Micro VCs Find Firm Footing In India's Startup Ecosystem These investors have nestled themselves between accelerators, incubators, and the larger VC ecosystem, says BlackSoil's Ankur Bansal

For many years, angel investors wrote the first cheques to startups in India. Today, with the growth of the startup ecosystem, and thereby the increased demand for early-stage investment in startups, we are seeing the rise of a new and promising asset class, which is, the micro venture capital (micro VC) funds.

According to Praxis report, India had 89 micro VCs in India in 2020, up from 29 in 2014. During 2014-2020, these micro VC funds infused $346 Mn in 574 startups through 741 deals.

In more developed startup ecosystems, micro VCs came to the fore almost a decade ago. For instance, the US had around 200+ micro VC funds in 2015 and more than half of them in Silicon Valley. They invest anywhere between $0.5 million to $5 million in a company. Some of the leading names are Bessemer, Sequoia, Greylock, NEA and Accel. The US being a mature startup ecosystem, there are a lot of sector specific micro VCs as well and they also invest in companies that are later-stage.

The rise of micro VCs

In India, the trend started when many individuals, who were looking to invest in personal capacity, felt that the startup ecosystem was evolving and could be a good bet. They came forward and set up funds as it made it easy for them to invest together rather than individually. Different team members or partners in the fund brought different expertise to the table, which not only gave them more confidence but also allowed them to manage time efficiently and work very closely with portfolio companies.

The promise of high returns that these investments offer also made it a welcoming asset class. "While the investments are quite risky, the scope of high returns make it attractive for investors and also for startups as they get single cheques instead of multiple cheques while they raise money through individuals," said Anil Joshi, managing partner, Unicorn India Ventures.

Typically, micro VCs invest early in the fund-raising life cycle of a startup which helps them to get a meaningful stake. "As they focus on early-stage startups with high growth potential, they have a higher potential to generate higher alpha. Additionally, the relatively low cost of setting-up a micro VC vs VC fund has made it easier for new entrants to enter the market," said Ankur Bansal, co-founder and executive director, BlackSoil.

Will angel investors lose relevance?

The investing community is of the opinion that both micro VC and angel investors will co-exist and continue to have relevance. "There is an increased competition for quality deal flow and some micro VCs are struggling to stand out in a crowded market. Despite this, the micro VC market in India remains an attractive option for startups seeking early-stage funding and support. Moreover, many firms in the Indian market straddle the line between micro VCs and angel investors, making it even more challenging to define the market overlap. But, it's safe to say that the number is growing and the Indian micro VC market is becoming more robust," said Yagnesh Sanghrajka, co-founder and CFO, 100X.VC. The firm works with many angel investors as it believes that they add a lot of value.

Experts also believe that there will be overlap sometimes between angel investor and micro VC, but both will exist and play their role in building the ventures. "From a long-term perspective, angels are better placed as they don't have the stress of exiting companies unlike micro VCs who need to wind up the fund in a fixed time period of 8-10 years. But both will have their relevance and will continue to exist, just that the startups now have more avenues to raise money," said Joshi.

With startups now raising funds across many stages, the very early stage could still have angels as investors. "Their role is important. What could probably change is that once the early revenue comes in, the fund or micro VC could come into play," said Brijesh Damodaran, chief investment officer and co-founder, Auxano Capital.

Bansal, however, feels that it is possible that angel investors may see a decline in relevance as micro-VCs become more prominent, but it is unlikely that they will completely lose relevance. "Angel investors and micro-VCs serve different purposes and play different roles in the startup ecosystem. Angel investors tend to be high net worth individuals who can provide startups with significant amounts of capital and bring their networks and experience to the table. Micro VCs, on the other hand, are able to offer more value in terms of support and resources," he said.

The needs of startups also vary. Some may prefer the hands-on approach offered by angel investors, while others may benefit more from the resources and expertise of a micro VC. "In conclusion, the rise of micro-VCs may affect the role of angel investors, but it is unlikely to completely replace them," said Bansal.

LPs of micro VCs

The number of LPs (limited partners) investing in the Indian micro VC market is constantly evolving and new firms are entering the market regularly.

The majority of the money today comes from high networth individuals (HNIs) as the size of micro VCs are small and funds get subscribed mainly by HNIs and fund of funds. However, in some cases micro VCs also get contributions from growth VCs or larger institutes, if they are looking for sector-specific opportunities and don't wish to get involved directly. In some cases, active angel investors also participate to have access to more qualified deals.

Second-generation entrepreneurs or family offices investing directly into the company and them being on the captable is also a show of confidence. "These LPs are often seeking exposure to early-stage startups and high-potential startups, and they see micro VC funds as a way to access this asset class. Micro VC funds typically have a focus on early-stage startups, many of which can be impact-led entities. Additionally, many family offices and second-generation entrepreneurs in India are looking for alternative investment options that align with their personal values and interests, and investing in micro-VC funds can provide them with a way to support the growth of the Indian startup ecosystem," said Bansal.

Micro VCs' next frontier

Moving into growth-stage and follow-up funding is expected to be a natural progression, with growing portfolio and access to good deals from the portfolio. "However, in most of the cases, micro VCs prefer to continue the space as that's what they enjoy, which is, working with early-stage ventures. However, we may see some of the micro VCs progressing to growth stage, especially for the fund manager who wishes to start small to gain traction and then gradually progress to growth stage funding," said Joshi.

Micro VCs have traditionally focused towards early-stage funding, but follow-up investment is already becoming a trend. "While the micro VC ecosystem in India is still in its early-stages, some successful micro VCs have already started stepping up their support to their portfolio companies by providing them access to additional funding. Micro VCs are also using follow-up funding to strengthen their position in a startup, making them more attractive to traditional venture capital firms for the next funding round," said Ankur Mittal, co-founder, Inflection Point Ventures.

Overall, as Bansal puts it, the micro-VCs have nestled themselves between accelerators, incubators, and the larger VC ecosystem. "Between the years 2020 to 2022, the seed stage deal volume (below $200K) continued to be less than 10 per cent of the total deals, a key gap micro-VC funds are keen to address," he said.