PE investors make a beeline for start-ups to generate higher returns

Traditionally, they invested only in firms with cash flow but these have not generated great returns; with tech disruption, trend set to continue

Last month, private equity (PE) firm WestBridge Capital led a $54.6 million Rs 391 crore Series-B funding in Roppen Transportation Services, which runs motorcycle pooling and taxi start-up Rapido. 

WestBridge has also backed start-ups such as Design Café, IndiaMart and IndiaQube. And, it is not alone. On Monday, Canada Pension Plan Investment Board (CPPIB) invested $115 million in logistics provider Delhivery. A business daily reported that PE firm Kedaara Capital could lead a new funding round in eyewear chain Lenskart that could value the company at $1 billion. 

Traditionally, PE firms in India or abroad only backed companies with cash flow. Globally, however, they are now looking to make higher return. And, led by sovereign funds like GIC and Temasek, PE firms are increasingly betting on start-ups.

Warburg has backed start-ups CarTrade, Ecom Express and Rivigo. TPG has invested in consumer internet firms Book My Show, Lenskart, LivSpace and Nykaa. General Atlantic has backed BillDesk, Byju's Classes and NoBroker. 

Temasek, the PE entity of the Government of Singapore, has invested in start-ups such as BillDesk, CarTrade, Eigen Technologies, Manthan Retail, Pine labs, PolicyBazaar, Snapdeal, and Zomato. GIC has backed Little Internet, Ola, ShopClues, Sulekha and Zovi.com. 

‘Historically PE firms investing in financials, services or infrastructure have not generated true alpha (term for excess return over the chosen benchmark). They are exposing themselves to rising input costs, political risk, fluctuating commodity prices and a delicate macro environment globally. The best tech companies grow at over 30 per cent a year, while large companies grow at less than 10 per cent a year,’’ says Sajid Fazalbhoy, principal at venture capital (VC) entity Blume Ventures. 

‘‘Also," he adds, "Most of these businesses have well-set valuation benchmarks. Tech investments insulate you from most of the above risks. Once there is large adoption on tech platforms, it is easy to extrapolate market penetration, revenues and even profit. Companies such as BookMyShow or Nykaa have achieved positive unit economics and could be profitable. They choose to keep high marketing budgets to dominate and make it a winner-takes-all."

Typically, VC firms target returns of two to three times. Hedge funds are happy with 18 per cent, while PE firms target 20-25 per cent return on their investments. VC firms invest early and take higher risks. When PE firms invest in these start-ups, they are valued at $200-300 million and have figured out their business models. The risks are considerably lower; yet, there is opportunity to take them from $200 million to $1 billion.

Girish Vanvari, founder, Transaction Square, feels this trend will only increase in the coming years, as technology disruption is here to stay. Such investment will only increase. 

In today’s smartphone-driven world, alternative asset managers understand the value of backing information technology-led businesses. They have caused global disruption across sectors — media, retail, financial services. Google, for instance, went public in 2004 at a $23-bn valuation. An investor buying Google at its Initial Public Offer would have multiplied its money more than 30 times. No wonder, large amounts of global capital now flow into tech businesses. Apart from Softbank Vision Fund, there are mutual funds, hedge funds and multi-billion dollar growth funds that chase tech. Going forward, there would be enough capital to fund the best assets.  

PE investors also realise that tech companies are nimble and acquisitive. ‘‘Generating MTM (increase in mark-to-market valuation) and even exits is possible now. PE risk with venture returns in tech growth companies is now possible,’’ adds Fazalbhoy.