Impact of COVID-19 on Indian Venture Capital Industry

Impact of COVID-19 on Indian Urban Mobility by Sam Ghosh 19th July 2020

Impact of COVID-19 on Indian VC Industry Sam Ghosh 17th October 2020
Indian Startup Ecosystem Indian VC Industry Impact of COVID19 Future of Indian VC Industry
Indian Economy amid
COVID19
Executive Summary
● Given considerable ambiguity around changing economic and industrial landscapes, most VCs may refrain from investment in companies other
than their own portfolio companies. As many sectors are being disrupted significantly by the pandemic, many portfolio companies may need
funding just to keep afloat. Given India focused VCs ended 2019 with a record amount of dry powder, they are positioned well to increase their
stake in existing portfolio companies through additional equity infusion at attractive valuations.
● Early-stage companies will have a hard time raising funds in the coming few quarters as VCs likely to prioritise strengthening their own portfolio
companies and companies with proven product-market-fit and revenue models. At the same time, late-stage startups may reap the benefits of
their user base and move to develop revenue sources.
● Investment instruments and terms may become more and more conservative both in terms of economics and control. We can expect stricter
liquidity preferences, stricter vesting schedules, and protective provisions.
● Venture debt is becoming popular as startups try to avoid dilution at unfavorable prices and terms.
● The current situation creates unfavorable circumstances for VC exits. Venture Funds may like to delay exits if possible to avoid selling at deeply
discounted valuations. This may result in a longer holding period and thus lower IRR. Funds at the tail end of their lives may be forced to offer
exits to their limited partners (LPs). This may lead to underperformance and/or increased sales by the LPs to secondary funds. The pandemic
has caused rapid digitisation of various sectors. Established offline players may look for acquisition to grow their digital capabilities. This may
bring strategic deal opportunities for digital startups and exit opportunities for the VC firms.
● Fundraising activity is expected to be slow in the coming quarters given fund managers may want to limit their exposure to risky investments in
the current economic scenario. The pandemic has caused and going to cause a correction in various asset prices from public equity, real
estate, and commodities. Restructuring of portfolios likely to further discourage fund managers from investing in venture funds.
● In this tough fundraising scenario, tried and tested fund managers will have a significant advantage over new fund managers.

Indian Startup Ecosystem
Indian Economy amid
COVID19

Indian Economy amid
COVID19
Indian Startup Ecosystem: Numbers
● The Indian startup ecosystem is becoming one of the most dynamic in the world. The number of startups stood at
~79K by the end of 2019 growing at a CAGR of 10%.
Data: BAIN & Company

Indian Economy amid
COVID19
● The number of funded startups in India stood at ~6.4K which is about 8% of the total startups.

Indian Economy amid
COVID19
● 92% of startups go unfunded and only ~0.15% of startups raise funding beyond series C.

Indian Economy amid
COVID19
● ~3 out of 1000 funded startups go to become unicorns, compared with ~23 in China.

Indian Economy amid
COVID19
Indian Startup Ecosystem: Regulatory Structure
SEBI (Alternative Investment Funds) Regulations, 2012:
● SEBI (AIF) Regulations, 2012 defines the primary framework for regulating Private Equity and Venture Capital funds
along with Angel Investors, Social Ventures, etc.
● It defines a Venture Capital Fund as “an Alternative Investment Fund which invests primarily in unlisted securities of
start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services,
technology or intellectual property right based activities or a new business model”.
● VC funds need to register as Category I Alternative Investment Fund under the regulations.
● As per the regulation (Section 16), at least 2/3rds of the Venture Capital fund needs to be invested in unlisted equity
shares or equity-linked instruments of a venture capital undertaking or in companies listed or proposed to be listed
on an SME exchange or SME segment of an exchange.
● At most 1/3rd can be invested in a subscription to IPO of the venture capital undertakings, debt or debt instrument of
a venture capital undertakings, preferential allotment, etc.

Indian Economy amid
COVID19
Indian Startup Ecosystem: Regulatory Structure
Income-tax Act, 1961
● Section 10 (23FB) of the Income Tax Act 1961: Any income of a venture capital company or venture capital fund
from investment in a venture capital undertaking is exempted from income tax.
Few other relevant regulations
The Securities Contracts (Regulation) Act, 1956
SEBI (Substantial Acquisition of Shares & Takeover) Regulations, 1997
SEBI (Disclosure of Investor Protection) Guidelines, 2000

Indian Economy amid
COVID19
Indian Startup Ecosystem: Programs to promote startups
● Startup India
○ Involves simplification of the regulatory process for startups.
○ Tax waivers incentivise start-ups and provide incubation assistance and funding to start-ups
● Digital India
○ Focuses on building digital infrastructure to support digital services.
● Alternative Investment Policy Advisory Committee (AIPAC)
○ Develops & promotes India’s private equity sector and actively demonstrates its impact to the government, media, and
the public at large.
○ Eases financial regulations for alternative investment funds (includes VC funds).
○ Tax benefits such as pass-through and TDS waivers for VC funds, less stringent angel fund regulations such as
reduced lock-in period.
● Atal Innovation Mission - Niti Aayog
○ Encouraging innovation and entrepreneurship from schools and colleges - Atal Tinkering Labs
○ Provide incubation and research/development support to small companies.
● SIDBI - Fund of Funds
○ A Fund of Funds with a corpus of INR. 10,000 Cr. for SEBI-registered VC funds.

Indian Economy amid
COVID19
Indian Startup Ecosystem: Recent Policy Initiatives
● Angel tax exemption
○ The Finance (no.2) Bill 2019 exempts startups from tax on “any consideration for issue of shares that exceeds the face
value of such shares” or Angel Tax by excluding investment from all Category I or II Alternative Investment Funds from
tax payability as defined by Section 56(2)viib of the Income Tax Act 1956.
● Pass-through status of losses to AIFs
○ The Finance (no.2) Bill 2019 amends section 115UB of the Income Tax Act, 1956 to allow losses to be passed through
to limited partners along with profits.
● Encourage AIFs to locate in International Financial Services Centres (IFSC)
○ Operating guidelines for AIFs in IFSCs issued by SEBI
○ 100% tax exemption: For fund managers operating from IFSC for any 10-year block within a 15-year period
○ Dividend distribution tax exemption: Companies and mutual funds exempt from paying dividend distribution tax on
meeting prescribed criteria.
○ Exemption from return filing: For non-residents and foreign companies earning income from Category I and II AIFs set
up in IFSC on meeting prescribed criteria.
● Modification in NABARD policy for greater participation in Alternative Investment Fund (NABARD)

Indian VC Industry: 2019
Indian Economy amid
COVID19

Indian Economy amid
COVID19
Indian Venture Capital Industry: 2019
● Indian VC industry was quickly gaining pace investing a record ~$10 billion USD in 2019. The recent rise in VC
investing was primarily driven by an increasing number of deals.

Indian Economy amid
COVID19
● Although, the average deal size was also on the rise.

Indian Economy amid
COVID19
● VC exits also saw growth during 2016-19.

Indian Economy amid
COVID19
● By the end of 2019, India-focused VCs had a record amount of dry powder available.

Indian Economy amid
COVID19
● Major VCs operating in the Indian market are Sequoia Capital, Accel, SAIF Partners, Chiratae Ventures, Kalaari
Capital, Nexus Venture Partners, Matrix Partners, and Lightspeed Management Company.

Indian Economy amid
COVID19
● Average holding period for these funds range from 3-6 years.

Indian Economy amid
COVID19
Indian Economy amid COVID19

Indian Economy amid
COVID19
Indian Economy amid COVID-19: Q1 FY 2020-21: Production
● Q1 of 2020-21 GDP at Constant (2011-12) Prices at Rs.26.90 lakh crore, as against Rs.35.35 lakh crore Q1 2019-20,
showing a contraction of 23.9%. Q1 2020-21 GDP at Current Prices was at Rs.38.08 lakh crore, as against Rs.49.18
lakh crore in Q1 2019-20, showing a contraction of 22.6%.
● Q1 of 2020-21 Quarterly GVA at Basic Price at Constant (2011-12) Prices: Rs.25.53 lakh crore, as against Rs. 33.08 lakh
crore in Q1 of 2019-20, showing a contraction of 22.8%. Q1 2020-21 GVA at Basic Price at Current Prices was at Rs.
35.66 lakh crore, as against Rs. 44.89 lakh crore in Q1 2019-20, showing a contraction of 20.6%.
Data: MOSPI

Indian Economy amid
COVID19
Indian Economy amid COVID-19: Q1 FY 2020-21: Production
● If we consider the factors of GDP, only Government Final Consumption saw an increase from Q1 2019-20
levels as GOI increases fiscal spending.
Data: MOSPI

Indian Economy amid
COVID19
Indian Economy amid COVID-19: Q1 FY 2020-21: Financial Sector
● Coming to the financial sector, bank deposits and credits grew although at a slower rate than Q1 of 2019-20.
LIC Premiums for non-linked policies decreased by 14.7%.
Data: MOSPI

Indian Economy amid
COVID19
Indian Economy amid COVID-19: Q1 FY 2020-21: Prices
● Consumer prices increased by 6.6% but wholesale prices decreased by 2.3%.
Data: MOSPI

Indian Economy amid
COVID19
Indian Economy amid COVID-19: Credit and Investment: Investment
● Now coming to Investments, investment by the Foreign institutional Investors saw improvement during the lockdown
period.
Data: RBI

Indian Economy amid
COVID19
Data: IHS
Indian Economy amid COVID-19: Production and Consumption: PMI
● Both Manufacturing and Services PMI were negatively impacted but the impact on services was drastic. Sentiment for
services was negative even when the lockdowns started and while Manufacturing PMI for August and September show
positive sentiment, Services PMI still shows slightly negative sentiment but stabilising.

Indian Economy amid
COVID19
Impact of COVID19

Indian Economy amid
COVID19
Impact of COVID-19: Global
● The global VC investing decreased a little in the first half of 2020 (Jan-June) compared to the same period in 2019.
Data: CRUNCHBASE

Indian Economy amid
COVID19
Impact of COVID-19: India
● Investment in Indian companies saw a drastic increase primarily because of $15.2 billion in funding for Reliance Jio.
Excluding Reliance Jio, the VC investment in India decreased by around a quarter.
● Edtech company BYJU’S received $500 million across three rounds in 2020.
Data: CRUNCHBASE

Indian Economy amid
COVID19
Impact of COVID-19: India: Monthly Trends
● As per data collated by the Indian Private Equity and Venture Capital Association (IVCA), the number of VC
investments wasn’t much affected but exit activity was badly hit.
Data: IVCA - Venture Intelligence

Indian Economy amid
COVID19
Impact of COVID-19: Monthly Trends
● The average value of exits decreased significantly this year.
Data: IVCA - Venture Intelligence

Indian Economy amid
COVID19
Future of Indian VC Industry

Indian Economy amid
COVID19
Future of Indian VC Industry: Investing
● Given considerable ambiguity around changing economic and industrial landscapes, most VCs may refrain
from investment in companies other than their own portfolio companies. As many sectors are being
disrupted significantly by the pandemic, many portfolio companies may need funding just to keep afloat.
● New investments, if any, likely to be limited to later-stage companies with proven product-market fit and
revenue models.
● Given India focused VCs ended 2019 with a record amount of dry powder, they are positioned well to
increase their stake in existing portfolio companies through additional equity infusion at attractive valuations.
● Investment instruments and terms may become more and more conservative both in terms of economics
and control. We can expect stricter liquidity preferences, stricter vesting schedules, and protective
provisions.
● Venture debt is becoming popular as startups try to avoid dilution at unfavourable price and terms.
SEBI(AIF) Regulations (section 16(2)) put restrictions on traditional Venture Capital firms in investing in debt
instruments of companies other than their portfolio companies.

Indian Economy amid
COVID19
Future of Indian VC Industry: Holding Period and IRR
● The current situation creates unfavorable circumstances for VC exits. Venture Funds may like to delay exits
if possible to avoid selling at deeply discounted valuations. This may result in longer holding period and thus
lower IRR.
● Funds at the tail end of their lives may be forced to offer exits to their limited partners (LPs). This may lead
to underperformance and/or increased sales by the LPs to secondary funds.
● The pandemic has caused rapid digitisation of various sectors. Established offline players may look for
acquisition to grow their digital capabilities. This may bring strategic deal opportunities for digital startups
and exit opportunities for VC firms.

Indian Economy amid
COVID19
Future of Indian VC Industry: Fund Raising
● Fundraising activity is expected to be slow in the coming quarters given fund managers may want to limit
their exposure to risky investments in the current economic scenario.
● The pandemic has caused and going to cause a correction in various asset prices from public equity, real
estate, and commodities. Restructuring of portfolios likely to further discourage fund managers from
investing in venture funds.
● In this tough fundraising scenario, tried and tested fund managers will have a significant advantage over
new fund managers.

Indian Economy amid
COVID19
Future of Indian VC Industry: Changing Landscape
● The pandemic is making winners and losers. Sectors such as co-working spaces and travel-related services
etc. may face painful quarters or may completely lose growth prospects. At the same time, sectors such as
tech, fintech, health tech, biotech, software as a service (especially Security, Collaboration, Mobility, and
Cloud applications), etc. may see a lot of traction in the coming quarters.
● Increased digitisation across industries is creating various revenue opportunities for startups who have a
sizeable user base. These startups may need funds to capture various revenue opportunities.
● Early-stage companies will have a hard time raising funds in the coming few quarters as VCs likely to
prioritise strengthening their own portfolio companies and companies with proven product-market-fit and
revenue models.
● At the same time, late-stage startups may reap the benefits of their user base and move to strengthen
revenue sources.

Thank You

Impact of COVID-19 on Indian Venture Capital Industry

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