Venture Capital for 2024 and beyond

TL;DR

• The reset of the ecosystem from a funding standpoint will only mean India will emerge stronger and better from a private investments standpoint.
• Education, healthcare, and financial services will be the sectors that will be disrupted over the next few years and will add value to India’s growth story.
• Aspirations across the Indian population (both urban and rural) are the same. And we should move past India 1,2,3 segregation (based on per capita income)
• For Rainmatter, the longevity of businesses we support is critical. We will expand to other sectors as we build expertise. We are a young team and will only learn and grow over the next few years.
• The next decade of VC in India will look significantly different to the past three years. We will have the best VCs backing entrepreneurs and less asset managers wanting to flip businesses.

Overview

History is always mesmerising. While this blog is all about contemporary VC sentiment, I think it is an excellent opportunity to walk down the memory lane of the Indian economic journey. Because to predict where we will be, we must know where we have come from.

Entrepreneurship was never alien to India - it defined us as a country. There is a deep sense of Indian history with self-employment going back to 2700 BC.

To discuss the growth or development of entrepreneurship in India, you must understand that India has one of the oldest and most civilized business histories. During the Harappan civilisations around 2700 BC, there was an internal and external trade culture. Also, due to this, most foreign countries recognise Indian entrepreneurial skills. (Source)

And during the pre-independence era, we saw entrepreneurship come to the forefront again,

• The first cotton textile mill was revolutionized in 1854 by an Indian entrepreneur, Kawasji Dover. It was one of India’s boldest steps in the modern development of entrepreneurship development.
• Jamsetji Tata founded the company Tata Group in the year 1868. With the foundation of the Tata Group, he has created a bar for entrepreneurship development in India.
• 1874 Cotton Mill by JRD Tata, TISCO by Dorabji Tata, 1932 Tata Airlines, Tata Steel Plant, and more were high-rate businesses in India. At the same time, it has also played a major role in various independence initiatives. (Source)

The post-independence era of 1950s to 1990s is well documented. Historians often reminisce how, in 1950, India was the best of the rest in Asia. But from 1950 until the mid-1980s, private capital was suppressed, and policies were not conducive to business. License Raj was on full steam. Our GDP grew by 3.5%, and per capita income grew by 1% per annum. Just like that, by the 1980s, we were one of the poorest countries in Asia. During this period, the industrial sector grew at an average rate of 4.5% yearly, compared with an annual average of 3% for agriculture.

Then, the 1990s arrived with full hoo-ha. While we keep referring to the reforms of the 1990s and the brilliance of then PM Narasimha Rao and FM Manmohan Singh, a bunch of economic liberal policies were already set in motion by the 1980s. Here is Montek Singh Ahluwalia describing the 1980’s,

Indeed, 1991 was a watershed moment. The basic idea that we needed to reform our industrial and trade policies was being discussed in the 1980s, and several important steps were taken, especially in the second half of the decade. But they did not amount to a comprehensive blueprint for systemic reform. That is what 1991 achieved. Within two years, India’s industrial and trade control regime had been liberalized beyond recognition. Someone who is 45 years old today was only 20 when those changes were made, and they cannot imagine the absurd level of controls that were in place.

Nonetheless.

“No power on earth can stop an idea whose time has come,” Singh quoted Victor Hugo in his Budget speech in July 1991.

From an average of about 4.4 per cent in the 1970s and a little further in the 1980s, GDP growth started hovering above 5.5 per cent in the 1990s and early 2000s.

Fast forward to today, the economic indicators make for a much better reading and the business ecosystem in India is thriving.

Here is Pranav Pai from 3one4 Capital explaining what has changed over the decade,

The Indian economy has outperformed most large economies since its 1991 liberalisation. It has grown from a 1991 GDP of ₹5.32 lakh crore ($275 billion) to ₹272 lakh crore ($3.47 trillion) in FY23. This translates to a robust CAGR of 13.08% in nominal rupee terms, and 8.24% in dollar terms over 32 years. No other country except China has achieved this tremendous feat, and India has laid strong foundations for its GDP leap forward from here. I India exited FY23 strongly with a nominal GDP of $3.4 trillion (₹273 lakh crore) and is now the fifth-largest economy in the world. It grew at a phenomenal 16% in FY23 (following 18.4% in FY22) in nominal terms, continuing to beat multiple forecasts that growth would slow down post the pandemic. India stands as the fastest-growing large economy in the world that has seen most large economies slow down significantly. The April 2023 update of the World Economic Outlook predicts India to remain the fastest-growing economy in FY24, as have other major economic institutions. Over FY24, budgeted real growth is pegged at 6.5% – the highest among large economies worldwide. Adding inflation of 4-5%, nominal growth could reach 11-12%, catapulting India’s nominal GDP to ₹303 lakh crore ($3.7 trillion). At the same growth rate, nominal GDP could reach ₹338 lakh crore ($4.1 trillion) in FY25.

Today, India is propelled by political stability, social unity, and demographic strength. Approximately 50 % of households are projected to have an annual income exceeding Rs. 5 Lakh by 2030, up from 33 % in 2019. This rise added to over 23 million households expected to earn more than Rs. 20 Lakh by 2030.

While a lot of the growth can be apportioned to larger businesses, smaller startups, MSMEs and all Indians have contributed to this journey. The growth in GDP, productivity, employability, skills and per capita income of the future are all linked to how the startup ecosystem holds itself together over the next few years. This was precisely what I was invited to speak about at the recent WeWork Event titled ‘The Next Billion’.

I had Siddhartha Anand from Karnataka Digital Economy Mision and Rajiv Srivatsa from Antler on the panel, with Jivraj Singh Sachar moderating.

Some of the questions and discussion points were quite interesting, and I felt it would be nice to document them on a blog for everyone else who missed the event. So here goes.

Where are we today?

The past decade has been the coming of age for the Indian startup ecosystem. Capital has been readily available, we have founders wanting to take risks and build businesses, we have a young workforce and talent, and we have great ideas being worked on. All of which are ingredients needed to propel us through the next phase of economic development.

Let’s go one step further and get a sense of the numbers,

• The amount of VC funding startups raised in 2023 was $10 bil - in comparison, it was $35 bil in 2021 and $21 bil in 2022.
• New and old VC funds raised $18 bil in 2022 to deploy but only managed to raise $6 bil in 2023.
• The ballpark calculator sets dry powder in the VC ecosystem to be anywhere near $18-20 bil.
• And there were ~10 lakh jobs created just by startups in the past 5 years,

While the 2023 funding amount seems low, it is, in fact, a mean reversion to the $10 bil/year amount that India has consistently attracted for a decade. So, the current situation is more of a reset than a winter. Maybe a much-needed reset and cleansing.

Statistics apart, a lot has changed on the people front as well. The past few years of mad rush towards private companies in India have also attracted a lot of tourist VCs and founders. But with easy money out of the picture and as the interest rates in the US have spiked, the risk capital availability in India has also dipped. After all, why would you invest in a risky VC fund in India while you are getting decent returns with minimal risk back home?

The truth is that packaging of VC assets was rampant over the past 2-3 years. The low-interest rate regime from the 1980s till 2022 meant excess capital kept moving higher and higher up the risk curve in search of returns. The interest rates on bank deposits were so low that the opportunity cost of maintaining the status quo was 0.

Here’s how the VC part of the journey looked like for the past 3 years - seed investors (early-stage investors who take the most risk) would invest, hoping the business would get Series A funding. The Series A investor (the next growth stage investor) would invest, hoping Series B funding is available and so on. At no point through those funding stages did the founder and investor slow down to think about capital efficiency and sustainability. Operating without external funding was never thought of. This is why, globally, we saw VC asset managers (investors who were flipping investments) rather than pure artisanal VC investors (VCs with deep expertise and motivation to guide companies at the early stages).

For India specifically, the easy money phenomenon of the West was quite a revelation. While domestic capital is available to a certain extent, risk capital or VC funds still have 80-90% of funding sourced from foreign investors, which is fair since the risk appetite is higher for these folks. And with all that is happening with rate hikes and monetary tightening in the US, we have seen how some of that foreign capital vanished. This compels us to think about the funding ecosystem and how we can be better prepared for the future.

Despite all of this, the resilience of the Indian startup ecosystem has been on full display throughout 2023. While things were falling apart from mid-2022, we have passionate founders working hard and amazing VCs willing to guide them. Not to say it was all positive - because when a reset happens, there is bound to be some pain in the short term. Layoffs, for example. But for most parts, the reset brought lessons and learnings that will only help the ecosystem in the long run.

But the key takeaway is that if you are a founder looking to build a great business, capital will always be available.

What will be levers to empower ‘The Next Billion’

I hail from a tiny village in Karnataka. And the community around me has enabled me to achieve whatever I have today. The gratitude I have cannot be described in words. This is why the topic of enabling prosperity for the next billion in India was very close to my heart. It is also a topic I spend quite a lot of time thinking about daily. There is an ever-increasing wish to give back to the community that has given me so much.

Even at Zerodha and Rainmatter, the focus has always been to help Indians with managing money and health and also to support teams solving for the planet’s health.

Having spent time learning across these sectors, I believe four critical levers would help India.

• Education - while there has always been a focus on jobs and incomes, focus on education will define the next decade for Indians. Practical education and skilling will translate to employment opportunities that would otherwise be elusive. The government and private sector will both be responsible for making it happen.

  Actionable items could be integrating soft skills early on in schools, awareness about career path options, and practical education on life skills such as personal finance early on, which will have compounding effects in the long run. Which can make a massive dent in developing the next generation of our workforce with equal access to opportunities.

• Healthcare - needless to say, healthcare is one of the most expensive services for Indians. One health event can wipe off life savings. While there have been govt schemes to augment expenditures - such as Ayushman Bharat- more needs to be done by the private sector to enable Indians to have easier and equitable access to healthcare.

  We will need to improve access to affordable healthcare. Health insurance awareness, telemedicine, and community health initiatives can ensure that Indians are safeguarded. We can start by increasing the penetration of Insurance (life and health) from a dismal 4% to atleast 8-10% of the population over the next 4-5 years.

• Financial services - are crucial for the population of a developing country like India for several reasons. They provide access to essential tools for economic participation, such as banking, credit, and insurance. Financial services enable individuals to save, invest, and accumulate wealth, fostering economic stability and growth. Financial services are pivotal in economic development, reducing inequality, and improving the population’s overall well-being.

  While the successes of Adhaar and banking penetration of 80-85% are commendable, a massive section of the population does not have equitable access to credit for several reasons. There is also a lack of awareness of insurance, as we pointed out earlier. All of these give entrepreneurs opportunities to build solutions in financial services and rethink how India behaves.

• Entrepreneurship - all of the above are potential candidates for government intervention, but they are also an opportunity for the private sector to solve some of these deep-rooted problems. India is such a vast country that there will always be a need for the private sector to augment all governmental efforts. Call it the multiplier effect, where small contributions compound over time as more people join in with efforts. And we will need as many hands to contribute as possible.

  We will need policies and infrastructure to back entrepreneurs willing to take risks. Thankfully, given all that has happened in the country over the past few years, entrepreneurship is a viable career choice today. Across several towns and villages in India, building a business is no longer looked down upon. I hope to see more localised solutions for problems that could never be spotted otherwise. All hail entrepreneurship.

  I must add though that Government initiatives such as Startup India, Seed Fund Schemes, and the SIDBI fund of fund scheme have all helped. In the next few years, we will all need to build on this.

What myths about the Next Billion can you help decode for us?

I relied upon Mohit, my colleague, for an answer. I did have a few thoughts about this, but his response wins.

He just said - “the aspirations are the same across this country”.

It was beautiful how simple and profound that was. And I could not agree more.

For all the segregation we have done over the past few years with India 1,2,3 based on per capita income and whatnot, I think it is time to understand that in the hinterlands of India, there is someone just like us wanting to experience everything we are seeking for ourselves.

Sure, if subjected to abject poverty, he or she will want to secure roti, kapda and makaan first. That is natural. But what follows will be the same life experiences as us. And I hope tons and tons of entrepreneurs read this, for it had a profound impact on me.

We have around 1.4 billion people in this country on Adhaar. We have 80-85% banking penetration, despite there being some inactive bank accounts. The fact that bank accounts have been introduced is quite an achievement. We have increasingly more of our fellow Indians moving out of multidimensional poverty.

But we are making progress,

For all entrepreneurs, here are a couple of tenets that will help build for the next billion - trust and feedback.

• Trust is built into everything we do as a community, and it is pivotal for any product out there. It could be being transparent about charges or being upfront with the workings of a particular product. Once you lose trust in a community, it is tough to earn it all back.

• Listening to customers on their experience of products and services forms the crux of the first few years of any business, even more so with the next billion. And it reminds me of a story from a recent interaction with a friend. He described how a farmer who walked into an ATM and withdrew 1000 rs instead of 100 rs. Not knowing what to do with this additional money and how to get it to go back into the account, he was subject to worries. The anxiety and helplessness he faced will mean he will probably never revisit an ATM. It got me thinking about how we take everything for granted - from ATMs to cell phones and apps.

In the sectors that Rainmatter focuses on, what next?

Finshots, one of the Rainmatter portfolio companies simplifying financial news, wrote about Japan at the start of the year.

Japan has about 1,500 earthquakes every year that people can feel.

You see, more than 52,000 companies in Japan are over a century old. They’re also called shinise, which translates into old shops in Japanese.

Well, the secret might lie in the fact that most of these long-surviving businesses have thought beyond the sole objective of generating profits.

At Rainmatter, we keep talking about this philosophy of building business. Nithin also has spoken a few times about how building a business in India differs from Western countries. Given the market, consumer preferences and history, longevity as a business usually means success. But longevity must be in collaboration with the community. Working with people from all walks of life. Giving back success. And so much more.

This concept of longevity is something that Rainmatter stands for. And as an initiative, it was born out of that very mindset. We knew that the success of Zerodha must go back to the community and other startups in the ecosystem.

This is why we feel that in the next decade or so, for startups in our portfolio and for new startups we will partner with, our input would be to evaluate the long-term view of the business while making decisions. Not only will that align incentives with customers, but it will mean the best for everyone associated with the business. And needless to say we will also stick by these startups for as long as they want us to and give them the freedom to run the business as they see fit.

With sectors we are focusing on, Nithin described his view of the ecosystem here. And we will expand our focus areas as and when we build competencies in the additional sectors. To all the founders from sectors besides those listed in the blog above, the goal at Rainmatter is not to generate financial returns. The idea is to be part of amazing businesses and journeys of founders where we can also add value. This limits the investment opportunities to spaces we understand and are passionate about. We bring not only capital with us but also our time and energy to help you build for your customers.

But apart from that, from a market standpoint, the markets across Fintech, Health and Climate will expand. There will be teams that will have opportunities to fill in and solve various problems. Supply and demand. But the winners will most likely be doing what suits the consumer and those who build trust as a critical part of their DNA.

And as we go through this decade, it will become clear that patient capital and patience with company building will be the x-factor. The long-term view will always win. This means VCs and investors will also have to tweak their models accordingly. We spoke at length about the incentive mismatch in some of my previous blogs. Do check it out if you want to read more about it.

One takeaway for everyone

Something that I have recently started doing is to allocate 1 hour of my time every month for anyone wanting to speak and get help from me on anything at all. This has probably been one of the most rewarding experiences, and I urge you all to try it out.

We are all good at something or want to get good at something. You can just start with that. You dont have to put out any Google forms or other websites for this. You can just focus on your network in some of those interactions, you will find people who you can help.

Final thoughts

Again going back to the intro, India is inherently a business-oriented nation. For centuries we have been trying our hand at business. While a few decades went by with Indians looking for financial security through jobs, I think the time is here for more Indians to build great businesses. Opportunities are everywhere.

The past few years have also made it clear that we cannot and must not depend on foreign capital as much as possible. Do keep that in mind. And always raise money like it is the last time you will do so. For a resource-strapped country like ours, capital efficiency will always be great to have. And investors also will have to do their bit and take risks on Indian founders.

While we speak about jobs that have been created, we need to do more in terms of enabling talented children to take up careers of their choice by enabling upskilling and education. The private sector must back the govt with initiatives and enable change in this sphere of our society too.

From a VC standpoint, the prediction is that wealth firms who waded into VC investments will not return as public valuations seem much better. The cross funds and asset managers also will avoid the VC asset class due to the long gestation in returns. This means it will be easier for the skilled and artistic VCs to operate and scout for entrepreneurs. We will have educational ecosystems like accelerators and incubators thriving. As Indians innovate and build for the world, we will have passionate and well-meaning investors standing behind our entrepreneurs.

I am exceedingly bullish and optimistic about India. Not just because of emotions but because,

“No power on earth can stop an idea whose time has come”