Start-up space is not without its challenges but there's no funding winter for angel investors

‘It’s a bear market.’ ‘We are headed for a recession.’ ‘There is a funding drought.’

I’d be willing to bet my bottom dollar that you have heard a version of these statements in the last couple of months. But the fact of the matter is that there is no escaping the cyclicality of economics. The markets will go through a downward cycle every few years. For an intelligent investor though, this is a golden opportunity.

Turning a slump into an opportunity

A sluggish market is the best time to start your investment journey in the start-up space or to double down on your investments. Because right now, a great idea or a start-up run by an enterprising founder can be available to you at a reasonable valuation. And if you approach the situation armed with the right thought, solid research, and clear objectives, you can possess (or increase) ownership of a well-founded company with great management that can
potentially generate great returns when the cycle will inevitably turn bullish again. If you are an early-stage investor, then these down cycles can also bring opportunities to invest in some selected start-ups that otherwise wouldn’t have been available to Angels.

Needless to say, there isn’t a single asset class that precludes the risk of loss. But you must remember that start-ups (when reviewed on a portfolio basis) have consistently delivered; 20 per cent Internal Rate of Return as opposed to 3 – 12 per cent IRR that you get by investing in other asset classes. Portfolio Strategy enabled with strong upfront due diligence and stronger post investment support should translate into best-in-class returns across different asset classes.

The COVID catapult

The COVID-19 pandemic was a horrific phase that put the brakes on countless industries and work models. With everyone stuck at home, it was e-commerce, digital payments, online education, telemedicine, and ancillary industries that moved the world around. The fear of catching the virus meant that no one wanted to touch anything, even money. It almost forced people to move to online payments leading to a rise in the number of online transactions. The pandemic has effectively propelled e-commerce and digital adoption in India 10 years into the
future. And now, even as the pandemic has loosened its hold on the world, people continue to use online payments and e-commerce, because of habit. What started as a compulsion is now a convenience.

It is no surprise then that 2021 was a major year for the Indian start-up ecosystem where more unicorns were added than all the previous year’s put together. And this upward movement continued in Q1 ‘22 when 528 start-ups raised $12 billion. Clearly, interest in the Indian start-up ecosystem is at an all-time high. And while we have seen some softening in the markets in the last few months, as mentioned earlier, it is part of the cyclicality and as is generally observed with financial markets, every trough brings a rise higher than the previous cycle’s high.

The domestic market advantage

India’s GDP is expected to cross $5 trillion in the next three years and $10 trillion in the next 10 years. Consumption has been on the increase, and we are spending almost twice what we were spending 10 years ago. What’s more, with 50 per cent of our population below 30 years, consumption and expenditure will continue to rise unabated. This means that the domestic economy will continue to show strong growth in the long run.

Apart from being a ‘young nation’, India is a ‘mobile first’ country. With close to 800 million broadband subscribers, it is second only to China in terms of internet users. And since man of these users are currently mostly urban, there is huge untapped potential in India’s rural markets. As rural internet users grow, so too will data consumption and the number of transactions. The space is nowhere near saturation and the demand for funding is set only for growth.

Government support

Today the governments at the centre and states are recognizing the important role that start-ups are playing in our economy. They are generating employment across industries. They are using technology to create solutions for problems that have been plaguing India for generations, thereby lifting people out of poverty. They are generating strong FDI inflow. So, the government has made it their business to not just support start-ups but also support the
funds that support start-ups.

Challenging times ahead?

The start-up space is obviously not without its challenges. Financial superpowers in Europe and America are all fighting inflation and consequent actions are forcing economies into recession. In the last few months, there has been a continuous decline in funding. Big players in the start-up ecosystem like Ola, Blinkit, Unacademy, Whitehat Jr, Vedantu, and Cars 24 have laid off staff to cut costs.

But it is these high-pressure times that separate a good start-up from a great one. It was during the economic downturn of the 1970s when visionary founders like Bill Gates and Steve Jobs found ways to build companies that are household names with trillion-dollar-plus evaluations.

And while these layoffs will pinch in the short term, in no way can they signal the demise of Edtech or Fintech, or the broader start-up ecosystem. A long-term investor needs 0nly the patience to ride out this storm. Sometimes the down cycles are good. And yet many funds have raised record capital in the last 12 months with a focus on India. And now Big Tech is making a comeback on global bourses and even Indian equity markets are bouncing back.

Bottom-line

For an investor in the start-up space, it is important to not be alarmed by temporary fluctuations of the market and to have an investment horizon of at least five to 10 years. As an investor, you may choose to work with the start-up, opening your network to help generate business, monitoring, and advising as required. But to be a successful investor in the start-up space, the process to generate returns begins with undertaking stringent due diligence.

Sustainable growth and leveraging the country’s local production strengths will dominate India’s investment estimate in 2022. It is still a positive outlook for the success and growth of the ecosystem, despite the challenges. To achieve success in Angel Investing as an asset class, this approach is crucial.

The author is Partner, Physis Capital. Views are personal.

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