'Discipline' was the defining word for the venture capital community in 2016. Even as early stage investments kept pace throughout the year, the number of late-stage VC funded startups reduced substantially. According to VCCEdge data, VC firms invested $1,355 million across 928 deals in 2016 as compared to $1,276 million across 2,606 deals in 2015. Investments in startups declined significantly in number (28%) and value (44%). The sizes of deals decreased as angel and early stage funding dominated.
On the plus side, we did see a dramatic improvement in the quality of entrepreneurs getting funded in 2016. Going forward, we think investors are looking to make a comeback. To name just a few, Sequoia Capital closed a new $920 million fund in 2016 and Accel Partners India raised a $450 million fund. They are now on the lookout for the right startups. However, we have seen that investors have been much more selective in deal picking, exercising far more discipline in 2016 than in 2015.
It was this discipline that shifted the focus to unit economics and profitable growth, in contrast to customer acquisition, where cost and the bottom-line were ignored. The age of the proverbial 'land grab' is well and truly behind us.
Investors have also learned a few hard lessons about the Indian startup ecosystem. They began to better understand the Indian customer and her behaviour. She is not loyal to a brand, preferring instead to be driven largely by price (or discounts, depending on how you want to look at it) of the product or service, and the resultant savings. As this realisation dawned, high discounts and cashbacks in erstwhile highly competitive categories like hyperlocal delivery, services on-demand or just good old fashioned e-commerce, reduced, and those that did not have the ability to adapt, hung up the 'Going out of Business' sign.
Discipline also brought about a much-needed shift in benchmarking metrics. We went from the esoteric gross merchandise value (GMV) to a more relevant unit economic driven approach. Valuations took a hit as investors finally acknowledged that they should calculate it as a multiplier of net revenues, and not the ubiquitous GMV. The adage 'Turnover is vanity, profit is sanity, but cash in the bank is reality' returned to dominate investor sentiment. Investors began prizing positive cash flows and the focus shifted back to reducing cash burn and achieving profitability. A lot of the valuation markdowns were mark-to-market, meaning that existing investors revalued their existing holding at a lower level based on various internal realisations and external factors. There may have been a few down-rounds as well, but we would only know about those once they are published.
Most startups raised money at lower valuations and were forced to give higher liquidation preferences, (contracts to specify which investors are paid first and by how much in the event of a sale of a company) amongst other more investor 'friendly' terms, to incoming investors. This sentiment affected even those raising money for the first time.
2017, however, looks much more promising. Overall, we expect the quality of the deal flow to further improve as investor confidence rises again.
Two of the biggest disruptions "the launch of Reliance Jio and demonetisation â€“ will counter the two major challenges technology startups face in India. One is the low penetration of affordable and reliable high-speed Internet access and second is the inability of companies to monetise on their installed base of customers.
Even with the explosive growth of smartphones, access to high-speed Internet has remained muted or patchy. Inspite of having the lowest tariffs in the world, customers are still not willing to spend for Internet access. Most smartphone users have limited their usage to just voice or text and access entertainment via memory cards. Jio has in one swift stroke disrupted the entire paradigm. It has amassed over 50 million customers, thanks to its 4G network which delivers high-speed Internet and the thousands of WiFi hotspots across the country.
We are also witnessing another major disruption in the realm of digital payments, which has become more and more ubiquitous. This is probably the most positive fallout of demonetisation. The government has shown its commitment to encourage digital payments, which augurs well for startups. As more and more Indians grow comfortable with digital payments and start using apps like BHIM (Bharat Interface for Money), cash on delivery (CoD) transactions will reduce. This will save startups a significant amount of money in operational expenses. Offline payments are also difficult to scale for digital businesses. Our portfolio company Rapido saw a shift in the last two months from 70% cash transactions to 70% wallet-based ones. Rapido further expects digital payments to comprise 80-85% of all transactions in the near future. As the friction of online payments reduces, micropayments will become easier, opening new channels of monetisation for a large number of startups. The freemium model will spur a new wave of innovation.
The next 400-600 million digital customers, aka 'India Two', will come from smaller cities and rural India. They will not speak English but will be ready to transact. Continued focus on bringing the Internet to the unconnected population, such as the proposal of offering 100MB per month free to all rural users, will play a key role in unlocking many hidden use cases in the Indian market. With access to high-speed Internet, proliferation of micropayments and latent unfulfilled demand for goods and services, India Two is an opportunity waiting to be captured.
Kunal Khattar is general partner at advantEdge Partners, an NCR-based early stage venture capital fund.