India’s venture capital firms are finding that leaner might be better

Similarly, Blume Ventures, which has invested in prominent Indian startups including Battery Smart, Purplle and Unacademy, doesn’t plan to increase the corpus for its next two funds, maintaining them at about $290 million, the venture capital firm told Mint in October. Peak XV also echoed similar sentiments when it slashed its $2.85 billion India and Southeast Asia fund by $465 million to reduce its cost of capital. A key reason for this: insufficient opportunities for Peak XV’s growth strategy.

A few other VC firms looking to launch their next fund have a similar strategy or plan only a slightly bigger corpus, reflecting more tempered expectations of Indian startups. Several venture capital are sitting on sizable dry powder—capital yet to be deployed—as they have become more diligent on which startups to back.

“The driving reason for fund sizes being scaled up or down is always based on past performance. Funds raised in 2013-14 with two extensions and a grace period of 1 year are ending in 2025 as no further extensions are possible and LPs (limited partners) are demanding exits,” said Anup Jain, founding partner, BlueGreen Ventures.

Limited partners are investors in venture capital firms, which are expected to return the investment and profit to their LPs at the end of a fund cycle, which typically lasts 10 years, or 12 years if an extension is approved.

“LPs will either get cash or shares of companies in a fund’s folio. Thus, cash IRRs (internal rate of returns) will be determined for all such funds and compared versus public market CAGR (compound annual growth rate), which is at 15%,” Jain said. “The earlier interest driven by FOMO for the new asset class has now changed into actual performance and team longevity and governance inside the funds.”

Jain along with BlueGreen co-founder Rajeev Suri announced the launch of their $75 million fund to invest in early-stage startups earlier this month. Suri and Jain were former partners at Orios Ventures.

“It is wiser to perhaps scale down the funds that you may have overspent acquiring stakes in a different macro period. Today, startup valuations are 25-30% more realistic and hence the scale of the funds can be lowered by that degree,” Jain added.

Recalibrating exuberance

Several of these modest fund sizes are geared towards growth-stage investments as investors take a more measured approach due to a lack of investable startups in an overvalued market. In other words, India’s startup ecosystem is reeling from a dearth of high-quality growth-stage companies.

Not that a lack of quality stopped companies from being able to raise capital at inflated valuations earlier, especially during the pandemic, when funding was more easily available. But during the extended funding winter that followed, underlying cracks in India’s startup ecosystem became evident as companies struggled to sustain operations without a steady flow of investments.

“The 2021-22 vintage offered abundant opportunities, fueled by the bull market. However, as we entered the bear market and things stabilized, it has become crucial for companies to focus on achieving the right milestones and aligning with the right upstream capital sources,” said Abhishek Srivastava, general partner at Kae Capital.

The investment firm, which has backed startups such as Healthkart, Traya and Nua, typically invests in pre-seed to pre-series A companies. A series A investment represents the first institutional investment for a startup, setting it on to the growth-stage.

“Today, several funds and companies alike are thinking of a trajectory that is better suited to creating value in the public markets and this is having some trickle-down effect in the early stages as well,” Srivastava said.

“With fewer high-quality assets, these growth funds are chasing a lesser number of companies. So there has been a reawakening of sorts for some of them as they recalibrate the exuberance… and have to take a hard call to resize their funds accordingly,” he added.

Rightsizing the funds

Venture capital firm 3one4 Capital plans to only slightly expand its corpus whenever it raises its next fund. The firm is currently investing out of its fourth fund, which has a corpus of about $225 million.

“Our next fund is still some time away and is likely to be around $250 million considering factors like inflation. Despite overwhelming investor interest, this fund range maintains investment discipline and is commensurate to the early stage,” said Siddarth Pai, founding partner of the firm.

Pai also alluded to the mismatch between the amount of dry powder and investable opportunities.

“Several venture capital funds are considering rightsizing their corpus as investors are asking tougher questions like how much capital general partners (who manage VC funds) have returned from their previous funds and the translation of paper gains to hard cash,” Pai said. “This is going to be a common overarching theme and for those who have been fund managers for a decade, there is going to be more scrutiny on their capability to deliver these returns.”

Venture capital funds are actively participating in secondary transactions (selling their investments in startups to other investors) and encouraging their portfolio companies to go public at an earlier stage.

The timeline for startups to go public has also reduced while secondary transactions have surged in value driven by mega exits in consumer-tech companies, consulting firm Bain & Co. said in a March report.

The sweet spots

For several fund managers Mint spoke with, the sweet spot for early-stage funds is $200-250 million. For very early-stage funds that span across seed to pre-series A investments, the corpus is typically $80-120 million if they are solely focused on Indian startups. Larger early-stage investment firms such as Accel have raised $600 million funds that invest across India and Southeast Asia.

“Over the past 4-5 years, the capacity for early-stage funds to deploy capital has increased—from around $40-45 million back then to $75-100 million today,” BlueGreen’s Suri said. “This is in line with the bigger role startups play in the market and hence absorb more capital, but this runs into constraints on the number of startups a portfolio can effectively manage.”

Pai added that limited partners are essentially looking for higher multiples on their investment, which is easier to execute through right-sized funds. 3one4’s fourth fund was heavily oversubscribed, but the fund managers decided to limit its size at $200 million plus 10%.

“The investment discipline and returns are far better when you have a disciplined fund size, and venture firms tend to optimize more efficiently when the resources are scarce,” Pai said. “Oversized funds face deployment pressure and may dilute return multiples.”