VC Buzz Turns to India's Startups

Early-stage telecom startups in India have traditionally had a hard time securing initial funding, as VCs have been focused on late-round investments in stable startups.

That tough startup situation is slowly changing, though, as new funds target India's high-tech sector. But the influx of hungry new investors is also creating new challenges.

Earlier this year, a report by Rafiq Dossani of Stanford University and Asawari Desai at TiE (The Indus Entrepreneurs), "Accessing Early-Stage Risk Capital in India," noted that although venture capitalists have been targeting India, a dearth of seed and first-round funding for new startups was hurting innovation in the Indian market and limiting the number of late-stage investment opportunities these investors could spend their money on.

They wrote: “Over 90% of the money is invested in late-stage initiatives by mature firms. Even the remainder mostly finances new firms replicating proven business ideas. As a result, very few innovative startups are funded. This will have a negative ripple effect on the quality of late stage opportunities in later years.”

But a recent report from analyst firm Evalueserve Inc. notes the pendulum is about to swing in the opposite direction.

Scores of firms have announced India-focused funds that include telecom among their target sectors, and many have said they’re seeking early-stage investments -- so much so that there’s likely to be a glut of money with nowhere to spend it. (See VC Funds Flock to India.)

Alok Aggarwal, author of the Evalueserve report, "Is the Venture Capital Market in India Getting Overheated?", notes that more than 44 U.S.-based VCs have raised, or are in the process of raising, between $40 million and $400 million each to invest in India.

“If these 40-plus firms are successful in raising money, they would garner approximately $4.4 billion to be invested during the next 4 to 5 years,” he writes.

He goes on to say that, as a typical startup in India needs $9 million during its first three years (if it survives that long), even if VCs spend only 50 percent of the amount they’ve pledged, they would need to find up to 180 companies in which to invest by 2010, “which would simply not be possible if the VCs continue to focus on their current favourite sectors” -- IT software and services, business process outsourcing, telecom, and consumer Internet.

He adds: “This, of course, would be a marked contrast to the current situation in India (wherein such funding is rather scarce) and it will also make the market for the ‘right deals’ extremely competitive for these VCs.”

Aggarwal lists some “on-the-ground realities” for investors, including a lack of sales/marketing and business development expertise among Indian entrepreneurs, and a need for continuous funding in small amounts rather than the traditional two or three stages for U.S. startups.

"Of course, this would imply that the VC has to be more involved operationally with the Indian start-up and simply attending a board meeting every two or three months might not be sufficient."

That suggests investors with international experience will be more likely to secure involvement with their favored startups.

In the meantime, the VCs are still assessing the Indian startup landscape. "The early-stage opportunity in India is still being figured out," says Rahul Khanna, director at Clearstone Venture Partners , which has a $200 million fund. "It has definitely been an underserved segment of the market."

As startups attempt to find their feet, "the time to maturity in India might be longer than classic Silicon Valley companies," he says. Like Aggarwal, he notes Indian startups "need more handholding" than their Western counterparts, and VCs should be "wary of just throwing money at companies… Beyond money, it’s about having the people to support the businesses."

He adds: “I think it's going to be difficult to find people that do understand what it takes and the context of the Indian market… That continues to be a challenge for all funds, especially for early stage investments.”

Khanna says despite all the immediate excitement over the Indian market, it's important to emphasize the long-term perspective and avoid looking for quick exits. Clearstone is looking at companies with a two- to three-year time frame in mind, he says. "Investors need to pace themselves; it takes time to create value."

— Nicole Willing, Reporter, Light Reading

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