Decoding The Micro VC Landscape In India

Startups in India have grown at a fast clip over the years, paving the path for traditional PE/VC funding in a big way. Traditionally, early-stage funding has been the domain of angel investors, although a few venture capital funds have taken an active interest in this space. But with the spread of new-age technology and digital innovation, more and more new ventures are entering the ecosystem, and the funding and mentoring requirements of young companies have changed.

Today, startups in pre-seed and seed stages need to accomplish more to stay operational beyond the first few years. (Statistically speaking, more than 50% go out of business by that time.) They need to look beyond brilliant ideas and minimum viable products (MVPs), focus on finding the product-market fit and develop a solid business plan to ensure sustainable growth.

This has led to the steady rise of micro VCs, an agile investment class experimenting with new niches and catering to the fast-evolving needs of very early stage startups. Unlike typical growth VCs, their specialised investments (pre-seed to pre-Series A) in early stage companies have created more value and momentum than traditional fund houses.

The Rise Of Micro VC Funds In India

“India is an exciting market with opportunities to invest at various stages. Also, founders’ needs have evolved over the years, and they demand different products from the investor ecosystem. Tapping into a super angel-turned-solo GP (general partner) could be best as they have unique deal flow and insights,” said Utsav Somani, founder of AngelList and the iSeed micro VC fund.

Alongside the change in requirements comes the need for access and speed, especially in a volatile economy first hit by a global pandemic and then by macro triggers, leading to the onset of a startup funding winter.

Take, for instance, 100X.VC that started its micro VC fund in March 2021. By now, it has more than 100 startups in its portfolio. The fund is looking at 75-100 deals per year and writing $160K cheques for a 15% future equity via iSAFE Notes. That is a welcome change compared to a long-drawn-out venture capital due diligence.

Other VC firms were also quick to spot the trend. Artha Venture launched its INR 225 Cr ($27.5 Mn) seed micro VC fund called Artha Access in September 2021 to invest in 40 startups by 2025 at a ticket size of INR 25 Lakh ($30K) per deal. In October this year, it launched another larger micro VC fund called Artha Select Fund with a corpus of INR 450 Cr ($55 Mn) to make follow-on investments, each worth INR 20 Cr ($2.4 Mn), at the Series B and Series C stages.

“When we close a second seed fund next year, we want to raise the average ticket size – it can be up to INR 4 Cr ($489K). We want to write seed cheques anywhere between INR 2.5 Cr and INR 7.5 Cr ($306K-$918K), depending on the company’s maturity,” said Anirudh Damani, managing partner, and director of Artha Venture.

Interestingly, a spate of moderate-value funding in several startups with sound growth potential may also lead to oversized returns and improve a fund’s overall performance. This is in stark contrast to what many mega-funds are doing today, throwing large sums at big private companies without adequate returns.

Given these factors, the enthusiasm around the micro VC model is building up. According to industry estimates, more than 80 micro VC funds are now active in India. Earlier this month, Inc42 announced CapitalX, an initiative to help investors learn the art and the science of building and managing a top-decile micro VC fund. 

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In the current scenario marred by a liquidity crunch, micro VCs are projected to bring twofold value. To begin with, they can bridge the funding gaps at pre-seed and seed levels as traditional venture funds have ceded early-stage opportunities to not-so-deep-pocketed angel investors.

Second, there will be a good amount of innovation around processes and platforms as these micro-investors add value to their portfolio companies through strategy and team building, networking, finding the product-market fit and helping young founders scale up sustainably.

How Micro VCs Are Differentiating Themselves In India 

According to SEBI (Alternative Investment Funds) Regulations, Cat I AIF includes both VC and angel funds. But there is no specific definition for micro VC funds, and all such funds are categorised as VC funds. As depicted in the infographic below, while only Cat I AIF or SEBI-registered VC funds can be considered as pure play micro VC funds, at the same time LLPs, syndicates and angel networks are also following the micro VC funding as a strategy.

Committed Compliances for Cat I AIFs are considerably high compared to syndicates and other micro VC funding models. Pearl Agarwal, founder and managing director of Eximius Ventures, explained in a LinkedIn post how a syndicate requires capital from LPs (limited partners) on a deal-by-deal basis, making it difficult to show fund performance and assess the availability of future funds. In contrast, Category I AIFs funds bring in committed capital from LPs and create a recurring investment vehicle framework.

“They [Category I AIFs] come in different shapes and sizes, and they have a different intent of how they want to grow and what they want to achieve out of it,” she said during an interaction with Inc42.

Investment Thesis

Until last year, the concept of a micro VC fund was pretty linear. These were small funds, with a corpus of $20 Mn or less, managed by one or two GPs. The ticket size varied between $200K and $1 Mn, with no commitment to follow-on rounds. Plus, there was limited involvement in the portfolio companies’ growth strategy. This was not surprising as their small team size prevented Micro VCs from getting a board seat at every startup.

“Micro VCs typically found a sweet spot between the angel and first proper venture round,” said Somani of iSeed.

But all that has changed today as micro-investors are rigorously experimenting with strategies, playbooks and funding targets. In fact, many of them are moving away from investing generally or looking at opportunities irrespective of sectors and themes. Instead, they are trying to position themselves in sync with the most critical requirements of the startup ecosystem. Contrary to the general concept, this may lead to a thematic focus or a specialised approach, especially as tech disruptions continue to expand across sectors.

The need to differentiate themselves has also emerged due to the growing competition from angel investors, LLPs and SEBI-registered VCs under Cat I AIFs (more on that later). Setting themselves up as a new breed of investors with savvier investment policies and maximum impact is crucial if micro-investors want to stay relevant in a market dominated by marquee VCs.

The investment thesis for micro funding in India

• Registered as category 1 AIF VC funds under SEBI (Alternative Investment Funds) Regulations, 2012, now known as SEBI (Alternative Investment Funds) (Third Amendment) Regulations, 2022
• Fund corpus: Anywhere from $10 Mn to $30 Mn for seed micro VC fund; under $100 Mn for follow-on funding in portfolio companies
• Investment stage: From pre-seed to pre-Series A; follow-on rounds into portfolio companies may continue up to Series C.
• Average ticket size of funding deals: Varies from $100K to $1 Mn up to Pre-Series A; between $1 Mn and $2.5 Mn for follow-on rounds
• Support provided to portfolio startups: Mentoring, networking access, helping reach product-market fit, Series A funding and above, advisory and legal support
• Exit: 4-5 years (on average)

Micro VC Funding Strategies

Although differentiation is critical, our conversations with several micro VC firms reveal that there can be no one-size-fits-all solution to amplify their operations and impact. From fund size and the investment stage to ticket size, allocation model and the support system offered to portfolio companies, the parameters vary widely, and new theses continue to come up.

Among these are sector-agnostic funds eyeing 20-40 deals per year and only writing first cheques. Others are gunning for sector-specific investments, which may get even more granular (read gender-specific). For instance, She Capital only backs women-led businesses. Then again, some micro VCs with a corpus of $10 Mn or so write very small seed cheques, while 100X.VC (and its ilk) is looking to invest in 100 companies from a $24.4 Mn (INR 200 Cr) corpus.

Although most of these micro-investors prefer to go for below-Series A funding, this trend is changing, too, as the likes of Artha Select Fund commit to follow-on rounds up to the Series C stage.

Eximius Ventures, a SEBI-registered (Cat 1 AIF) micro venture fund, reserves 30-40% of the corpus for follow-on investments. When co-investing, it puts in less than 30% of the total funding, reflecting an example of conditional micro VC funding strategy.

Micro VC Funds Vs Other Early Stage Investor Classes

According to Shashank Randev, founder VC of 100X.VC, the intent and the ability to deploy capital would have more significance for a micro VC fund than the corpus size.

Consider the Fund I raised by pi Ventures, an early stage VC backing deeptech and AI startups. The said fund had a $30 Mn corpus and invested in 15 startups in a year. However, it cannot be classified as a micro VC fund. The key parameters that differentiate the two are the average ticket size (big VCs do not write below $500K) and the investment stage when a VC enters a startup.

“As a micro VC it is important to define your ticket size first and the number of companies you are looking to invest in a year. If Micro VCs are only doing five investments a year on an average ticket size of $300K, they are not actually creating much of an impact. Also, higher ticket size will not allow you to serve the basic premise of being a micro VC fund,” said Shashank.

Will There Be More Room For Micro VCs In India? 

Micro VCs have seen a favourable environment given a sharp rise in the number of seed-stage deals in spite of the pandemic and the funding winter. For context, between January 2014 to October 2022, approximately $5 Bn was raised across 4K+ deals. Here 65% of the fund flow at seed stage was observed between 2020-2022 period, as per Inc42 data.

However, one may easily argue that the concept or the business model offers nothing new. Small-ticket funding has been prevalent all these years; even idea-stage startups have raised capital from angels and early stage VCs keen to work with disruptive companies.

Therefore, one of the most challenging tasks is to rethink and redefine PE, VC and micro VC funds and their respective relevance in the Indian context to make the startup funding ecosystem more effective and inclusive.

Going by its most dominant features in terms of fund size and ticket size, micro VCs closely resemble angel funds rather than traditional VCs.

“We must bear various expenses for regulatory compliance as we are in the VC category. But this is not apt considering our investment strategy. We should be put under the angel fund category or one notch higher than that,” said Damani of Artha Venture.

According to Pearl Agarwal, founder and managing director, Eximius Ventures, the most critical aspect of a micro VC is the source of capital or their LPs.

“If your fund largely depends on LPs who take decisions on a deal-by-deal basis, they may decide not to invest during a funding down cycle. In such cases, it will put the fund off track and impact its overall performance,” she told Inc42.

Another core challenge highlighted by industry experts is the need to work on the ground to improve deal quality. The VCs see a lot of ideas, but the fundamental innovation in overall technology, SaaS and certain deeptech and biotech sectors is still missing.

“This is because these startups are primarily incubated at incubation centres. Post the idea stage, these centres are unable to support the startups in their growth journey, while the current VC ecosystem is accessible primarily for startups with some traction. Micro VCs fill this gap from idea stage to MVP/early traction stage quite comfortably,” said Randev of 100X.VC.

As the startup ecosystem in India – the third largest and counting – continues to thrive despite many odds, micro VCs can undoubtedly usher in a paradigm shift in the startup funding space. In fact, we expect more micro VCs to emerge and grow as LPs and GPs expand their investment portfolios by adopting a low-risk, high-potential approach.

The next article in this series will feature more on the key factors leading to the popularity of micro VC funds in India and their growth path.

Stay Tuned!

[Edited By Sanghamitra Mandal]