What is the Role of Venture Capital in Startup Funding
Dec 11, 2023
Have you ever wondered how some startups manage to grow from a simple idea to a billion-dollar company in a few years? How do they get the money to build their products, hire their teams, and reach their customers? The answer is often funding - beat it;’s from angel investors or private equity (PE), debt funding or the most common among founders i.e. venture capital (VC).
VC is a form of private equity that funds startups and early-stage emerging companies with little to no operating history but significant potential for growth. VC investors, also known as venture capitalists, provide capital in exchange for equity or ownership shares in the startups they fund. They also offer technical and managerial expertise, network and mentorship, and access to other investors and partners.
Startups need VC funding for various reasons, such as for prototype creation, product development, team hiring, working capital, marketing and sales, etc. VC funding can help startups accelerate their growth, overcome market challenges, and achieve competitive advantages. Some of the most successful startups in India, such as Flipkart, Ola, Zomato, Paytm, etc, have received VC funding from prominent investors like SoftBank, Tiger Global, Sequoia Capital, etc.
However, VC funding is not easy to obtain, nor is it without risks and trade-offs. Startups have to compete with thousands of other startups for the attention and interest of VC investors, who are very selective and demanding in their criteria and expectations. Startups also have to give up some of their equity and control to VC investors, who may have different goals and visions for the startups they fund. Moreover, startups have to face the pressure of delivering high returns and exits for their VC investors, who typically seek to exit their investments within 5 to 10 years through IPOs or acquisitions.
In this article, we will explore the role of venture capital in startup funding in more detail. We will discuss the different stages of VC funding, the benefits and challenges of VC funding for startups, and the trends and opportunities of VC funding in India. We hope that this article will help you understand the dynamics and implications of Venture Ccapital funding for startups, and inspire you to pursue your entrepreneurial dreams.
The Role of Venture Capital in Startup Funding
Venture capital plays a vital role in the startup ecosystem, as it provides funding and support to entrepreneurs who have innovative ideas but lack the resources to execute them. Venture capital can help startups to: Develop and launch their products or services, Hire and retain talent, Expand their market reach and customer base, Acquire other startups or technologies, Scale their operations and growth, Exit through an IPO or acquisition.
Venture capital can also benefit the economy and society by: Creating jobs and wealth, Fostering innovation and competition, Generating returns for investors and stakeholders.
One of the indicators of the role of venture capital in startup funding is the number of deals that are made in different sectors. According to the chart, the sectors that attracted the most venture capital deals in 2022 were financial services, e-commerce, and technology. These sectors are also known for their high growth potential, innovation, and disruption. This suggests that venture capitalists are looking for opportunities to invest in startups that can create value and solve problems in these domains.
How PE/VC Investments performed in India in 2022 and 2023
India has emerged as one of the most vibrant and dynamic startup ecosystems in the world, with a record number of VC investments, unicorns, and exits in the past few years. According to Bain & Company’s India Venture Capital Report 2022, VC investments in India grew 3.8 times over 2020, reaching $38.5 billion in 2021. This was faster than China’s growth of 1.3 times, and accounted for more than 50% of the overall private equity and VC investments in India. India also added 44 unicorns in 2021, surpassing China’s 42, and becoming the third-largest home of unicorns after the US and China.
However, 2022 saw a slowdown in VC investments in India, as the global macroeconomic environment became more uncertain and challenging. According to Bain & Company’s India Venture Capital Report 2023, VC investments in India declined by 33% from $38.5 billion in 2021 to $25.7 billion in 2022.
Despite the decline in VC investments in India in 2022, the report also highlighted some positive aspects, such as:
The decline was mostly concentrated in the second half of 2022, as the global headwinds intensified. In fact, VC investments in India grew by 1.4 times in the first half of 2022 compared to the first half of 2021, but dropped by 70% in the second half of 2022 compared to the second half of 2021.
The share of India-focused VC investments within Asia-Pacific reached 20% for the first time, and India continued to account for around 5% of the global VC funding, in line with 2021.
The deal volume saw a marginal growth of 1.1 times, reaching 1,611 deals, led by an expansion in seed to series B deals. The average deal size of series A deals also maintained at around $11 million, indicating a step shift in early-stage dealmaking in India.
The chart shows the quarter-on-quarter PE and VC deal value in India from year 2019 to H1 2023. It also shows the average deal size and the deal volume for each quarter.
The main insights from the chart are:
The PE-VC deal value in India has increased significantly from $45 billion in Q1 2019 to $70 billion in Q1 2021, a 64% growth over two years. This indicates that India’s PE-VC market has been resilient and attractive for investors despite the challenges posed by the Covid-19 pandemic.
The average deal size in India has also increased from $37 million in Q1 2019 to $52 million in Q1 2021, a 41% growth over two years. This suggests that investors are willing to pay higher valuations for quality assets and businesses in India.
The deal volume in India has fluctuated between 1,200 and 1,400 deals per quarter, with no clear trend over the two years. This implies that the PE-VC market in India is diverse and dynamic, with opportunities across sectors and stages.
One of the main reasons for the surge in PE-VC deal value in 2021 was the increase in the number and size of large deals. The report states that there were 11 deals of more than $1 billion in 2021, compared to 6 in 2020.
Another reason for the growth in PE-VC deal value in 2021 was the expansion of the VC and growth stage, which accounted for more than 50% of the overall investments. The report states that the VC and growth equity deal value increased by almost 4x from 2020 to $38.5 billion in 2021. This was driven by the emergence and scaling of new-age businesses across sectors such as edtech, Fintech, Healthtech, Gaming, Social media, and e-commerce.
A third reason for the increase in PE-VC deal value in 2021 was the rise in buyouts, which reached over $16 billion in 2021, a 5x increase from 2020. The report states that the average deal size of buyouts tripled since 2016 to $52 million in H1 2023. This was enabled by the availability of quality assets, the willingness of promoters to sell, and the availability of debt financing.
The report also highlights that the exit momentum in India’s PE-VC market increased by 4x to $36 billion in 2021, with huge exits across sectors as valuations inflated further. The report states that there were 9 exits of more than $1 billion in 2021, compared to 2 in 2020.
Trends and Drivers of PE/VC Investments in 2023
Some of the key trends and drivers of PE/VC exits in India 2023 are:
Strategic exits have been the dominant mode of exit in 2023, accounting for 54% of the exit value and 38% of the exit volume in the first eight months of the year. Strategic exits involve the sale of a portfolio company or a stake in it to a strategic buyer, such as a competitor, a customer, or a supplier.
Some of the notable strategic exits in 2023 are:
The sale of Manipal Hospitals by select funds (TPG, NIIF), Kotak Mahindra-CPPIB, and Temasek to KKR for $2.4 billion in August 2023, which was the largest PE/VC exit in India in the last 22 months.
The sale of Sona Comstar by Blackstone to BorgWarner for $1.6 billion in March 2023, which was the largest exit by a PE firm from an Indian auto component company.
2. Secondary exits have been the second most preferred mode of exit in 2023, accounting for 28% of the exit value and 25% of the exit volume in the first eight months of the year. Secondary exits involve the sale of a portfolio company or a stake in it to another PE/VC fund.
Some of the notable secondary exits in 2023 are:
The sale of Lenskart by TPG Growth and TR Capital to SoftBank Vision Fund 2 and Temasek for $1.1 billion in August 2023, which was the largest secondary exit in the Indian consumer tech sector.
The sale of Delhivery by Multiples Alternate Asset Management and Nexus Venture Partners to Carlyle Group and Fidelity Management & Research for $500 million in July 2023, which was the largest secondary exit in the Indian logistics sector.
3. Public market exits have been the third most common mode of exit in 2023, accounting for 18% of the exit value and 37% of the exit volume in the first eight months of the year. Public market exits involve the sale of a portfolio company or a stake in it through an initial public offering (IPO) or an open market transaction.
Some of the notable public market exits in 2023 are:
The IPO of Policybazaar in October 2023, which saw SoftBank Vision Fund, Tiger Global, and Info Edge partially exit their stakes for $250 million, $200 million, and $150 million respectively, valuing the online insurance aggregator at $6 billion.
The IPO of Zomato in July 2023, which saw Info Edge and Ant Group partially exit their stakes for $200 million and $150 million respectively, valuing the online food delivery platform at $12 billion.
Conclusion
Venture capital is a crucial source of funding and support for startups and entrepreneurs who have high-growth potential and innovative ideas. Venture capital can help startups to develop, launch, grow, and exit their businesses, while also creating value for the economy and society. Venture capital funding is a process that involves multiple stages, each with different goals and challenges. Entrepreneurs should be aware of the role and requirements of venture capital in each stage of their startup journey.
PE/VC exits in India 2023 have shown a strong recovery from the slump of 2022, driven by a few large strategic and secondary exits in the healthcare, auto, and IT sectors. Strategic exits have been the dominant mode of exit, followed by secondary exits and public market exits. The outlook for PE/VC exits in India remains positive, as the economy is growing, the public markets are buoyant, and the deal pipeline is robust. However, there are also some challenges and risks that could affect the exit environment, such as valuation gaps, regulatory uncertainties, and geopolitical tensions.