Steep drop in early-stage funding, slowdown in start-up investments and lack of exits lead to concerns over return on funds in 2015 and 2016
Most of India’s top venture capital firms raised successively large funds in 2015 and 2016, betting on what looked like an internet gold mine then. After the slowdown in the growth of the consumer internet business since the start of 2016, venture capital firms are struggling to justify the large funds they raised.
A steep drop in early-stage funding, slowdown in start-up investments and continued lack of exits has led to concerns that venture capital firms have raised too much capital and will struggle to generate returns on the funds they raised in the past two years, investors said.
India’s top eight venture capital firms—Sequoia Capital, Accel Partners, Nexus Venture Partners, Kalaari Capital, IDG Ventures, Lightspeed Venture Partners and Matrix Partners—have together raised $3.8 billion since the start of 2015, according to Mint research. This amount doesn’t include investments committed by other investors such as Lightbox Ventures, Blume Ventures, Kae Capital and Inventus Capital Partners and recently launched funds such as Stellaris Venture Partners, Pravega Ventures and Endiya Partners.
Additionally, Matrix and Inventus Capital are in the process of raising their next funds, which will only add to the glut of early-stage capital.
The war chest accumulated by venture capital firms stands in stark contrast to the drop in investment activity. While start-up investments have increased this year in terms of value, the number of deals has dropped from 2016. Mint reported on 2 November that early-stage funding of India’s internet start-ups in 2017 has fallen to a three-year low, indicating that there may be an acute shortage of deal supply for venture capitals over the next two years.
Privately, many venture capital firms admit that they overestimated the potential of the internet market. They say that the internet market will grow, but at a much slower pace than they estimated in 2015.
“It’s clear now that most funds have raised too much money. Anything more than $150-200 million and you’re going to struggle to give returns. But most venture capital firms have raised funds that are two to three times bigger. The fact is that India is just not a deep enough market to absorb that kind of capital. And that will have consequences for the return profile of funds,” said a partner at one of India’s top five venture capital firms. He spoke on condition of anonymity.
Sequoia, Accel, Nexus and Kalaari all raised significantly larger funds in 2015 and 2016, compared with their previous funds. SAIF Partners maintained its fund size at $350 million, both in 2015 and this year.
Given their large fund sizes, some venture capital firms have tweaked their investment strategies. For instance, Sequoia Capital, which was doing a large number of seed-stage deals in 2014 and 2015, has reduced its early-stage investments. From its new $450 million fund, Accel Partners, which was primarily a seed-stage investor, is expected to carry out both a higher number of late-stage investments and plough more follow-on capital into portfolio companies compared with its previous funds.
Some experts said the drop in investment activity was an indicator that venture capital firms were taking investment decisions in a more thought-out manner and that investments made this year would lead to better returns than those made in the rush of 2014 and 2015.
“Across the board, funds have become a lot more disciplined and new investment activity has been restricted,” said Niren Shah, managing director at Norwest Venture Partners India, which invests in start-ups and larger companies. “The FOMO (fear of missing out) factor is no longer there and because of that you’re seeing better capital allocation. It augurs well for the health of the ecosystem because it means there will be less volatility. You’re also seeing venture capitals investing in new sectors (for them) like financial services and consumer and there will be multi-stage investments by the same venture capital.”