Venture Capital in India
A surprisingly small industry!
Venture Capital can be a mysterious term to the uninitiated. But it is a industry which fits within the life-cycle of a startup perfectly. Geographically, US has the dominance in this industry and India is in the early stages. In trying to understand this space, we look at it through various lenses.
First, we look at the startup financing life-cycle and how the VCs fit into it.
Second, we focus on the Indian economy and the role VCs play in it.
Third, we look exclusively at the VC firms and understand how they make money.
1. Through the lens of Startup Cycle
Definition
In Indian context, VCs are investment firms which invest in startups which are in their early stages but have demonstrated product-market fit (PMF) and are past the break-even and generating significant revenues and profits as well.
VC in Startup Life Cycle
VCs are the first ones in make the bigger rounds of investment size (in orders of ₹10–100 crores per startup). These are termed as different series such as Series A, Series B etc. They are preceded by Angels investing upto ₹1 crore per startup and followed by private equity firms (PE) which invest in the order of ₹1000 crores per startup.
India VS US VC Space
Aggressive estimates of Indian VC market size are around $70B which translates to ~₹6 lakh crores while more conservatives estimates may give a tenth of it, ₹60 thousand crores. The US VC market is 10–15x bigger than this. The PE market is 3–10x bigger than the VC industry in India and globally.
Indian VC Space in numbers
In terms of numbers, there as 173 home-grown VC funds in India and another 286 foreign funds that operate in India (as of December 2023, registration data of SEBI) which gives an average corpus per VC to be around ₹1300 crores. Obviously this in reality this would be more skewed towards the bigger VC firms in India with an extended long tail.
2. Indian Economy
In nominal figures, India’s GDP is above $3 Trillion as of 2023. Adjusted for purchasing power, this sky-rockets to $11 Trillion. More than half of it is from the consumer market, equally split between final consumption (retail) and supply chain (business investments). The remaining 30–40% comes from government expenses, exports and other capital formation activities.
The VC industry hence directly accounts for around 2–3% of the GDP but it’s effects might well go into larger shares through various indirect outflows.
The VC industry in India took off in the last two decades only. Starting with Accel and Sequoia in early 2000s and with the introduction of SEBI’s AIF Regulations 2012, this space became more organised and regulated. As of 2023, Accel has over 200 investments in India.
AIF Regulations limit Venture Capital firms from holding public market securities. They are placed under category 1 which is the highest risk category. This is a move to mitigate the risk for the retail investors while giving SEBI the ability to make separate regulations for this category.
3. How VCs Make Money?
Till now we have looked at how the VCs fit in the larger puzzle of the investment space and startups. We now look at how they actually operate and make money.
Structure
VCs are the bridge between investors and startups. Investors collect money from High Networth Individuals (HNI) or national governments looking to diversify. They choose to invest through family houses and sovereign funds respectively. On the right, startups are looking to raise capital for growth, operations and angel exits. VCs take the risk of this investment promising stable returns to investors and networking and scaling opportunities to entrepreneurs and startups.
Over Time
Let us assume a VC firm raised 100 units (units can be in any currency and multiple of denomination). This will be projected to the investors as a stable 17–18% YoY return with 80% of the over-and-above profits after the fund maturity including all the fees paid to the VC firm over the years. Usually, this fund would be set to a maturity of 10–11 years.
The VC firm would have consumed 20% of these funds in their expenses over the years. The remaining 80% would be invested in multiple startups over the next 10 years. Out of these startups, a third will fail and not return anything. 10–20% might just break-even. The other 20–30% return just 5x which accounts for the average returns promised to investors by the VC firm initially. Only 5–10% might return around 80% of the total share of returns made from this pool of money in the first place!
In this post, the numbers are estimates with broad variation. It is also important to note that these numbers are as of 2023. The growth rate of these figures and the range are equally important. They should be used to build a mental model of the industry in general and help place it in the larger economy. The sources for these article are listed below in decreasing order of share of reference.
