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Indian start-ups must compete without protection, says Deepak Shahdadpuri

LiveMint logoLiveMint 27-04-2017 Joji Thomas Philip

The reluctance of venture capitalists (VCs) to fund non-tech businesses and consumer-focused products is largely related to “pace of scale”—it takes a very long time, often decades, for a non-tech consumer business to create a brand and become a market leader, says Deepak I. Shahdadpuri, founder and managing director of Singapore-based investment firm DSG Consumer Partners Asia Pte Ltd.

Shahdadpuri’s firm, which recently hit the final close of $40 million for its second vehicle, is among the first funds to focus exclusively on the consumer space in India, having put capital in companies such as specialty food ingredients maker Veeba Foods, Greek yogurt maker Epigamia, and tea chain Chai Point.

In an interview, Shahdadpuri said while India still has very few consumer-focused VC funds, the country has hit a point of inflection as venture backed consumer brands are scaling quicker, and there are several success stories around. “We also have other funds broadening their mandate to include early-stage non-tech opportunities, just like Sequoia did successfully 5-6 years ago,” he added. Edited excerpts:

Even today, when it comes to consumer brands, start-ups in that space often can’t raise funding from banks, they are too small for private equity (PE) and most VCs don’t want to be seen doing anything outside tech. Despite the opportunity, why are VCs not jumping on board when it comes to consumer businesses of the non-tech variety?

I think we will see more venture funds enter the market as the opportunity becomes more obvious. There is a very long gestation period to develop, build and scale a consumer business and the gestation is longer in the non-digital physical world. I started focusing on the space in 2004 with my investment in Sula Wines. At that time, there was almost no institutional capital available to back seed and Series A rounds in non-tech consumer businesses. Fast forward 13 years and things look better. However, demand for early-stage risk capital from consumer-focused entrepreneurs still materially outstrips demand. Many of my peers have started looking at this sector more aggressively, including Saama Capital, Sequoia and Verlinvest. These investors are patient and understand that it takes a very long time, often decades, for a non-tech consumer business to create a brand and become a market leader. I believe we have hit a point of inflection. Venture-backed consumer brands are scaling quicker and there have been success stories like Sula, Veeba, Paperboat, Raw, Epigamia, Kama, Forest Essentials and Bira. This will attract more funds who can now see that you can build a profitable business and exit. I am glad VCs have not been jumping on the bandwagon as you put it; but they will be sooner than you think.

You have seen the VC space in India for a long time. MintAsia recently reported as to how during the past 18-odd months, a whole new generation of venture capital firms have taken root, hoping to usher in the next era of early-stage investing. How do you view this, considering that not since 2006-07 has the market in India experienced such an influx of new firms, especially home-grown ones?

There are many more new VCs in India today, highlighting the opportunity and the demand for capital. They play across the spectrum from seed to late stage and are a mixture of local, regional and global firms. India is a very attractive market, given its strengthening economy, and its very attractive and large base of domestic consumers. The emergence of new funds will take a Darwinian evolution with only the best funds attracting the most capital and the bottom tier funds exiting. This is great for both the venture industry and entrepreneurs. What is concerning is that many of the funds are generic and looking at the same deals. As the market evolves and matures, I would expect to see more funds getting more domain focused, given the large opportunity in so many different sectors. For example, even within the consumer segment, I expect to see more specialization into FMCG (fast-moving consumer goods), fintech, healthcare, education, etc.

We now have a situation where local VCs are sourcing a substantial portion of their capital from domestic investors—family offices, HNIs, some local financial institutions and even a bunch of local corporate houses. How can this alter the character of the country’s start-up market?

The emergence of local pools of capital is fantastic news. Each LP (limited partner) brings a different perspective and will contribute to the local start-up ecosystem. It is important that India has, and maintains, a robust, early-stage market so that start-ups can emerge and grow. In the past, the bulk of the capital was mid-market and buyouts. Successful early-stage funds raise larger and larger funds and are forced to abandon doing seed deals. I hope that the next generation of early-stage managers find their own sweet spot, develop their own defensible investment thesis and stick to doing early stage.

Does the current downturn (in funding) spell an opportunity for some of the smaller Indian VCs—since large firms have all been cutting back on seed-stage investments—and does this provide a gap in the market for these new/smaller VCs?

I have a different perspective. There always has been, and continues to be, a gap in early-stage investing, particularly in the non-tech segment. Successful funds like SAIF, Sequoia, Matrix and others scale up as they succeed. Poor performing funds will leave the market as they are unable to raise new funds. As a result, there is almost always a continuous vacuum in the early stage segment. This is an opportunity for new managers to step in and prove their ability to make returns and forces established managers to debate raising new funds materially larger than previous funds.

Has India reached a stage where home-grown packaged consumer goods type of business can thrive—today, new firms don’t need tens of millions of dollars to achieve scale due to new distribution and marketing models. Are we, therefore, at an inflection point for the creation of such consumer businesses, or is that still far away?

Yes and no—FMCG-type business can thrive, ecosystems have evolved, and it is easier today for FMCG start-ups to scale. But it is still not easy. Some firms have built a business by organizing the unorganized segment and repacking a traditional product to make it more relevant like Hector Beverages has with its Paperboat line of products. Other firms identify a white space with no direct competitor, think about Raw Pressery, India’s first High Pressure Processed cold press juice company, or Drum Foods and its first to market greek yogurt brand Epigamia. These firms must create the category and be creative about how they market and reach new consumer. The eco-system continues to change and so does consumer behaviour and demands. I expect the pace of such new investments entering the market to accelerate...

The lack of exits in Indian start-ups is by far the biggest concern among global LPs who are investors in venture capital and private equity funds. How big a concern is this?

This is a real concern and something that all GPs (general partners) spend a lot of time thinking about. However, they continue to be exits across stage and sectors including DSG Consumer Partners Asia’s part exits from Redmart, OYO and Veeba; Saama Capital exiting from Paytm and Snapeal, and others. However, this is a very small percentage of invested dollars in the same period.

As someone closely involved in the VC space, and also with entrepreneurs, what is your take on the current situation? When will investor sentiment improve?

I am very bullish at this stage and the pipeline is very exciting. Without articulating a reason, the India entrepreneur scene is as robust as it has ever been. With a thriving local market and consumers who are demanding and willing to spend, most VCs are excited about the prospects to back tomorrow’s winners. However, very few investors have a dedicated focus to the consumer space. I expect this to change over the next five years as more specialized funds enter the segment. We also have other funds broadening their mandate to include early-stage non-tech opportunities just like Sequoia did successfully 5-6 years ago.

What are the investment trends that you are bullish on this year? What are the trends in the start-up space in India and South-East Asia that one should watch out for?

We continue to look at medium- and long-term consumer trends in India and SE Asia. The demographics are super exciting: young population, higher GDP income, propensity to spend and exposure to global media. In particular, we like big, long-term themes, including retail, food, beverage, packaged products, wellness, health, financial services and other businesses that will benefit from the boom in consumption.

You recently partnered with another INSEAD alumnus to create a investment firm called InseadAlum Ventures in Singapore, with a capital of nearly $700,000 to invest in start-ups founded by ex-students of the international business school. What was the logic behind this?

InseadAlum Ventures (IAV) was an initiative of Will Klippgen (managing partner, Cocoon Capital) and myself to start a fund focused on mentoring and funding promising INSEAD alumni. The logic is two-fold—we believe very exciting entrepreneurs are graduating from INSEAD and will be a source of deal flow and, second, this was a meaningful way that Will and I can give back to INSEAD, where we both earned our master’s degrees.

Both for investors and also for start-ups, has the Narendra Modi government delivered on its promise to improve the ease of doing business?

Modi was elected to power in May 2014 and one of his election mandates was to make it easier to do business in India. It is still not easy; but from my perspective, Modi has made it easier to do business.

What is the biggest pain point in India—is it series A and B? I am asking because data shows early-stage investment still continues to be robust.

What I see is a polarization in the availability of capital. I see a lot of capital at the seed stage from family and friends, angel investors, new funds and dedicated early-stage funds. As markets progress, the most successful funds will raise new rounds of capital while poor performing funds will exit the business. So you have the best funds moving up the value chain...

Of late, we’ve been hearing some arguments on capital dumping and whether Indian start-ups need protection from foreign competition? What is your take?

This is a thorny subject. I have heard both sides of the argument and each camp has a well argued and substantiated position... but I do feel Indian start-ups need to be able to compete in the open marketplace and there should be no protection.

How will the goods and services tax (GST) reshape the Indian start-ups?

Many market players are concerned about the negative impact of GST. However, I feel the impact will be positive. GST is a unified code that does away and consolidates VAT (value-added tax), service tax, central excise, octroi or entry tax.

Dry powder with PE/VCs active in India stands close to a six-year high of $7.1 billion, according to data from private deal tracker Preqin. Does this suggest an improved fund-raising environment? Or does this suggest lack of strong deal flows, or even a lack of confidence to deploy capital in India, considering the negative news that start-ups there have been attracting for a while now?

I think the reality is somewhere in between. India is a very large economy and will continue to attract the interest of both international and domestic investors. In the short term, we will probably see periods of exuberance and periods where the news is negative. Overall, I believe, India and South-East Asia are very attractive destinations.

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