The everything year

As we take our first steps into 2019, the most common question in the venture capital business in India—one which induces awe, delight, and relief in equal measure—goes something like this: “What’s the status of the SoftBank Vision Fund II?”

It is a question that is equally illuminating and frustrating.

Illuminating because it shows how like in most parts of the world, SoftBank has emerged as the epicentre of funding conversations in India too. Depending on the position of your seat at the table, SoftBank is either the giant red star around which all other funding vehicles and players dutifully revolve while paying guarded obeisance or the giant black hole inexorably swallowing and subsuming all funding activity within itself.

It is a well-deserved reputation. If you glance at the list of heavily-funded startups in India, other than Swiggy and Byju’s, every name on the list is backed by SoftBank—the likes of Paytm*, Ola, OYO, Snapdeal. Equally important is the name that is no longer in SoftBank’s portfolio—Flipkart, which recently provided a big-bang exit to SoftBank and a host of other marquee investors.

But the question is frustrating as well because SoftBank promises a quasi-IPO type of accelerated exit that many startups and investors might find irresistible. While this might look like a good outcome on the surface, it can easily lead to perverse incentives where short-term tactical thinking replaces ambitious long-term plans. A fund manager who is out fundraising for his nascent fund says the LPs (Limited Partners—investors in a VC fund) bring this up often. “The LPs are clear that SoftBank cannot be an exit outcome,” he says. The fund manager requested not to be named so he could share his views candidly. “And after that, the discussion moves to the lack of Initial Public Offerings (IPOs) in India. That is the outcome that is best for everyone but one that has been sorely missing, and as a fund manager, you’ve promised that at some stage this will happen.”

The conversation obviously does not stop there. “The other conversation is with late stage investors,” adds the fund manager. “Their simple metric is dollars in, dollars out. Not some fancy valuation. If you look at late 2017 and 2018, there are a lot of highly valued private companies that have been created. In the same time, the public technology companies are down some 25%. So I am not expecting 2019 to be any different, but I am expecting that in the next twenty-four months, some of this crazy funding environment should subside. Then again, a lot is dependent on Masayoshi Son (founder and CEO of SoftBank) and SoftBank Vision Fund II.”

For a moment, you might think the fund manager is hedging.

He is. No doubt. But that’s because India, for most parts, has been unpredictable. For every Flipkart-Walmart, there is a Snapdeal and Shopclues. For demonetisation and Paytm, there’s Google and Facebook’s WhatsApp. For every phrase that sings the Chinese investors are making a beeline for India, there is the massive distrust of the Chinese in a country of a billion consumers that’s prone to look at them with suspicion. India is just a complex, unpredictable place to do business, and predicting outcomes is a pointless exercise. Which is why for this piece, we will look at patterns that are likely to emerge in 2019. Lines, not dots.

Pattern No. 1: There is going to be a world with and without SoftBank

While there is no doubt that SoftBank is going to continue being a key investor in India in 2019, there are already signs that its influence in waning.

This is due to a combination of factors.

First, SoftBank has already made a meaningful number of big bets in Indian startups and is likely to focus its energies on doubling down on its existing portfolio. This will allow its portfolio companies to not just expand into adjacent markets within India itself but also spread their wings and fly overseas as the likes of OYO and Ola have already done. New bets are more likely to be in the hundred million dollar range rather than the billion dollar bracket.

Secondly, there are macro headwinds that are likely to temper SoftBank’s immediate ambitions. The sharp slowdown in China’s economy, rising trade tensions and uncertainty around the US presidency are dampeners. As are specific issues around SoftBank’s major LP partners such as the UAE government. There is a real fear that SoftBank’s dreams of having follow-on Vision Funds might not actually fructify.

Finally, there is likely to be a pushback from Indian startup founders who are not ready to enter into Faustian deals with SoftBank and instead seek to charter independent destinies for themselves by allying with other investors. For instance, despite being backed by SoftBank, Ola has erected covenants that limit SoftBank’s ownership and rights. Other founders voice concerns around accepting money from SoftBank at puffed-up valuations—the short-term gains from accepting such an investment at artificially-high valuations have to be balanced with the reality of having to deliver a much higher exit down the road to justify this valuation. Ironically, partly thanks to SoftBank’s largesse with secondary exits, many other investors have been able to demonstrate strong exits to their LPs, allowing them to raise large follow-on funds that provide founders with a viable alternative to SoftBank.

A fund manager we spoke to agrees. “I think what you will see in 2019 is different approaches to building the company. So, if you look at Ola, Bhavish (Aggarwal, Ola’s founder) is building the company from a point of view of how can I run this venture and make money in it. He is also careful about SoftBank’s overbearing nature in his cap table. A contrast is Paytm, where you can see that Vijay Shekhar Sharma* is pretty much building the company in the direction of Alibaba taking it over and running it. To me, both of these are fascinating approaches.”

Pattern No. 2: A glut of funding will make large startups larger, endowing them with a ravenous appetite to grow and get into newer businesses

The Flipkart exit in 2018 is likely to have a momentous impact in 2019 and beyond. The immediate impact has been a direct one related to the availability of capital. Flipkart investors who made handsome returns are now going to re-deploy this capital into the next generation of Indian startups. Most notably, Tiger Global, which has been crouching on the sidelines for the last two years, will make new bets in India emboldened by its success in Flipkart. The signalling effect of the Flipkart exit is equally important. Funds operating in India will now undoubtedly have a slide in their own LP pitch decks highlighting the Flipkart story. Furthermore, the scale of Flipkart’s exit will encourage global LPs, who might have previously seen India as a small market with an anaemic exit record, to revisit their assumptions and enter the country.

While it is tempting to believe that this glut of funding will benefit all stages of Indian startups with money flowing in from seed-stage startups onwards to more mature companies, that is unlikely to be the case. LPs managing tens of billions of dollars will look to funds that make bets worth hundreds of millions of dollars at a minimum. An overwhelmingly large part of the capital is therefore likely to flow into a handful of startups who are perceived as potential leaders in markets worth hundreds of billions.

The impact of this dynamic is three-fold.

Smaller startups are going to find it increasingly difficult to not only raise money but to also compete with the behemoths who have benedictions from the likes of SoftBank and Tiger Global. The competitive landscape is going to be extremely uneven with a chosen few startups having a disproportionately large treasure chest to ward pretenders away.

Secondly, these large startups are not going to be content with operating in their own niches. The imperative of returning a multi-fold exit to billion-dollar investment bets will lead them to enter new businesses and start treading on each other’s toes. Look for deep discounts and scorched-earth stratagems to play out in all major segments, with companies looking to defend their own core citadels on one hand and break into competitors’ forts. Ola will fight Swiggy. Swiggy will fight BigBasket. BigBasket will fight Flipkart.

The most meaningful impact of these battles is likely to be in terms of developing markets in India. Deep discounts will introduce new customer segments to online markets, with new classes of shoppers learning about and becoming comfortable with the notion of transacting online. Allied investments in infrastructure in terms of devices, access, and payment systems will lead to the creation of real and robust markets in the days to come.

Pattern No. 3: Early stage venture capital investors have good exit opportunities if they can get past FOMO

These high-stakes battles will foment both greed and fear in equal measure. Greed that the upcycle will last another year and fear that it won’t. The bull run in 2018 has raised expectations for an encore in 2019, but has the hype galloped ahead of reality? At least in public, investors have swiftly moved on from core e-commerce to talking up the next generation of sunrise sectors and segments. Vernacular. Tier 3 markets (the real Bharat, if you will). But in private, investors are already voicing concerns that a large part of this bullishness might be unwarranted and/or premature. For instance, it is not yet clear how vernacular markets will be monetised, and no one seems to have an answer, even in theory. Tier 3 and 4 markets might be good long-term trends but the long-term is a while away.

Smart investors are, therefore, already lining up portfolio companies to get acquired by the large startups jostling for space in every sector. Whenever a large startup, like say Swiggy, enters an adjacent market, it is all but inevitable that it will look at acquisitions to complement organic growth or to use as a beachhead to enter the market. Founders and investors who are pragmatic enough to recognise that an acquisition by Swiggy is probably the best-case scenario for them given the current market context will keep doors open for conversation and consolidation.

Pattern No. 4: Google. Facebook. Microsoft. The year Big Tech moves from the sidelines to the spotlight

Amidst all the talk about startups in India, Big Tech—the likes of Google, Facebook and Microsoft—rarely figure as central players. That is likely to change in 2019. After years of watching from the sidelines, the time is now ripe for these companies to play more active roles in the Indian startup ecosystem. From investments to acquisitions to larger marketing outlays, look for these companies to play far more active roles in India.

As it is, some of these companies have built a formidable presence and influence in India despite hardly being seen in public or being subject to public scrutiny. Secrets hiding in plain sight. A fund manager we spoke to adds, “I think the Indian venture capital market is seriously underestimating the unspoken command that foreign tech companies have over India. All companies are now doing more than billion-dollar revenues in India, what sort of a multiple will you give to them? Is WhatsApp in India bigger than, let’s say, Paytm in multiples? I would hazard a guess that it’s not $16 billion, but it is not very far away. These tech companies play a serious role in India. I would love to have an internet where none of them are allowed to do business in India, but I think the time is past for that.”

All in all, the lines seem to indicate that irrespective of whether SoftBank gets its next Vision Fund off the ground, 2019 is going to be “the best of times, the worst of times”—say hello to the epoch of belief, the epoch of incredulity, the spring of hope, the winter of despair.

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