to the matured Silicon Valley and USA ecosystem.

Table 2: Comparison of India and USA’s VC ecosystem

Source: NASSCOM, Preqin, NVCA, ACA

While the comparison can be termed as unfair, it points to the general direction in which the VC industry can grow -- that is, only up. In 2014, 14 VCs closed their India-focused funds collecting US$ 2.2 billiom from local and international investors. This includes the largest India focused fund of US$ 740 million raised by Sequoia. In fact, India-based VCs like SIDBI and Nexus Venture Partners have cumulatively raised over US$ 1 billion over the past 10 years.

eCommerce, transport, food, logistics, and financial services remain some of the more sought after sectors. The most encouraging aspect of last investment cycle has been the US$ 800 million worth of exits achieved by VCs in India successively over the past 3 years. The exits includes the likes of Freecharge (US$ 400 million valuation), Myntra (US$ 300 million), VRL Logistics (US$ 250 million), and TutorVista (US$ 213 million).

How Should a Startup Take Advantage of Funding in India?

In general, VCs look for 3 criteria while identifying start-ups for funding:

Market/ opportunity size: As a thumb rule, if you’re not serving a market that is worth at least US$ 1 billion of net revenues on national level within the next 5 years, you’re not relevant to most professional VCs. This market size maybe estimated based on substitute products/services, customer purchasing power, potential savings delivered, or as a share of broader market pie amongst other things.

A large market size provides cushion against competitive forces, learning curve, and challenges of scaling. For example, eCommerce, healthcare, or F&B might fit this criteria whereas rooftop gardening, reggae music listeners, or sports goods for physically handicapped might not. Also, without a large valuation in later rounds, a VC’s likely single digit equity share will not be worth much.

Defensibility: If a start-up’s market size is large but with low barriers to entry, it will not satisfy most VC’s criteria. The presence of large number of competitors or established leaders will be a turn-off. Even if a startup has identified a niche but others can copy it quickly or the market leader can introduce it as a business vertical, the pitch to VCs will significantly weaken.

Defensibility can be inferred from exclusive tie-ups, proprietary content, lead time to imitate, or patents (albeit to lesser extent in India) amongst other things. For example, F&B industry with over 50 startups or eCommerce with established leaders like Flipkart and Snapdeal are probably not on top of most investors’ radar today.

Team pedigree Factors such as founders’ educational background, professional background, relevant experience, level of product/service/business model innovation, hustling ability, and presence of complementary skills play a role in figuring if the team can execute the plan to its potential or not. It remains one of the single biggest factors in the decision to invest. Most VCs are not looking for the billion dollar start-up but for the billion dollar entrepreneur.

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But even if you fit the above criteria, entrepreneurs have to keep in mind that VCs are more than just bags of money while accepting funding. Most professional VCs will be able to provide true operational value add to start-ups in the form of industry knowledge, implementation expertise, client acquisition, team building, and/or M&A. Like every start-up is unique, so is every VC.

Our Top 10 Predictions for the Next 5 Years of India's Startup Ecosystem

1. 2016 to 2020 will be more about exit valuations rather than entry valuations

2. India will overtake UK to become the second largest ecosystem in terms of number of startups

3. Home grown VCs will overtake international VCs in terms of funds under management

4. Singular India-focused funds of more than US$ 1 billion will be raised

5. Next set of unicorns will emerge from niches within larger categories

6. Average valuation rounds will peak, then fall, and stabilize

7. Women entrepreneurs and women investors alike will form an increasingly larger share of start-up ecosystem

8. M&A and consolidation amongst start-ups will gain ground either for survival or to fend off competitors

9. Well-funded Indian startups will increasingly become an important source of early stage funding and exits

10. The share of start-ups originating outside the Big 3 BDM — Bengaluru, Delhi NCR, and Mumbai, will rise as tier 2 towns such as Pune, Ahmedabad, and Hyderabad increasingly become more important

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While one can choose to focus on the negatives, there is a lot for Indians to be proud about — the startup culture and spirit of entrepreneurship is definitely amongst them. India has grown at +8% for over a decade in spite of an unsupportive ecosystem because of its citizens. A strong startup ecosystem in India signals to the world that emerging markets are willing to take a lead in innovation and disruption. Wouldn’t it be a culmination of India’s scientist president, APJ Abdul Kalam’s Vision 2020 in its purest form?