Consumer internet businesses are passé, venture capitalists are now betting on SaaS and Deep tech.

VCs are changing how they invest A shorter life-cycle faster exits and better returns
Atom Startups Wednesday, June 14, 2017 - 13:50

Back in 2007 or even 2008, investing in a startup was always for the long haul. Typically, an investment cycle lasted for at least seven years where the Venture Capitalist (VC) would look to not only invest capital, but also invest time and energy to help the company grow and shape up.

But VCs soon began realising that this was not yielding the desired results. Forget an ideal exit option of say an Initial Public Offering (IPO), even operational break-even or healthy gross margins were nowhere in sight. Take for example Flipkart or Snapdeal, these companies are still years away from profitability.

Is consolidation the way forward?

While early investors in these companies should be nearing the completion of their investment cycles, consolidation seems to be their best bet.

“A number of VCs are now pushing towards consolidation. They are pushing to see how they will get exits and because of that the very nature of how they invest is starting to change,” says Bhaskar Majumdar, Managing Partner, Unicorn India Ventures.

Snapdeal is being acquired by Flipkart, which also bought eBay, Myntra and Jabong. Zomato and UberEATS are reportedly in talks to acquire Runnr. Paytm, MobiKwik, Bank of Baroda are in talks to buy FreeCharge.

“Many investors are looking at an exit in 3-5 years where the strategy is not to have an exit through IPO or big acquisition but a Flipkart kind of acquisition. And moreover, most of the acquisitions happening now are all-stock deals. It’s largely equity, no cash is involved,” says Ashish Sanganeria, Executive Search Consultant, Longhouse Consulting.

A closer look at the companies being acquired show that, what was once a good bet in its respective industry, has now failed to survive. And hence investors are looking to sell them off to bigger players in order to make some returns on that particular investment.

SoftBank is the best example here. After registering a loss of nearly $1 billion on Snapdeal and Ola, it aggressively pushed to sell off Snapdeal, which was failing to stay afloat, to Flipkart or Paytm, with Flipkart finally bagging the deal.

And thanks to this, the way VCs view their portfolio or look to invest has changed. 

It’s all about the path to profitability

“No more will you see investments happening where companies spend millions on marketing to get land grab. At one point, investors told startups to go ahead and launch across cities, and that we will take a bet. But that is changing. He is now asking them to invest in city one, reach an operational breakeven and then only venture into city two. More and more VCs are asking for the path to profitability,” says Bhaskar.

VCs are a lot more cautious now. Only companies with a sustainable business model, where cash is not burned only for customer acquisition, are garnering investor interest.

Not just VCs, even at the seed level, investors are now looking at what value the company is adding, what problem it is solving and what kind of an exit it will give the investor.

“Investors like us look for a good exit, or we invest if we connect with the company’s work and if it has growth potential. Investors also look for companies that have high margins and a low burn rate and can make money right from day one. It is not easy to think of an exit unless the company reaches a certain milestone,” says Sanjay Enishetty, Managing Partner, 50K Ventures.

With changing focus, the mix of their portfolio has also changed.

Promising sectors

Back in 2013-15 consumer internet was everyone’s best bet. But Bhaskar says that the consumer internet companies are now being looked at as a bust or grow business. They either bring multi-bagger returns or just shut shop.

Investors are now looking at businesses that are a lot more sustainable and stable, which have a clear long term picture of steady cash flow.

B2B businesses are beginning to gain traction. Even 2-3 years ago, no VC would want its company to focus on B2B, but that’s changing.

Sanjay says that investors are emphasising on B2B businesses now. Even if their investee has a B2C focus, they’re discouraging that.

“The advantage with B2B is that there is certainty of revenue coming. A startup does not have to spend much on customer acquisition. In the B2C space that cost is very high, which is a huge roadblock for profitability. Investors too, are emphasising on a B2B model,” he adds.

In terms of specific sectors, one sector that every business is betting on is the Software as a Service (SaaS) sector.

Ashish says that investors are now betting on SaaS companies, where though the multiplier is not that huge, there is a lot of scope to make money.

Bhaskar says that new generation IT service businesses like SaaS companies are coming into the forefront now. These are companies that serve international clients with India as a base in terms of a product roll out. Freshdesk, Zoho are some examples.

“In 2014-15, these businesses wouldn’t have even crossed the door of most of the VCs in India. With Core IT services companies in India under pressure, SaaS companies are becoming good acquisition targets for VCs. There is consciousness among investors now that these companies are a fast forward bet,” he adds.

Apart from that, deep tech startups, those working in artificial intelligence, machine learning are also attracting a lot of interest.

Deep tech has a great problem-solving capacity and with AI and ML being applicable across sectors, it is no surprise that startups in this space are worth betting on.

The startup industry has seen a tremendous change in the past few years. From changing strategies to focus areas and promising sectors. After a lull in 2015-16, investor activity is showing some positive signs. VCs too, Bhaskar says, are looking at how they can stay nimble and agile in this whole scenario.

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