VC Insights | Issue# 6 [October 7, 2024]
What?
Peak XV Partners has reduced its eighth VC fund worth $2.85 Bn by 16%. The fund was closed in May 2022 and happens to be the VC’s largest fund earmarked for Indian startups. The decision to return $465 Mn to investors (Limited Partners or LPs) stems from a slowdown in growth-stage investments in Indian startups. This slowdown has been noticeable over the last two years, reflecting challenges in capital deployment, increase in regulatory scrutiny by the government, and the startup ecosystem’s changing dynamics. Here are a couple of articles about the development by YourStory and Inc42. However, it is interesting to note that this step comes at a time when the funding winter in the Indian startup ecosystem seems to be receding, and there is increased optimism about venture funding in the country’s startups. The Indian startup funding doubled Year-on-Year (YoY) to $3.4 Bn In Q3 2024, reported Inc 42.
Background
Peak XV Partners, formerly Sequoia Capital India, has been a key player in the Indian startup ecosystem since its entry in 2006, following the acquisition of WestBridge Capital’s team. Over the years, the VC giant has backed several unicorns, such as CRED, Meesho, Groww, Mamaearth, and Unacademy. In 2023, Sequoia Capital underwent a major restructuring, resulting in the formation of three independent entities. The India and South Asia operations rebranded as Peak XV Partners, while the China business became known as HongShan. Peak XV Partners has been one of the most prolific VCs in India, investing in close to 700 startups.
Shift in Investment Focus
Even with the reduction in its largest fund size, Peak XV is bullish about investments in Indian and South East Asian startups. The VC confirms being on track to have its second best year in terms of distributions and exits and attrubutes the same to a strong portfolio performance. However, Peak XV emphasizes its need to rethink and recalibrate its investment strategy and take a cautious approach in the wake of the richly valued Indian public market. The firm is now shifting its focus towards seed and early-stage investments, where it sees more promising opportunities. In contrast, growth and late-stage funding have been harder to secure and startups have also been impacted by governance and compliance issues. This includes some of Peak XV’s portfolio companies, such as GoMechanic, BYJU’S, and Mojocare. Additionally, in order to achieve better valuations, and also due to investor pushing for exits, the Indian startups at growth and late stages are increasingly looking at public markets for raising capital.
Adjustments to the Fund
To adapt to the reduction in its fund size, Peak XV has also reduced its management fees and carried interest rates for investors. The fund management fee that it charges to the LPs will drop from 2.5% to 2%, 2% of the size of the fund being the market standard. The carry – a VC’s share of the overall profit, is reduced from 30% to 20%. However, the firm will maintain the higher carry if the fund delivers a strong performance, specifically, if the fund achieves 3X of the invested capital, or 3X Distributed-to-Paid-In-capital, also known as DPI, which refers to the total capital returned to the fund’s LPs or sponsors. These adjustments aim to reflect the reduced capital deployment in growth and late-stage ventures. There has been no change to the economics of the early-stage funds. As per Peak XV, the decision to reduce the fund size will benefit both – the founders and the LPs. The VC firm has confirmed that the decision has been positively received by the LPs.
Market Shifts
The Indian VC ecosystem has undergone significant changes over the past couple of years, with firms struggling to meet expectations around returns on investment. Peak XV’s strategy reflects broader trends in the market, as many funds face challenges in delivering strong returns to their investors. This has resulted in VCs looking at profitable and sustainable startups as against richly valued startups for new investments and are firming up strategies for exits through secondary transactions or IPOs. Here is YourStory’s coverage of Peak XV’s increased focus on exits.
However, despite obstacles, Peak XV has achieved notable exits, generating $1.2 Bn since it separated from Sequoia Capital in 2023. The venture capital giant has divested shares in about a dozen publicly listed companies over the past year, including Zomato, Mamaearth, and Truecaller. It also sold stakes in K12 Techno Services (edtech), Pocket Aces (digital entertainment), and PingSafe (cybersecurity, now a part of SentinelOne), through secondary sales and M&As.
Thoughts
This is notably the first reduction in fund size by a leading Indian VC, following the underwhelming performance of the growth- and late-stage startups, and the increasingly complex regulatory / compliance requirements for VCs in the country, over the past couple of years. We do trust a leading VC like Peak XV to show the ethical, fare, and yet logical way to realign investment strategies and investor expectations in the Indian VC and startup ecosystem. This will not propel the VC giant to push for investments in startups with weak fundamentals and bloated valuations. Instead, we can expect investments in startups showing consistent and strong signs of profitability and sustainability. This, in turn, will help startups, as they focus on profitable, sustsinable growth and stronger fundamentals to build investor trust, and also evaluate alternative exit options, such as going public.
If a fund, or any strategy for that matter, is not peforming as per expectations, the strategy and expectations are recalibrated, which is exactly what Peak XV has done here. We do agree with the prolific VC that this recalibration exercise will go a long way in strengthening investor trust in VCs and Indian startups alike. Additionally, the VC firm would probably like to focus on quality startups, as against just the quantity, in order to minimize the number of investments that do not work out well in the longer run. We are confident of Peak XV’s continued support to identify and fund the top startups in the country in the longer run and wish them all the luck.
If you are interested to learn more, feel free to check out this coverage by YourStory and this article by Inc42.
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Acronyms used in the blog that have not been defined earlier: (a) Venture Capital (VC), (b) Billion (Bn), (c) Million (Mn), (d) Initial Public Offering (IPO), and (e) Mergers and Acquisitions (M&A).