VC firms like Iron Pillar, Zodius and B-Capital eye mid-stage deals

With hedge funds keeping away, there are few investors willing to lead Series-B/C rounds

A Mumbai-based software firm is raising $20 million in Series-B funding. Its existing investors are willing to chip in $5 million and it has identified three investors who are willing to bring in $4-5 million. The problem is it is unable to find an investor who can lead the Series-B round. 

This is a common issue being faced by start-ups looking to raise a Series-B or Series-C round of fundings. With hedge funds, who were active in this space in 2014-15, no longer investing in India, there are few investors willing to lead rounds in Series-B/C of Indian start-ups. 

‘‘Lot of start-ups have raised Series A, but not able to raise Series B, or those who have raised Series B, but are not able to raise Series C. That's the biggest challenge as there are no mid-stage funds in India,'' says a partner at a venture capital (VC) firm. A firm raising $10 million or less can find several early-stage firms; there are many who can write a $50-million cheque, but not many VCs who can invest $10-40 million.

This could change with several VC firms — Iron Pillar, Nandan Nilekani-Sanjeev Agarwal’s VC fund, Ratan Tata, Zodius, Stripes and B-Capital — eyeing this space. ‘‘India is not just about a Flipkart; many interesting tech firms are coming from India. Zoho, for instance, could be valued at $4-5 billion if it lists at Nasdaq, but not many have heard of it,” he says.

‘‘I see at least 75 good firms which can be funded every year in the mid-stage space. With an average deal size of $15 million, you are talking of $1 billion-plus in a year. As it takes on an average three years to deploy a fund, there is an opportunity to deploy $3.5 billion over three years in India mid-stage,” says Anand Prasanna, managing partner, Iron Pillar.

There were 90-odd Series-B deals in 2015 and 2016 with deal value of $484 million and $662 million, according to Venture Intelligence. There are other players in this space like New Enterprise Associates, Bessemer Venture Partners, Omidyar, Bertelsmann and stage agnostic players like Sequoia Capital.

If this was such an opportunity, why there are only few players operating? Very few people, including PE/VC investors, understand this market. It’s also difficult for early-stage funds like Accel, Matrix or Sequoia to lead a Series-B deal, unless there's a new investor coming in. 

‘‘Earlier, hedge funds were playing that role; now there’s nobody to fill in that role. That’s the biggest problem. Deals are not getting done as there’s nobody to lead,” said another VC, who didn’t wish to be quoted. Hedge funds invest with short timeframe but misjudged India. They came looking for the next Alibaba, Uber or Tencent, but it may take longer to build them here. Besides, the biggest tech company in China (Alibaba) doesn't look like the biggest tech firm in the US (Amazon).

Currently, start-ups are raising Series-B/C money from random investors who may invest in one company a year. ‘‘There’s no go-to guys. You have to approach some investor in China, Japan or the US, and raise money from them. You may find an investor, but he may not invest for the next 18 months,” says Prasanna. Most recent deals in mid-stage were one-off deals, led by investors who are not in India.

 

Limited partners (LPs) or investors in VC firms should find mid-stage deals appealing. There is a good pipeline of early-stage businesses, 200-250 firms, that get funded every year. A bunch of them are growing and trying to prove themselves. There’s a great opportunity for investors to come in and invest at Series-B or Series-C stage without taking the risks of an early stage investor. Typically, mid-stage VC firms look to invest in start-ups with $4-20 million in revenues, and many are profitable. 

Yet, it would be challenging to convince the LPs ‘‘to understand this space because that's a large education process. It's extremely expensive processes to fund raise for India,” says a VC. 

Early stage investors have each made 2/3 bets in payments or SAAS, investing $3-5 million in Series A for a significant stake, and there’s no incentive for them to leave their own companies and invest in another firm backed by another investor. 

Early stage investors are not keen on leading mid-stage deals as they feel it’s not their business. ‘‘We are early stage investors. We don't understand mid-stage. The skill sets required for doing mid-stage are very different. Our job is to find the best entrepreneur and the best ideas and backing it with risk capital,” says an early-stage investor.  

Mid-stage VCs invest when they see a good business being built, unit economics are in place and provide growth capital to grow it. ‘‘It's like moving from a VC to a PE, with an ability to help the companies do M&As, do fund raising. We are happy with 60-60 per cent growth, while early-stage investors would expect 5x-6x growth,'' explains a mid-stage VC.