Micro VCs Catalyzing the Growth of India’s Startup Ecosystem

With fintech player Zeta being the latest entrant, it’s been only five months into 2021 and India already has 14 members in its coveted unicorns club. Almost a 70% rise from the 12 unicorns that the pandemic-hit 2020 birthed in the entire year (the highest for India ever). With analysts estimating almost 50 unicorns by the end of 2021, this sudden growth spurt in India’s startup ecosystem has come as a surprise to many. 

But is this really that shocking? Especially considering that statistics have a relatively different narrative. 

Today, Indian investors are betting big in the world's third-largest startup ecosystem. Within the first four months of 2021, Indian startups have raised $7.8 billion. Even in a Covid-ridden year, India closed almost 1,200 startup deals, more than 50% of which came from seed-stage investments. Thus, it is safe to say that there is no stopping for India’s startup ninjas anytime soon.

In the current scheme of things, one arm of funding whose contribution is phenomenal to all the early stage entrepreneurs in the startup world is that of micro venture capitalists. Such investors have amassed a total investment of almost $341M across 700-plus deals in the past three years.

Role of micro VCs in the startup food chain

The pre-seed/seed stage or the ‘Valley of Death’ is a long corridor. At this stage startups are primarily working on their MVP (minimum viable product) and looking for early signs of product-market fit. A majority of investors come in only after this stage where the initial set of survivors have been identified, to bet on the horses they believe will win. 

To cross this valley, founders often have to rely on their personal savings and relationships, or existing angel investors in their network. While those with deep pockets and the right reach may survive, most struggle to raise adequate initial capital and eventually perish. This is where micro VCs come into the picture. 

Micro VCs bring in the heft of an institutional investor with the agility of an angel. In the initial stage, like traditional VCs, they can provide the required industry insights and resources (talent acquisition and mentors) to propel the growth of startups as well as write bigger cheques ($100,000-$500,000) than most angel investors can. At the same time, given their lean structure, micro VCs can also build conviction as quickly as an angel does. Thus, with capital and resources secure, founders can focus their energies on their MVP and execution, and sail through this valley of death toward large-sized funding. 

Another reason why micro VCs are important is because of the changing perception of the startup ecosystem in India. The startup industry in India is maturing, we are seeing larger seed funding of nearly $1 million-$2 million. To procure large seed rounds without diluting interest heavily, it is essential that startups raise $100,000-$500,000 at the pre-seed stage to show early signs of traction. This is only possible with the growth of micro VCs that can provide quick capital and extend the runway for startups.  

Moreover, this evidence of early VC funding also allows traditional VCs to assess a startup's worth better and enables startups to command better valuations in future rounds. 

Why do limited partners (LPs) invest through micro VCs?

Traditional VCs have their advantages, but, like mentioned above, the Indian startup ecosystem is currently in the state of a transformation. Foreign direct investment (FDI) has always contributed a substantial part to domestic funds. However, the trend has changed in recent years. From a paltry 5% earlier, active funds in India have now begun to raise almost 20-25% of their capital from domestic sources. 

Interest rates on fixed deposits in the last few years have also declined. From 9.4% in 2011 to 5.4% in 2021 (SBI 5 years FD). Thus, the quest of higher risk-adjusted returns has started to turn the investor’s purview toward alternative assets such as venture capital funds and private equity funds. 

Additionally, as family offices and their management evolved, startups started to emerge as a preferred choice for risk capital. While several have begun to explore investing in startups, allocating capital via smaller, startup-focused funds like micro VCs allows them a dual benefit. One to write small-sized cheques of $1M-$2M instead of $10M+ per fund and second to diversify their portfolio allocation. This enables them to achieve superior returns while staying connected to the startup ecosystem and enhance their startup investing practices. 

Final thoughts

With a decade of investment activity behind us, the startup ecosystem is deeper and more mature today. As India sees a proliferation of startups, it needs agile funds like micro VCs to act as catalysts to promote the ecosystem's growth. These have the irreplaceable benefit of acting as the perfect bridge between domestic LPs looking to strengthen startup investing practices and talented founders working on innovative products, becoming a win-win situation for both the parties. 

Pearl Agarwal

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Pearl Agarwal is founder and managing director of Eximius Ventures. The views in this article are her own.