A Game Of Returns: Is India Finally Living Up To Its Exit Potential For Startup VCs?

There’s a change in the tune when it comes to the narrative around the Indian startup ecosystem for venture capital funds and their limited partners. And this time around it’s not about new deals, but exits from old deals.

Big exits with large returns have always been a sore topic for Indian VCs. Over the past decade, we have seen only a handful of such events despite over 5K funding deals recorded since the beginning of 2020. Indeed, when one looks at the data around events such as mergers and acquisitions (M&A), we are in the midst of a slow year, as of H1 2024.

Let’s also consider that many of the M&As in the past year, including in the first half of 2024, were distress sales, where returns were not on the table. Investors were happy with just a piece of their capital invested.

While some mergers and acquisition deals do end up bringing returns, VCs are not really hot on M&As at the moment as much as they love the two other ways to get exits.

For one, there is an IPO revival with startups not just eyeing the main boards but also SME boards for public listings.

The latest is D2C meat delivery startup Zappfresh, which is filing for a listing on the SME platform of BSE. The startup counts the likes of SIDBI, Dabur Family Office, LetsVenture and Keiretsu among its investors.

Ecom Express and SmartWorks have also filed for IPOs in the past month, after the listings of ixigo, Ola Electric, Awfis, Go Digit, Unicommerce and FirstCry this year on the main boards of the stock exchange. In most of these cases, investors have made a hefty return.

VC funds and in turn their LPs would be hoping that the new-age tech IPO train keeps rolling on.

And then there is the wave of secondary deals in the first half of the year, where more than a dozen such deals were recorded and which gave early investors exits from the likes of Capillary, ixigo, Urban Company, Porter, and Pocket FM, among other startups.

These events have triggered a new narrative — perhaps exits aren’t as rare in India as previously thought by the likes of Tiger Global partner Scott Schleifer who said last year that  “returns on capital in India have sucked historically,” and how the market is struggling to live up to the trajectory of the US or China.

One could not blame Schleifer or any other VC firm or their LPs for harbouring this view at the time. Besides the massive Walmart-Flipkart deal, we have not seen plenty of large exits from India outside of IPOs. And in early 2023, the IPO class of 2021 was still struggling to prove its value to public shareholders.

But the past 12-18 months have shown that some Indian startups do have the tenacity to last through tough times, and these startups are being rewarded.

IPOs Become Real

Among the three main events, IPOs are clearly the most attractive for VC funds, given the potential for huge upsides there, as witnessed by the likes of Peak XV in the post-pandemic market.

Things have changed drastically since 2021, which was the first big wave of startup IPOs in India.

Most listed companies that went public back in 2021 have cracked profits, and some, such as Paytm, were on the very brink of getting there before a major crisis unfolded at the fintech giant. More and more companies find themselves with the right playbook for public listings because of the experience of Zomato, Paytm, Nykaa, Policybazaar and others that IPOed in 2021.

This has fuelled another wave in 2024. The IPO market is expected to see more action in the remaining months of 2024. The much-awaited public offering of food delivery and quick commerce major Swiggy is likely to open this year if the SEBI approval comes on time, while BlackBuck, Ecom Express, Zappfresh, MobiKwik, Smartworks, Avanse Financial Services, and Ullu are also awaiting the go-ahead.

Beyond this bunch, the biggest prizes for investors will come from PhonePe, Flipkart and OYO’s listings, which could happen in late 2025. Among these, PhonePe and OYO have taken major steps towards profits, so they are clearly on track to get a rousing welcome to the stock markets as and when they list.

EY’s Global IPO Trends report for Q2 2024 noted that India was at the forefront of global IPO activities in the first half of 2024, accounting for more than 27% of worldwide IPOs. While there was a decline in IPO activities in global regions, including Mainland China, there were 38 mainboard IPOs in India in H1 2024 compared to 11 during the same period in 2023. This excludes the 100-plus SME IPOs where startups are equally active.

“The entry barrier for an IPO is lower than believed. Companies like Tracxn and Unicommerce (listing at approx INR 1,000 Cr / $120 Mn) have shown that the public market has a huge appetite for profitable/close to profitable tech companies with even as little $10 to $20 Mn in revenue,” VC firm Blume’s Karthik Reddy said in a recent look at the state of exits in India.

VCs Sharpen Exit Thesis

The deal activity, especially on the IPO side, is booming, believes Vinay Singh, partner at Fireside Ventures, particularly given the listings for Bikaji, GoColors, FirstCry and ixigo this year. Fireside is a consumer-focussed VC and Singh is bullish on the IPO destination for consumer brands after the turnaround shown by Honasa and Nykaa in the past year.

“This run is causing a lot of comfort among LPs and their VCs about Indian startups as a viable liquid investment asset class. For a lot of international LPs, India comes under the Asia pool of capital, and we are measured along with China. But China has had its own troubles recently, and therefore there is a lot of comfort being taken from the fact that Indian startups are trending towards profits,” Singh told Inc42.

He added that there is more positivity about Indian startups providing liquidity and the large outcomes because of the behavioural change brought about by the funding winter. After the bruising experience of 2022-23, Indian startups and their boards, including founders, have become more cognisant of the fact that they need to show profits, and as soon as they are close to profits, now startups have the option of an IPO to deliver on the exit promise.

The IPO wave and the profitability potential shown by some startups has also had a trickle-down effect on M&As and secondary sales.

Secondary Deals In Focus

“More and more PE and VC investors are comfortable with secondary deals in startups that may list in a year or two. This provides them with an easier path to exit and a view of the IPO runway. LPs are also getting more used to backing funds that only enter secondary deals,” according to a Delhi NCR-based fund manager.

Earlier this year, former Peak XV Partners MD Piyush Gupta quit the firm to set up a secondary-focussed fund. As we reported at the time, Peak XV Partners intends to work closely with Gupta to facilitate transactions at its portfolio firms.

Similarly, asset management company 360 ONE Asset launched the INR 4,000 Cr Special Opportunities Fund-12 to invest in late-stage startups. The company claimed that this is India’s first alternative investment fund (AIF) dedicated to the private equity secondary market.

Of course, these are large funds, but the entry of new micro VC firms with tighter entry and exit points for their potential portfolio is also causing a lot of comfort among LPs. And there is a lot more confidence about exits for micro VCs through secondary deals and smaller IPOs.

It’s not the era of excess any more and LPs are only keen on backing those funds that have a clear path to exit. Even if that means not backing the global VC giants and focussing on the domestic class of fund managers.

About secondary deals, Blume’s Reddy wrote, “A 1% holding can yield $750,000 to $5 Mn in cash returns, making it a sweet spot for micro-VCs. However, it is usually unattractive for large funds as the returns are much smaller as a % of their fund size.”

Incidentally, while Blume is a large VC fund today with a corpus of roughly $290 Mn for its fourth fund, Reddy wrote that the firm’s exits from Mobstac, Purplle, Zopper through secondaries were “game-changing returns” for Blume’s $20M maiden fund, which he called a micro VC fund.

This potential to cash in on ‘game-changing returns’ is also why we are currently in the midst of a renaissance of micro VC funds, which offer an expedited exit option for some limited partners.

Of course, while exits are great at the moment and the market seems to be bullish, this also opens up the risk of another era of inflated expectations. “The long-term trajectory seems fine. A lot of right things are happening as well. But the real consideration should be how disciplined can VCs stay. If suddenly we start seeing domestic VCs launch larger and larger funds, they might not remain so tight and focussed on their entry and exit points, and then we would be back to the situation we were in in 2022,” added Fireside Ventures’ Singh.