Foreign due diligence ‘crunching’ start-ups in India

Company background checks by foreign equity funds are denying Indian start-ups the capital they need to reach the growth stage after they’ve acquired seed funding by domestic investors.

MUMBAI – February 19, 2015.

While angel investors and accelerators have been broadly supportive of innovation in India across sectors ranging from IT to healthcare, closer scrutiny by larger foreign investors have stopped start-ups progressing to the next stage of funding by uncovering flaws in their business plans or company records.

The ensuing funding chokehold – being felt particularly acutely for non-tech start-ups in India at the moment – has even given rise to its own terminology, known in venture capital circles as ‘Series-A crunch’.

Findings by Indian deal database VCCEdge illustrate this growing phenomenon… Their research shows that while completed angel and seeding finance rose to 283 last year (up from 117 in 2011), Series-A deals fell to 74 from 119, over the same period.

Their data also shows that VCs invested over $2bn across 246 deals in 2014 (including 60 seed investments), compared to $1.4bn of funding across 217 deals the year before. (Indian start-ups typically look for $1-3m as they scale up, two to three years on from receiving their initial investment.)

Aneesh Khanna, the entrepreneur behind healthcare firm MyLabYogi, raised US $160k of seed funding from Hyderabad Angels two years ago but has been unsuccessful in achieving further financing, since.

Big investors were interested in the SaaS, e-commerce and mobile sectors last season, leaving us at a loss in healthcare” he said.

Blume Ventures’ founding partner, Karthik Reddy, says a critical bottleneck has been created by companies competing for post-seed funding, where no single entities are being granted Series-A cash.

His fund has witnessed only a handful of tech-related start-ups – including Grey Orange Robotics and price comparison site, Zopper – successfully scaling up globally by acquiring follow-on funding in recent times, notably from the same US investment firm, Tiger Global.

Venture Intelligence, an Indian analytics firm that provides information and analysis on private company financials and transactions, says its research shows funded companies in the country increased to 230 in 2013 (from 160 in 2010), but that the volume of start-ups securing re-funding over the same period fell to 32 in 2013 (from 43, over the same period).

Serial entrepreneur Krishnan Ganesh, behind online tutoring business TutorVista and healthcare provider Portea Medical, says barriers coming down to registering a company in India, and getting initial investment to get it off the ground are part of the issue.

Larger investors coming in after the seeding stage don’t demonstrate the same rigour in evaluating these companies, leading to them being rejected for Series-A funding by venture capitalists looking squarely at validation and proof of concept,” he explains.

Harvard Business School lecturer Shikhar Ghosh says India is not the only country where the quality of start-ups hasn’t kept pace… His study of 2,000 venture-backed companies in the US – between 2004 to 2010 – found only 24 per cent were able to return profits for their investors.

One person active in the angel investment scene in India is Mumbai-based Rehan Yar Khan, who has successfully seeded half a dozen Indian businesses at $30k-$100k per deal, in the past four years.

“While the number of angels, investors and incubators has grown,” he says, “the quality of start-ups is playing catch-up on a grand scale… As such, over the last decade, the start-up mortality rate has risen globally.”

Smaller investors are so keen to back ‘the next big thing’ in India that some are even funding start-ups by backing business ideas without a monetisation plan, so long as they can see the required level of engaged adoption.

Start-ups are consequently becoming more savvy about who they take seed capital from, so as to insure themselves against hitting the follow-up funding wall that so many of their peers face.

An answer to avoiding the crunch could soon be to use seed stage investors who are responding to the problem by opening up their own first and second round funding channels, too.

Regardless, founder of crowdfunding platform Wishberry, Anshulika Dubey, advises all entrepreneurs in India to exercise comprehensive due diligence when taking initial capital from anyone.

“Entrepreneurs should consider who they want on board, and vet funders properly to see exactly what they have done prior in their investment space,” he advises.


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