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Things Look Up For The Indian Start-Up Ecosystem As China Struggles To Attract VC Attention

As global VC biggies raise their biggest India-centric funds this year and visibly lose interest in China, India's start-ups are gearing up to grab the gain

Things Look Up For The Indian Start-Up Ecosystem As China Struggles To Attract VC Attention
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POSTED ON September 08, 2022 11:40 AM

Globally, every start-up or venture capitalist (VC) movement has some China angle to it. Obviously so, for, after the US, it is the biggest start-up ecosystem in the world. The good news, however, is that India is fast catching up if the current trends are any indication.   

Some of the largest VCs moving away from China and raising large India-specific funds this year are the biggest indicators of global investors’ rising confidence in the country.  

In total, VCs, like Accel India, Elevation Capital, Sequoia Capital India, Lightspeed Ventures and Jungle Ventures, have raised $4.195 billion this year alone for investments in India. Sequoia Capital India led the pack with a $2 billion fund and also raised its first dedicated $850 million Southeast Asia fund. In contrast, till May 2022, China-focused VCs had raised just $2.1 billion as against $27.2 billion in all of 2021, as per information from data provider Preqin. 

According to business analytics platform CB Insights, in Q1 2022, Indian VC funding almost doubled year-on-year (yoy) with investors increasingly focusing on the market—particularly after China’s introduction of new regulatory measures in its tech sector. 

While some experts argue that it is India’s own worth as a start-up destination that should be credited for the fund surge, what the trend really means for India going ahead will only emerge later. 

Shifting The Gaze

Numbers indicate that funding is slowing in China and increasingly moving in India’s direction. According to CB Insights’ State of Venture Q1 2022 report, funding in China saw a 53% quarter- on-quarter dip in Q1 2022 as against a decline of 21% in India.  

"China is not a preferred investment choice now for VCs. That is also because India has emerged as the third largest start-up ecosystem in the world with more than 100 unicorns and all the economic drivers are in its favour," says Ankita Vashistha, managing partner, StrongHer Ventures. 

Going forward, most VCs are strategising to invest in early-stage start-ups as the focus is more now on unit economics and sustainability, she adds.

While launching its $2 billion fund, Sequoia Capital India had said: “The start-up and venture capital ecosystem in India and Southeast Asia has made great strides in the last decade and will continue to mature. Valuations and velocity will move with markets. What endures is value creation in terms of revenue growth, profitability and free cash flow rooted in real innovation, excellence in execution and a maniacal focus on customers.”  

Likewise, Accel unveiled its largest India and Southeast Asia fund of $650 million in March this year—16 years after its first fund in India raised $10 million. The fund is said to focus on early-stage businesses, investing anywhere between $1 million and $5 million in seed and pre-seed funding rounds. The firm, unlike its peers, tends to invest at an earlier stage and its previous early-stage investments have resulted in blockbusters such as Flipkart and Freshworks. 

Lightspeed Partners, Elevation Capital and Jungle Ventures, too, raised their biggest India-centric funds this year. 

VC investors in India have now completed a full cycle of investments and exits, says Amit Nawka, partner, deals and start-up leader, PwC India.

"Many notable VCs in India started investing actively in Indian start-ups during 2008-10. In the last few years, many exits have happened—IPOs, strategic exits, etc. and because of that, VCs that went for a fund raise this year were able to show real exits and not just an increase in paper valuations," Nawka adds.  

This year’s funding trend seems to be continuing last year’s momentum when VC investors pumped about $20 billion into Indian companies during the first nine months, an increase of 150% from the same period in 2020. The deal share for early-stage start-ups grew to 75% till October 2021 in India as against 58% in China. 

In fact, last year, based on Tracxn data, Nikkei Asia had reported that 211 funds had made their debut investments in India in 2021—64 more than the number of funds in 2020. It had also elaborated how Beijing's regulatory crackdown on its tech sector had resulted in the loss of its appeal as the first-choice investment destination for global venture capital in Asia. 

Graph 1

The Trust Factor 

Over the years, Southeast Asia and India have emerged as attractive markets for investors due to the fast growth of start-ups in both the regions in recent years. That has resulted in the birth of a slew of unicorns and a series of spectacular stock market listings such as Zomato and Nykaa in India and superapp Grab in Singapore. Data suggests that India’s unicorn count, which stands at 108, will see a jump of 140% over the next three years.

Taking on China’s mature start-up ecosystem, with giant investors such as SoftBank and Alibaba—backers of Indian start-ups such as Paytm, Ola, Flipkart, Snapdeal, OYO, Zomato, etc.—was far from easy. But today, China clearly seems to have lost out on trust. 

The Covid-19 pandemic played a major part in denting investors’ trust and led to the exodus that is being witnessed in China currently. According to reports, the country has been witnessing an over 10% y-o-y fall in foreign direct investment since 2020. 

The debacle of Chinese real estate giant Evergrande last year and the Chinese government’s unwillingness to save it from sinking only sent out negative feelers to global investors. 

A ban on for-profit tutoring last year and a sudden turnaround in China’s policy for edtechs came as a big blow for companies into online education, many of which had global investors. For instance, Japan's SoftBank Group had to write down its $700 million investment in Zuoyebang, the developer of an app that helped students with their homework, to $100 million by March 2022. 

Apart from that, in March this year, China brought in a new law to govern the way tech firms use recommendation algorithms. These algorithms are the secret sauce behind the success of many of China’s technology companies and are often used to target users with products or videos based on information about them. Over the past two years, the Asian giant has tightened regulation in its domestic tech sector in areas of data protection and antitrust in a bid to check the power of the country’s tech giants. The moves, however, have caused shares of listed companies, such as Alibaba Group Holding and Tencent Holdings, to fall sharply. 

While Beijing recently indicated that the crackdown is over, strict Covid-19 restrictions in Shanghai and Beijing arising out of their zero-Covid policy has shaken the faith in its economy, making investors switch to the alarmed mode. The constant fall of the yuan in the global market is only adding to the pressure on the Chinese economy. 

“All of this is leading to valuation rationalisation in the VC funding space ... One does not expect any significant slowdown in the VC funding space [in India] on the back of so many India-focused VC funds already raised,” says Dilip Dusija, Partner, Deloitte India.

Graph 2

Beyond The China Advantage 

Is China’s loss India’s gain? Certainly. But is it the only reason for India’s gain? Not entirely, say experts. 

It is certainly an advantage for the Indian markets, given how scales are tilted currently, and one big reason is how the global perception and behavior of China is, says Ashish Fafadia, partner, Blume Ventures.  

Having said that, he says, “It [VCs’ interest in India] has also got to do with the fact that the Indian government has managed to create a positive narrative all through the last few years, coupled with the fact that the Indian markets have been fairly resilient all through the pandemic. Also, the digital economy has become mainstream. So, a combination of all these factors is creating a certain amount of capital flow and stability in the country.”  

Sid Talwar, partner, Lightbox, agrees, adding that India’s funding success does have a China angle to it but it is more than that. The issues in China were a tipping point for global funds to start looking at India more seriously but it can no longer be seen as the core reason for any pool of capital to enter India, he says. 

“India’s success is far more dependent on Indian capital eyeing the VC/start-up space than foreign capital. Although the Indian ecosystem has survived so far on foreign funds, this ecosystem will thrive on the emergence of more and more domestic pools of capital emerging,” Talwar explains.  

He also says that India’s market size, labour cost, quality of infrastructure and government policies give it an edge over other countries such as Singapore, Vietnam and Indonesia. 

The fact that funds are indeed flowing out of China and towards India was also vetted by Ankur Pahwa, leader, ecommerce and consumer internet, EY India.  

“Directionally, it is true as India is providing far greater opportunities than it did in the past to LPs who like to invest in the VC asset class. Also, China plus one [strategy] has become the norm across all segments. The digital adoption curve is still early and with 5G and other enabling technologies and solutions being deployed, the acceleration is imminent, which provides huge white spaces for growth and large outcomes for investors,” says Pahwa.  

The emergence of new-age companies with a strong focus on fundamentals and sustainable economics, allowing them to be sturdier rather than being dependent on "tourist capital", is also a reason that is driving VC interest in India, he adds.

For now, the future of India’s start-up world looks bright.

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