Investing in Digital India

1Investing in Digital India

Investing in Digital IndiaIndia is an exciting space for investing in digital start-ups. How can global and Indian corporates benefit from this growth story?


India is a hotbed of digital start-ups, with even the most conservative estimates showing more than 4,000 players. As Prime Minister Narendra Modi’s government actively promotes the Digital India initiative to transform the country into a digitally empowered society and a knowledge economy, investment and growth in the digital space will surge ahead.

The number of corporate venture capitalists (VCs) investing in start-ups has grown and will likely become more prevalent in the near future. As more VCs seek to benefit from this investment boom, start-ups will look for investors that can provide more than monetary support. In this paper, we discuss how large investors can succeed in this booming start- up environment.

Trends in India’s Fast-Growing Digital ArenaSeveral factors are supporting the growth of India’s digital start-up space (see figure 1).

Source: A.T. Kearney analysis

Favorable demographics

• More than half of the population is between the ages of 15 and 45

• Online and digital services are in high demand

Figure 1 Four factors are driving digital growth in India

1

Evolvingstart-up ecosystem

• There were more than 70 venture capital and private equity firms in 2014, more than 550 angel investors, and more than 80 incubators and accelerators

• Engineering talent is abundant

2

Rising Internet penetration

• Internet penetration has grown by more than 200 percent in the past five years

• 4G will drive mobile Internet usage

3

Increasing government focus

• The Digital India campaign focuses on digital infrastructure, e-governance, and citizen empowerment

4

The dominant industries are consumer technology, IT, financial technology (fintech), and healthcare. Consumer technology is the most active, particularly in e-commerce, with major start-ups such as Flipkart, Ola, and Zomato securing late-stage investments. IT is seeing growth with analytics, big data, and cloud services gaining traction. Fintech is seeing develop-ments in personal finance, lending, and financial investments, with product and price-discovery platforms and innovative crowdfunding start-ups coming up. Healthcare is dominated by the doctor search site Practo and others that offer access to medical experts, while online advisory and consultation in healthcare are nascent. Beyond these verticals are what we call enablers, mainly B2B start-ups that facilitate relationships between companies and their customers, including payment services firms such as Paytm and logistics providers such as Delhivery.


Five major trends are having an impact on the success of digital start-up VCs:

The B2C space is getting crowded, but niche segments remain attractive. B2C firms have attracted significant investments, and some start-ups have already received follow-on funding. E-commerce is the biggest digital start-up segment, with three-quarters of all B2C investment. Enablers and fintech firms also look promising and are expected to grow.

B2B investments are in the early stages, with many good opportunities. While investments today are skewed toward B2C start-ups, we believe the balance will shift toward B2B start-ups in coming years, as has happened in developed countries. Enablers such as B2B logistics providers are likely to play a big role given the rise in online retail start-ups that lack back-end infrastructure support. B2B analytics and big data companies will also benefit from the need to mine sales information and consumer behavior data to support fast decision making. Moreover, revenues are low because of B2C discount-based models, which are more realistic in B2B. Hence, investors will get pulled toward the latter.

Many investors are funding India’s digital ecosystem, but the presence of strategic investors is limited.Start-ups are expanding vertically and horizontally in the home market. Companies are increasing their footprint from large metros to smaller towns and rural areas. Other players such as Urban Ladder are integrating vertically to provide one-stop solutions. They are also moving into adjacent segments, offering larger portfolios of products and services to benefit from economies of scale. One example is cab-hailing app Ola’s move into food delivery.

Players with a head start are expanding globally by organic and inorganic means. Bigger start-ups are going for international expansion by acquiring smaller players in foreign markets. Zomato and Practo are examples of fast-growing start-ups in more than 15 countries. Expansion rates highlight growth opportunities for Indian start-ups.

Consolidation has begun in relatively mature sectors such as e-commerce, travel, and food. Major start-ups such as Flipkart and foodpanda are acquiring competitors and suppliers as they seek front-end customer synergies, back-end technology synergies, new talent, and scale benefits in marketing, overheads, and logistics.

Big Investors Can Benefit but Must Be CarefulMany investors are funding India’s digital ecosystem, but the presence of strategic investors—in particular, corporate VC funds—is limited.

In the United States, more than one-fifth of investors are corporate VCs. As more corporate VCs invest in India, they will need to align their tactics to succeed. Disruptive changes in technology continue to become more difficult to track, and the big conglomerates will need start-ups’ breadth and agility to better understand the market. In this fast-changing digital world, it is cheaper and less risky for the giant, less nimble players to fund a diverse set of emerging tech-nologies and then acquire the fruitful ones later rather than develop the capability in-house.


For a start-up, investment by corporate VCs is a signal that the market views it as stable. Corporates come with relevant technical and business expertise to help scale and run the growing start-up. And in sectors such as pharma and telecom, where internal R&D is expensive and requires hiring talented people, corporate VCs can significantly reduce this investment cost and risk.

Two moves can help corporates make wise investment decisions:

Select the right investment archetype. To choose the ideal mix of start-ups from the country’s vast pool, corporates will need to evaluate their strategic interest, investment size with risk appetite, and operating model. Firms can invest in and grow start-ups using synergies from supporting technology expertise, manufacturing capabilities, distribution networks, and branding. Fund terms and size should consider diversification and follow-on financing. There are four different models for investment (see figure 2). The models differ in how much involvement investors have in decision making and operations and the risk of investment (see figure 3 on page 4).

Decide the mode of entry. Within each of these four archetypes, a company can invest alone or co-invest with other companies or traditional investors. Co-investment is preferred when the firm wants to reduce exposure in one investment and fund multiple areas, as Flipkart and Tiger Global have done with Nestaway, a luxury rental homes start-up. This strategy also works if a company is new to a region or has limited experience in venture capital; a VC’s expertise in selecting the right investment portfolio would prove valuable. For example, SAP Ventures made its first few investments in the country in JustDial and iYogi, where it co-invested with Canaan Partners and Sequoia Capital. In many cases, co-investing also reduces cost because of low- or no-fee structures.


Incubator Disruptor

Experimenter Speculator

Figure 2 Firms have four choices for investment models

• Investment in similar sectors

• Support in management and operations

• Maturity level of start-up• Sector synergy and market risk

Investment risk HighLow

Strategicinvolvement

High involvement(strategic)

Low involvement(financial)


When investing with other corporate VCs, both firms can empower start-ups in their own areas of expertise. For example, California-based Expect Labs received funding from Intel Capital, Samsung Venture Investment Corporation, and Telefónica Digital. Samsung will use the start-up’s context-based technology to enhance its smartphones and Telefónica to improve its communication applications. Some corporates also form short-term joint accelerator programs; GenNext Ventures and Microsoft Ventures together mentor 11 start-ups.

For start-ups, investment by corporate VCs is a sign of stability.Sole investment is appropriate for firms such as Google Ventures, which has large funds and investment expertise. It is also useful when the company is looking for specific patented technologies and is eyeing an acquisition of a start-up that is aligned with its objectives. Sole investment is often used when the investment amount is small, such as Infosys’s investment in DreamWorks Animation. Such deals are fairly rare in India and are most common in mergers and acquisitions, such as AskMe’s investment in Mebelkart and Snapdeal’s purchase of FreeCharge.


Incubator

Disruptor

Experimenter

Speculator

Figure 3 Firms have various reasons to invest in digital start-ups

• Capture a competitive advantage• Gain market entry or penetration • Integrate the value chain• Create strategic alignment with

start-up; high probability of success means few big bets

• Flipkart’s acquisition of Myntra to gain a competitive advantage and market share

• Hitachi’s acquisition of Prizm Payment Services to develop IT services in India and around the world

Target Investment rationale Examples

Leading consumer and tech industry players

• Penetrate relevant and adjacent sectors

• Leverage start-ups for technology and strategic R&D, typically low time criticality

• Samsung Ventures investment in medtech start-ups such as EarlySense, dacadoo, and Scientific Magnets with inclination to develop medical devices

Corporates looking for innovation-led growth

• Gain a return on investment by investing in safe late-stage start-ups that are doing well

• Make an arms-length investment to monetize assets

• Reliance Ventures’ investment in diverse start-ups such as Yatra, Suvidhaa, and HealthSpring; sold 45% stake in Dhama, getting 100% internal rate of return

Diversified conglomerates

• Enter a pure-play return-on-investment game with small bets in emerging technologies across sectors

• Google Ventures’ investment in wide range of companies from life sciences and consumer products to mobile, e-commerce, and data

Conglomerates with large funds


Four Factors for Success In a market that is full of frantic activity, where to invest and how to benefit both investor and investee are crucial. In India, four factors are essential to success:

Avoid the fear of missing out. Overvaluation is becoming a big worry in some segments, so investors are on the lookout for undervalued properties with the potential to grow. Investors can evaluate start-ups not only based on cash flow and growth, but also strategic alignment, risk of imitation, and the sustainability of revenue.

Ensure you can offer unique value to the start-up. With a growing pool of potential investors, start-ups are looking for firms that can provide more than just monetary support. Corporate VCs can provide industry and technical expertise, a business expansion strategy, talent, and operational support to move the start-ups through the stages of growth. They can also create a collaborative ecosystem for start-ups and industry experts to exchange insights and gain from each other. Also, start-ups can benefit from greater visibility through branding and contacts and lower financial risk through flexible fund size and exit timelines.

The time is right to invest in India’s exciting digital start-up space. While it is important to move at speed, getting the right value and fit is also crucial.Partner with other investors. Co-investing with traditional VCs or private-equity firms lowers the risk and the required fund size. Global investors can look for co-investors in India to filter out the most promising start-ups. Still, firms need an investment roadmap and an exit strategy from the outset, and they must be clear on the focus areas and strategic support to be provided by each investor.

Develop exit options. Create a network of investors and syndicate partners to get follow-on investment or exit from the start-up. Google Ventures and Intel Capital have very strong investor networks that have enabled them to make more investments and to exit more easily. During exit, investors need to know the term of investment and the range of the return on investment, as well as the start-ups’ technology approval, market penetration, and profit-ability. Acquisition is also a conversion option, depending on strategic alignment with the start-up. Lastly, an exit strategy must consider the risks, including overvaluation, the lack of logistics and technology infrastructure, uncertainty over taxation, and regulations on foreign investments.


An Exciting Time to InvestThe time is right to invest in this exciting digital start-up space. However, the window will close, so there is little time to waste. The key is to think upfront about the “why” and the “how” of investing.

Authors

Ajay Gupta, partner, Mumbai [email protected]

Udit Gupta, consultant, Mumbai [email protected]

Abhay Kumar, consultant, Mumbai [email protected]

Lavanya, consultant, Mumbai [email protected]

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Investing in Digital India