VC Insights | Issue# 4 [August 29, 2024]
The Indian startup and VC ecosystem has seen an interesting change over the past two-odd years – the rise of the micro VCs. Here is an Inc42 coverage exploring the same. Micro VCs are a type of early-stage VC firm focussing on smaller, niche investments, as compared to the larger institutional VCs. They would typically invest in pre-seed- / seed-stage startups and exit within within the first 4-5 years at valuations below $75 Mn, more here. What could be the factors and dynamics influencing the rising trend. Let us dive deeper to explore.
Rise of Micro VC Funds in India
India has witnessed a significant surge in the number of micro VC funds, particularly since the onset of the funding slowdown in late 2022. Despite challenges in the funding landscape, 62% of the 126 funds launched in 2022 were focussed on early-stage startups. 31 early-stage funds were introduced with a total corpus of $1.8 Bn in 2023. Notable firms, such as Better Capital, Java Capital, Sauce.VC, Neon VC, All In Capital, and others have been active in launching new or additional funds over the past two years.
Recent entrants, such as Volt VC and ajvc highlight the growing momentum in the micro VC space. Volt VC, with a focus on consumer businesses, and ajvc, targeting pre-seed investments, are part of a larger wave of funds aimed at early-stage startups. Such funds, while smaller in size, are filling critical gaps in the investment landscape, often focusing on emerging sectors, such as gaming, AI, and consumer brands.
Over two dozen new early-stage micro VC funds, primarily with corpuses under $60 Mn, have collectively raised more than half a billion dollars this year. Initially, micro VC funds in India were much smaller, often around $10-12 Mn, but growing interest from Limited Partners (LPs) or investors has driven these funds to increase in size, with the average corpus now being around $30 Mn. In fact, many firms are still awaiting regulatory approval from the Securities and Exchange Board of India (SEBI) to launch their funds, which will further boost early-stage investments.
Sector-Specific Focus
One of the factors driving the micro VC trend is the need for early-stage funding, with dozens of new funds being established to target niche sectors. The emergence of micro VCs is characterized by smaller fund sizes and a specialized focus, often led by individuals with deep expertise in specific industries. These funds cater to the initial stages of startup development, where traditional VCs are less involved.
Micro VCs are particularly drawn to sectors like AI, gaming, and deeptech due to the high growth potential. The focus on these areas reflects a broader trend where investors are seeking faster returns by betting on innovative and untested markets. An example would be Lighthouse Canton’s GenInnov Global Innovation Fund that is focussed on tapping the potential of startups buliding applications on top of AI and GenAI. Another area of focus is the new-age retail and D2C startups, especially startups with premium offerings. The targeted approach has attracted a diverse range of LPs, including those from specialized industries. As an example, Mumbai-based Centre Court Capital launched a $45 Mn fund focussed on sports and gaming. The fund has been founded by Mustafa Ghouse, ex-CEO of JSW Sports and a bronze medal winner in tennis for India in the Asisn Games. As a result, the fund attracted many LPs interested in the sports and gaming space.
Strategic Shifts in Larger VCs
The larger VC firms have been quick to adapt to the micro VC boom by launching smaller funds or accelerator programs. The shift allows them to capture opportunities in niche markets that micro VCs are increasingly occupying and fosters an environment of healthy competition. Programs, such as Chiratae Ventures’ Sonic and Peak XV Partners’ Surge, exemplify this strategy, supporting early-stage startups with targeted funding and mentorship.
Corporate-backed Micro VC Funds
In the past two years, there has been a rise in corporate-backed micro VC funds, which differ from typical investment funds as they often serve as pathways for future acquisitions. Leading companies like Tata Consumer, Marico, and Emami have developed strategies where their investments in startups frequently lead to profitable acquisitions. This trend is gaining traction among other corporations as well. For example, Lotus Herbals is preparing to launch a $50 Mn fund aimed at investing in early-stage beauty brands and startups, viewing such investments not only as financial opportunities but also as strategic moves.
Emergence of New Fund Managers
The micro VC ecosystem in India is being significantly propelled and diversified by a new wave of fund managers, often former startup founders or partners from established firms, who are venturing out to create their own funds. Volt VC, founded by industry veterans with a focus on consumer businesses, and ajvc, launched by Aviral Bhatnagar, a former lead investor at Venture Highway, are prime examples of this trend. These new entrants bring a deep understanding of their respective niches, allowing them to innovate in investment strategies and target sectors that are often overlooked by larger VCs. This influx of new talent and ideas has added a dynamic and maverick character to the micro VC landscape, enabling it to explore and invest in emerging, uncharted areas with agility and precision.
The Role of LPs
LPs play a crucial role in fueling the micro VC boom. Their interest in early-stage investments has made it easier for micro VCs to raise funds, particularly in the underrepresented or emerging sectors. Such a dynamic has led to an oversubscription of micro VC funds, with many funds exceeding their target corpus. Additionally, more exit opportunities have opened up in India in the form of secondary share sales, SME (or even mainboard) IPOs, M&As with established giants. This has significantly enhanced oinvestor confidence in early-stage bets. Read more about the growing exit opportunities for Indian investors here.
Potential Risks and Opportunities
While the influx of LP capital into micro VCs has accelerated growth, it also brings potential risks. The hype surrounding sectors like AI could lead to an oversaturation of investments, with some early bets failing to deliver. However, the same dynamic could also drive significant returns, particularly in consumer brands that may replicate the success of high-profile IPOs, such as that of Zomato, Nykaa, and Mamaearth. Additionally, not all of the emerging fund managers will have the best set of skills and track record to lead a fund to a successful outcome.
Regulatory Considerations
The rapid growth of micro VCs has caught the attention of regulators, with SEBI tightening rules for new fund registrations. Given that most micro VCs aren’t managed by traditional venture capitalists, SEBI’s intervention appears to be specifically designed for these type of firms. Despite the challenges, the sector continues to expand, driven by the desire of new fund managers to capitalize on early-stage investment opportunities.
Thoughts
The proliferation of micro VCs in India represents a dynamic shift in the VC landscape, characterized by smaller, highly specialized funds targeting niche markets. This trend is reshaping early-stage investment, with significant implications for both startups and the larger VCs. Venture capitalists are increasingly favoring safer investments, raising concerns about whether the recent surge in micro VC funds will truly benefit startup founders. However, industry experts argue that the market tends to reward bold investments. As larger VCs focus on lower-risk opportunities, the next wave of innovation will likely depend on a new class of investors willing to take risks. As the ecosystem evolves, the interplay between new fund managers, LPs, and regulatory frameworks will determine the future trajectory of the burgeoning micro VC sector.
We do believe that there is enough innovation happening in India that can accommodate the ecosystem of larger institutional VCs, PE investors, micro VCs, and accelerators. The proliferation of micro VCs will help foster healthy competition among the early-stage investors and VC ecosystem. The micro VC boom helps with an additional avenue for the startups to get funded. It also gives more opprtunies to the LPs to choose from when it comes to investing. We welcome more niche players within the VC ecosystem with a word of caution for the LPs to be thorough with their due diligence before backing funds.
If you are interested to learn more, feel free to check out this blog post by Inc42.
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Acronyms used in the blog that have not been defined earlier: (a) Venture Capital (VC), (b) Million (Mn), (c) Billion (Bn), (d) Artificial Intelligence (AI), (e) Generative Artificial Intelligence (GenAI), (f) Direct-to-Consumer (D2C), (g) Chief Executive Officer (CEO), (h) Small and Medium Enterprises (SMEs) (i) Initial Public Offering (IPO), (j) Mergers and Acquisitions (M&A), and (k) Private Equity (PE).