Making Sense Of India’s Micro VC Boom

Is it a fad or the sign of the times in the Indian startup ecosystem? Whatever you may call it, we are in the midst of a micro venture capital (micro VC) renaissance in India, with dozens of firms being registered with SEBI, several more waiting in the wings, and even marquee VCs that ordinarily cut large tickets are acting like micro VC firms.

To be clear, this is not a new trend — in fact, Inc42 has tracked this for over two years now and things really started changing in late 2022, when the funding winter took root.

This past week:

• Gujarat-based Volt VC launched its maiden early-stage fund with a target corpus of INR 45 Cr
• Aviral Bhatnagar, former lead investor in SaaS, consumer, and AI sectors at Venture Highway, launched a new venture capital fund called AJVC

SEBI-registered Volt is a Category II alternative investment fund (AIF) and will focus on pre-seed investments in consumer businesses across sectors.

While AJVC will also be sector agnostic, according to Bhatnagar, it will solely focus on pre-seed bets, which is often the first institutional funding raised by startups.

These two funds represent just a drop in the micro VC ocean. Data shows that the number of new funds in India has seen an exponential growth over the past three years, and a lot of the activity is geared towards the early stage, where micro VC funds have become a distinct category similar to angel funds.

Typically speaking, micro VC funds are set apart by the fact that they have a special focus or a highly evolved thesis, thanks either to the fund manager’s expertise in a particular niche or whitespaces in the market.

For instance, in April this year, Mumbai-based Centre Court Capital rolled out an INR 350 Cr ($45 Mn) fund with a focus on sports and gaming space. Mustafa Ghouse, former CEO of JSW Sports and Asian Games bronze medalist in tennis for India, is the founder of the fund, and naturally, it has attracted limited partners from the sports and gaming industry.

A former athlete running a fund is quite unusual among larger global VCs, but such dynamism is quite commonplace in the world of micro VCs. And it’s also why most limited partners have taken to the allure of backing micro VC funds with differentiated thesis.

Micro VC Funds Punch Big 

India is a hotbed for new startup funds and there’s never a dearth of investors in the early stage, even at the peak of the funding winter. Out of the 126 funds launched in 2022, 62% were focused on early-stage startups, while last year, active Indian VCs launched 31 early stage funds with a total corpus of $1.8 Bn.

The likes of Better Capital, Java Capital, Sauce.VC, Neon VC, All In Capital, Eximius, Propell, Gemba Capital, Upekkha, Silverneedle Ventures, SenseAI among dozens of other firms have either launched new funds or announced additional funds in the past two years.

This year alone, more than two dozen new early-stage micro VC funds (under $60 Mn in corpus) have launched with a total corpus of well over half a billion dollars. While micro VC is a loosely defined category, typically, these funds have a small corpus and focus on early-stage investments.

When the term first began making the headlines in India in 2021, micro VC funds typically had very small corpuses in the range of $10 Mn – $12 Mn, and sometimes even half of that.

But in the past two years, the more attractive early-stage opportunity and the bleaker late-stage situation have pretty much forced micro VCs to launch larger funds. Such is the volume of interest from limited partners (LPs), that schemes for micro VC AIFs typically get oversubscribed.

This means, micro VC funds announced or raised this year have an average corpus of $30 Mn, a tally that excludes funds that have not announced the target corpus.

Sources in the industry indicate that dozens of firms are still awaiting SEBI clearance following which they would be launching their funds and adding to the early stage volume.

In our coverage last week, we spoke about how SEBI is tightening the rules for fund managers of new AIFs as it is currently processing thousands of applications from potentially new AIFs or existing AIFs with new funds and schemes. It is not unreasonable to assume that many micro VC funds might face some regulatory challenges in complying with these terms.

If we consider the fact that most micro VCs are not run by typical venture capitalists, then SEBI’s certification mandate seems particularly tailored for such firms.

That makes one wonder: if SEBI is not particularly keen on relaxing norms for new fund registrations, what is actually pushing more and more fund managers to launch new micro VC funds, even when these fund managers might not have the requisite skills and track record?

Are LPs Fuelling The Hype?

The answer lies in the source of VC funds, as it usually does when it comes to examining VC trends?

It’s no secret that LPs are chasing the early-stage bets and spreading capital among micro VCs with diversified thesis areas, which has made fundraising easier for early-stage funds. Moreover, this means micro VCs are occupying niches and sectors that have typically seen low investment activity, or are just emerging.

That’s also why larger VCs are spinning off smaller funds or accelerator programmes to capture some of the niche areas. Chiratae Ventures, Peak XV Partners, Accel and others have scaled up their accelerator programmes significantly in the past few years.

Chiratae’s Sonic programme has backed 20+ startups over two cohorts, while Peak XV’s Surge is close to announcing in its tenth cohort.

The number of new micro VC funds focussing on gaming, AI and deeptech is much higher given that these are the segments that investors believe have the highest upside. Moreover, there is a glut of micro VC funds that are fuelling the modern retail and D2C 2.0 wave, especially as this space has seen a post-pandemic revival and a move towards premiumisation.

“One of the things that has changed is that even limited partners are seeing that exit opportunities have grown considerably in India, from SME IPOs to M&As with established giants. They want VCs to focus on these categories that could reduce the exit horizons not only for the funds but also for LPs,” according to the founder of a prominent Mumbai-based micro VC fund, which has backed over 150 startups in the past four years.

If LPs are indeed chasing faster exits through micro VC bets, it’s a double-edged sword.

On the one hand, there is a frothy hype around startups that are developing next-gen applications in depth or AI, which could mean some of these early bets will die off sooner than expected.

Conversely and perhaps more positively, there is the fact that consumer brands that many investors are hoping will replicate the Mamaearth or Nykaa IPO trajectories.

As for the AI hype, Lighthouse Canton’s Nilesh Jasani believes that the tech industry has moved beyond the foundational elements of computing and large language models, where large investors had the bulk of the deals. Now AI’s potential is being tapped by applications that have real-world implications.

Jasani floated a GenAI-focused investment firm GenInnov Funds in April this year to tap early-stage deals. Besides GenInnov, the company runs other public and private market funds. “It’s in the downstream use cases — beyond chatbots, image editing and text formation — where the transformative power of AI is coming to life. Our fund is poised to capitalise on these advancements, aiming to surpass transient trends by investing in groundbreaking innovations that promise enduring impact and value,” Jasani told Inc42.

More New Fund Managers, More Micro VC Funds

There’s another undercurrent behind the surging wave of new smaller funds: a number of startup founders, fund managers and partners quit from their positions to float new funds. This is also why the micro VC ecosystem seems rather maverick compared to the straight-edged VC and PE class of investors.

Besides the example of Centre Court Capital, which we highlighted above, another instance is Bhatnagar and AJVC. The AJVC founding partner quit Venture Highway in April after it was acquired by General Catalyst.

Similarly, former CXOs at unicorns (BharatPe) have also floated funds in recent months that fall squarely in the micro VC category. These so-called operator-led funds fit the micro VC mould.

In a somewhat different vein, we have seen a wave of corporate-backed micro VC funds in the past two years as well, which are seen as acquisitive vehicles rather than a typical investment. FMCG majors Tata Consumer, Marico and Emami have created a playbook of investments that turn into profitable acquisitions, and others are latching on to this trend as well.

These corporate-run funds see startups not only as upside bets, but also from a strategic point of view. For instance, personal care major Lotus Herbals is close to launching a $50 Mn fund to invest in early stage beauty brands and startups.

AJVC’s Bhatnagar believes there is a significant gap in the pre-seed ecosystem, where many founders struggle to raise their first cheque, and have to court dozens of investors to secure enough capital to float new businesses.

“I want to solve this problem through a fast, approachable, pre-seed firm for Indian startups. The aim is to build a founder-friendly institution. AJVC’s first fund received SEBI approval last week. The fund is largely committed on launch day itself. I aim to bring the decade-long learnings as an investor supporting startups to build AJVC,” Bhatnagar said in a LinkedIn post.

There is some truth to the notion that promising startups and founders fail to find investors, but this is not due to the lack of investors. The fact is that seed investing has a huge upside only because it is so risky.

At the same time, we also know that VCs as a class are moving away from risk to safer bets. So it’s not unreasonable to have doubts about whether this recent influx of micro VC funds will make funding more accessible to founders.

But as many in the industry point out, the market often rewards brave bets. As larger VC firms eye low-risk bets, the next generation of innovation needs a new breed of investors.

Of course, not all micro VCs will see those returns despite assuming a lot of risk. But for now at least, we will not focus on how many of India’s micro VCs will actually raise a second or follow-on round and how many will just be a blip in time.