After two successive years of poor investment activity, start-up funding may start improving later this year as secondary share sales, strong performances by Flipkart and other large internet firms and an expanding internet user base drive an improvement in investor sentiment.
Mint had reported in November that early-stage funding of internet companies dropped to a three-year low in 2017, partly as start-ups were still struggling to justify their excessive valuations and venture capital (VC) firms who burned their hands in 2015 were still cautious. Over the past three months, investor sentiment has shown signs of improvement.
Education content platform Unacademy, online loans provider Lendingkart, social network Sharechat and a few others have raised successive rounds of funding in a short span – something that had stopped after the funding boom ended in late 2015.
Online retailer Flipkart and cab hailing app Ola have maintained their lead over Amazon India and Uber India, respectively. One of the reasons behind the funding slowdown was the fear that Flipkart and Ola, which have taken up a large amount of the capital invested into all Indian start-ups, would lose out to their rivals. Instead, the strong showing by Flipkart against Amazon over the past 18 months has helped boost the investor outlook on the entire ecosystem.
Now, the trigger for an improvement in start-up funding could be the proposed multi-billion-dollar deal between American retailer Walmart Inc and Flipkart, investors said. Walmart wants to buy a majority stake in Flipkart in a deal that could value the online retailer at more than $20 billion. If the deal goes through, many influential start-up investors including Tiger Global Management, Accel Partners and Naspers will see massive gains on their investments.
As the consumer internet market adds millions of new users every year with faster and cheaper data, opportunities are opening up for new types of digital businesses.
“I believe that the Walmart investment in Flipkart is definitely very positive for the Indian VC ecosystem,” said Niren Shah, managing director at Norwest Venture Partners. “It will prove that M&A exits for scaled internet companies is only a matter of time and will provide secondary exits to VCs.”
Shah added that the “ripple impact of the deal on the early-stage ecosystem” may take a few more quarters.
“The funding market has definitely improved in the past few months,” said Anand Lunia, managing director at India Quotient, an early-stage VC firm. “This year, I wouldn’t be surprised if (deal) volume increased by 50% or so from last year.”
What’s also helping investors is that over the past nine months, secondary share transactions have become a major source of generating returns.
Secondary share sales worth thousands of crore of rupees in start-ups including Flipkart, Paytm, Ola, Lenskart and others have provided funds with desperately-needed returns. These deals helped VC firms prove to limited partners – large investment firms that put money into VCs – that start-up investments in India could be lucrative even though returns take longer to materialise compared with the US and China.
Investors pointed out that funding boom and downturns happen in cycles. After a flurry of investments in 2010-2011, start-ups had to struggle through a funding winter for nearly three years until the middle of 2014. That upturn lasted for 18 months till investors pulled back at the end of 2015. Now, investors are slowly regaining the confidence to start investing heavily again.
Still, there are factors that could hold back a sharp improvement in funding volume. While investor appetite may increase, they may not find enough companies to place bets on. Mint had reported in October that the number of new internet and technology start-ups launched in the first nine months of 2017 had slumped to 800 from more than 6,000 in 2016 - a worrying sign for the next two years. Additionally, macro-economic and political factors such as an interest rate hikes in the US, the performance of stock markets (for domestic LPs) and the national elections next year could affect start-up funding.
“The funding market will improve this year for sure but for a 2015-type scenario to happen again, the number of VC firms will have to increase and the start-up formation will also have to increase dramatically. I personally think that in the second half of 2019 and 2020, we could see another bubble,” Lunia said.