Why VCs are still backing Indian startups despite growth stocks crashing

Growth stocks like Indian companies Paytm, Zomato and Freshworks are some example of unicorns that went public recently but have performed poorly against the rest of the market

The last few months have not been good for startups and their venture capital (VC) backers.

Growth stocks like Southeast Asia's largest ride-hailing and food delivery company Grab, ecommerce giant Sea Limited, Indian companies Paytm, Zomato and Freshworks are some example of unicorns that went public recently but have performed poorly against the rest of the market.

Grab and Sea Limited, both listed in the US, are down 65 per cent year-to-date. India listed delivery firm Zomato is down 49 per cent whereas fintech company Paytm is down 53 per cent.

Both are listed in India while Nasdaq listed software house Freshworks is down 40 per cent for the year. This is in comparison to the SENSEX which is down just six per cent and S & P 500 index's decline of 14 per cent since the start of 2022.

These growth stocks have been impacted by rising interest rates and inflation which is seen by the market as bad for newer firms which typically require loans to expand quickly. The possibility of a coming recession, and the uncertainty caused by supply chain problems and the Ukraine-Russian war are not helping.

Indeed, Amit Anand, co-founder of Singapore-based venture capital fund Jungle Ventures told CNBC that three of its companies have deferred their IPO plans. However, "the companies will definitely go public in the mid to long term," he said.

The current market and economic doubts are by no means the only problem facing startups.

Celebrated VC firm, Sequoia Capital was reported in the media to have postponed the closing date of its USD 2.8 billion India and Southeast Asian fund. The reason given was alleged financial irregularities and corporate governance issues at some of its portfolio firms. It has been widely reported that problems have cropped up at two of the startups it backed - lifestyle video app Trell and Singapore-based B2B e-commerce fashion firm Zilingo.

Poor market sentiment towards growth companies has also caused SoftBank Group to report a loss of USD 13 billion in 2021, a sharp reversal from a record profit of USD46 billion a year ago. This was on the back of a stunning USD 26.2 billion loss at its two Vision Funds which has over USD 150 billion of funds under management. SoftBank's Vision Fund is a VC fund that takes bets on high-risk technology startups.

The loss was triggered by the market downturn as some of its recent listing are trading below their IPO price as well as due to re-valuation of its unlisted portfolio due to weakness in the public markets.

Publicly listed Grab, Didi Global, Coupang and Alibaba are among the companies in which Softbank has a significant stake in.

Vision Fund has 475 companies in its portfolio and made 43 investments during the fourth quarter of 2021.

Its founder and CEO Masayoshi Son said at its earnings briefing in May that it is slowing the pace of investment as private prices lag the fall in public markets and expects to par back investments by as much as a quarter to half of last year.

However, the market downturn has not stopped other VCs from upping the tempo of its investments in India and Southeast Asia.

Nikkei Asia reported last week that venture capital (VC) firms that back startups in India and Southeast Asia are raising record sums for new funds as investors back away from China.

India and Southeast Asia focused VC funds have raised USD 3.1 billion so far in 2022 according to data from London-based investment data firm Preqin. In contrast, fundraising by China-focused VCs fell dramatically from USD 27.2 billion in 2021 to just USD 2.1 billion, as investors shied away from China startups due to last year's tech crackdown. This year the harsh COVID measures introduced to slow community transmission of the disease is doing the damage.

"Fifty per cent of investors we spoke to are trying to diversify out of China," said Jungle Venture's Anand, which recently raised USD600 million for new funds to invest in Indian and Southeast Asian startups.

In May, Singapore-based East Ventures said it raised USD 500 million to invest in startups in Southeast Asia, bringing assets under management to more than USD 1 billion. In April, India's Elevation Capital said it raised its largest-ever fund with USD 670 million.

The reason VC funds, which raise money from investor that range from pension funds and university endowments to wealthy individuals, find the region attractive is because of the fast growth of startups. This is due to favourable demographics. Encouraging trends include a rapidly rising middle class, youthful population and growing digital adoption. Some of these trends have been accelerated following COVID.

The Google, Temasek Holdings and Bain & Company 2021 report on the state of the digital economy revealed that 40 million people in six countries in Southeast Asia - Singapore, Malaysia, Indonesia, Philippines, Vietnam and Thailand - became new internet users in 2020 during the pandemic. This was fuelled by lockdowns and working from home, leading people to turn to technology-driven services.

According to analysis by Bain & Company produced in 2019, if India's economy continues to grow at a rate of 7.5 per cent, 500 million people will move into the middle- and high-income bracket by 2030. Another report published in 2020 by IAMAI-Kantar ICUBE, says that India's active internet users will increase from around 622 million in 2020 to 900 million by 2025.

Anand believes that India and Southeast Asia is only getting started. In the same CNBC interview mentioned earlier, he said that Southeast Asia's e-commerce ecosystem is still at a "very, very nascent stage." "We've not even scratched the surface of that," he added.