On June 6 2018, Prime Minister Narendra Modi said that 44% of all startups are found in Tier 2 and 3 cities across the 419 districts of India while extolling the Startup India policy. At first, the statement infused a wave of excitement, but as we go deeper into the facts, a different picture is revealed.
According to Datalabs by Inc42, 96.54% of the total funding in Q1 2019 was raised by tier 1 startups with Bengaluru (70) and Delhi NCR (36) fetching the maximum number of deals. Among the tier 2 ecosystem, the most remarkable was Jaipur, with 2 deals raising $110 Mn, while the ventures from other key cities like Surat, Madhya Pradesh, Uttar Pradesh, Punjab, Lucknow, Kolkata, Kochi and Ahmedabad received just one deal each in Q1 2019. The reach to Tier 3 is far less to even consider for data mapping.
Considering that until now these cities were mainly known as monetisation and expansion hubs for retail and ecommerce businesses, seeing them featured on the funding map is exciting in itself. But in comparison to the existing Tier 1 startup hubs, the road is still too far for the Tier 2 and Tier 3 startup ecosystem.
So, what are the reasons for this gap? How the investors are bridging these gaps? What conditions should entrepreneurs in Tier 2 and Tier 3 cities be willing to meet to attract more early-stage capital towards them?
As part of the ongoing Inc42 and Amazon Web Services (AWS) series, Over The Horizon, we put the spotlight on the angel investors such as Paula Mariwala, Dr Aarti Gupta, Revathy Ashok, Abhishek Rungta, Hari Balasubramaniam and Shashikant Chaudhary who have been observing the angel ecosystem closely in smaller cities of India.
Angel investors not only bring in much-needed risk capital at an early stage for startups but also play a crucial role in determining the trending sectors. The years of experience, being a part of either a family office, VC fund, corporate or being an entrepreneur themselves, helps angel investors assess the right opportunity at the idea stage.
“Tier value at the angel stage is not just the money, but the other inputs you are able to impart. Money anyone can give in, but I think the other guidance, various things we do along with that is equally, if not more valuable,” added Ashok.
Mending The Gaps In Tier 2 And Tier 3 Ecosystem
When talking about the gaps in the Tier 2 ecosystem, the issues that come to the fore are the lack of a mature ecosystem, lack of talent pool and resources in smaller cities as well as the lack of proximity to established and more visible ecosystems in India. While these are some long-term gaps that will be fulfilled in time, Ashok turned the arrow towards investors and said this group need to bring in the change.
She believes that the money is not only in two-three big locations like Bengaluru, Gurugram or Mumbai. Several people have money and they want to participate and invest back into innovation in their local startups. But what happens is such angel investors themselves are investing possibly for the first time, making it difficult for them to play the role of an angel investor efficiently.
“That is why I am doing a cautious effort to run masterclasses for the investors especially in Tier 2 or Tier 3 cities,” she said.
The startup problems in such areas are unique due to lack of resources and they constantly juggle between growth and capital availability, as well as scale and profitability. “These are things that if a seasoned angel investor understands and can also guide them through this, can make this ecosystem much more scalable,” she added.
Investors such as Dr Gupta are going back to their roots and working to strengthen the young entrepreneurial minds at an early stage itself. Being from Kanpur, she is working with the IIT Kanpur incubation centre to nurture young entrepreneurs, invest in ideas and mentor them. She also suggests that not all students can be entrepreneurs and there is a need to identify a certain group of people who have a definite mindset of an entrepreneur, and then provide specialised training for them at an early stage only.
As Balasubramaniam aptly says, “If you have a vision and are close to the marketplace as a buyer or seller, it really does not matter on a day-to-day basis. But of course, there is always the inconvenience of not having an Airport or hire experienced professionals or attract accomplished people to your town/city. Zoho is one great example of what we could do if we have a vision.”
Beyond Tier 1: Cautious But A Determined Approach
Chaudhary has an interesting theory. He considers the growth in Tier 2 and Tier 3 startup ecosystem equivalent to the growth in cricket talent. Initially, most of the talent in cricket was from metros only. But as facilities started coming in Tier 2 and Tier 3, raw talent started coming from small towns. Similarly, he believes it’s only a question of time, and eventually, seed angels will come for Tier 2 and Tier 3.
Well, we are not saying that Tier 1 will get saturated, but the investors are now observing a lack of disruption as compared to the Tier 2 ecosystems. According to Dr Gupta, people have started seeing regular business ideas as startups and are raising money for it. “The very concept of a startup is it has to be very disruptive and should be high-risk high return investment for an investor. So the lack of disruption or abundance of similar ideas in Tier 1 is what is pushing investors to Tier 2 or Tier 3 to get a fresher perspective,” she added.
According to DataLabs by Inc42 estimates, there are approximately 338 active angel investors in India, and around 5.92% of these are active in Tier 2. Though the number is quite less comparatively, a lot of investors are observing the ecosystem closely and making small cautious bets to test the water.
Mariwala believes there is a tremendous opportunity to address in these cities. Market proximity is important in getting an early product-market fit. With access to data networks across India, it is becoming easier for entrepreneurs to operate in these towns and keeping their ear close to the ground. It is also much less expensive to operate in these towns.
The angel investors only expect Tier 2 and Tier 3 entrepreneurs to have the right attitude, be open and adaptable with a passionate drive to solve extremely relevant problems. They would like to see mature founders who have some networks in their towns and are able to work independently.
As Rungta rightly pointed out, “This shift is happening because people there are more grounded, more hungry, more eager to prove themselves and know how to run business with low resources. Hopefully, Tier 2 and Tier 3 are showing more promise.”
Evolution Of Angel Investors As Ecosystem Enablers
In 2018, the number of unique angel investors that participated in Indian technology startup funding was 416 — a 42% drop compared to 2016 and a 30% drop compared to 2017. Also, the average number of deals per investor also came down drastically. From 1.35 in 2016, it stood at 1.15 in 2018.
On one look, this seems like a matter of concern. But being the second largest startup ecosystem, India is a land of entrepreneurship offering a great opportunity for the ecosystem. While every metric whether it’s VC investments, funding, angels, is considerably low as compared to the US, there is hope. Dr Gupta further believes that another positive thing is that a lot of founders who have failed earlier with their initial ideas are now coming back.
“This is a great sign as the most unforgettable lessons you can learn are from your failures. Some handle their failures well if they have showcased that they have done everything in their capacity to sustain and yet they fail, I being an investor is ready to bet again on them because they are more evolved after the failure,” she added.
This also shows how mature the angel investors ecosystem has become in the last few years. They now recognise that early-stage investing is a high-risk proposition with limited liquidity. Unless there is a long term view with a portfolio approach, it can not give returns.
“With many successful entrepreneurs becoming angel investors, we see a maturing of angel investing with a more collaborative approach rather than the expectation of a quick return. Many of the investors who were in this to make a quick buck have vanished and now have angels who understand the time investment and risk-return profile of angel investing. This bodes well for the ecosystem,” Mariwala added.