Why Japan-Based Incubate Fund Is Bullish On India’s Consumer Economy

India’s investment landscape was transformed for good when the SEBI (Foreign Venture Capital Investor) Regulations 2000 opened the floodgates for global VC giants. The optimism was palpable from Day I, and a host of US-based funds, such as Tiger Global, Sequoia Capital, Y Combinator, IDG Ventures and Norwest Venture Partners, made forays. They empowered India’s burgeoning startup ecosystem and catalysed innovation and growth across sectors.

SAIF Partners, then a JV with the iconic Japanese investor SoftBank, was an early entrant in 2001, and SoftBank established its India operations in 2013, demonstrating a long-term commitment to the Indian startup ecosystem.

Several VC firms from Japan, especially early stage investors, also started exploring India as a promising destination around that time. By 2014, Indian ecommerce giant Flipkart raised $1 Bn in a single funding round, while the total funding for Indian startups surpassed $5 Bn. In brief, the global funding scenario was looking up even in those early days.

One of the standout entities in those days was the Japan-based Incubate Fund. It was launched in 2010 by a team of four – Tohra Akaura, Yusuke Murata, Masahiko Homma and Keisuke Wada – and initially focussed solely on the Japanese market. Incubate quickly rose to become the top performer by 2015 and soon recognised the vast potential offered by international markets. Therefore, the general partners (GPs) made the strategic decision to expand globally.

The two major markets at the time were the fiercely competitive US and the highly localised China. However, India quickly emerged as the next significant frontier with its rapidly expanding startup ecosystem. Recognising an early opportunity, the Japanese VC firm started investing in Indian startups in 2015 through its $91 Mn Incubate Fund III.

Seeking a trusted partner to establish an India-focussed fund, the team from Incubate Fund got in touch with Nao Murakami, a former investment banker and entrepreneur running his startup in New Delhi.

“After my i-banking stint at New York-based Nomura Securities, I came to India in 2015 to start my venture, Gamma India. Unfortunately, it shut down within eight months. I met the Incubate team during that time, and together we set up Incubate Fund India,” Murakami shared in an exclusive interview with Inc42 as part of its ongoing Moneyball Series.

In February 2016, Murakami joined Incubate Fund India as founder and GP. Between 2015 and 2024, the VC firm invested in 29 startups through Funds I ($3 Mn) and II ($15 Mn). Among the portfolio companies are prominent startups like Captain Fresh, Yulu, ShopKirana, Plum and Includ, which have made significant strides in their respective industries.

The India entity was rebranded as Incubate Fund Asia in September 2023, with a renewed focus on Southeast Asian startups. At that time, it also announced the first close of Fund III, targeting a corpus of $50 Mn (around INR 416 Cr). However, it was closed at $30 Mn in June this year, as Murakami did not want to stretch the fundraising timeline beyond its schedule.

Nearly 80% of the new fund will be used for investments in India, and the remaining 20% will be deployed to Singapore, Indonesia and the Middle East.

“We may deploy the new investment budgets of this fund quickly, say within one year or one and a half years from now, and start raising the next fund (Fund IV) with a bigger corpus next year (2025),” shared Murakami.

A Leap From B2B To B2C: Incubate Fund Asia’s Shift In Investment Thesis 

Incubate Fund Asia has been active in India for nearly a decade and initially focussed on B2B commerce.

“In 2015-16, we saw the startup bubble build up in India for the first time, marked by a surge in investors fervently chasing B2C opportunities. But we concentrated solely on the B2B space due to our limited fund size,” said Murakami.

But unlike the cash-guzzling B2C space, which requires huge promotion to create brand awareness and acquire customers, B2B follows a more targeted model, without spending much on advertising or marketing. This enabled the fund to spot promising opportunities and back strong founders minus a significant financial outlay.

In 2023, Incubate Fund Asia launched Fund III with a $30 Mn corpus. Demonstrating strategic foresight, the VC firm recalibrated its investment strategy to target B2C and B2B2C ventures targeting Tier II and III regions or beyond. Although Fund III is sector-agnostic, it focusses on four key areas: Consumer brands, greentech, cross-border B2B e-commerce and fintech. The change in investment thesis also emphasises Incubate’s commitment to identifying and nurturing high-potential ventures across sectors and emerging markets.

“However, 70% of the decision-making depends on a company’s founders. The other two investment criteria are market size and potential profitability,” added Murakami.

Asked to clarify the sudden shift from B2B to B2C at a time when most VCs are focussing on enterprisetech to future-proof their earnings, Murakami said that the change was driven by the increased availability of capital for Fund III. It enables the fund to support portfolio companies through their Series A journeys and provide them with a competitive edge.

For instance, with Fund I, Incubate Fund Asia led a round with an average cheque size of $200-250K. But the fund can now invest $600-700K, which can go beyond $1 Mn in certain cases. Essentially, the change in investment thesis reflects the fund’s increased investment capacity and willingness to take bigger risks.

The team also recognised the potential of a fast-expanding B2C market, with middle-income groups emerging in Tier II and beyond. Given his experience in venture capital, Murakami was confident that the new fund could effectively support B2C and B2B2C companies in this changing scenario. Incubate Fund Asia has already invested in BuyEazzy, a beauty and cosmetics brand focussing on Tier III and IV markets. It recently raised a Series A round from Info Edge Ventures, a testament to its growth potential.

“The playbook for B2C and B2B2C companies succeeding in Tier II, III or IV markets differs significantly from those targeting Tier 1 clientele. Here, logistics and supply chain management are crucial to winning the game, rather than marketing and advertising,” said Murakami.

VCs Must Excel To Stay In The Race

Homegrown investors have significantly ramped up their deal-making activities in the past decade. Angels, PE/VC firms, family offices, pension funds and HNIs are now actively looking at the burgeoning Indian startup ecosystem, especially early stage businesses. According to Murakami, this surge in interest among Indian investors has created more co-investment opportunities for their overseas counterparts.

“However, a limited partner must always choose wisely, distinguishing between good and average VCs,” he said.

But given the challenges and changes faced by Silicon Valley VCs over the past few years – some deciding to call it quits and others refraining from investing or raising new funds – what are the parameters to identify excellent performers?

Murakami sticks to a simple parameter. Now that the business headwinds have considerably subsided, many VCs are raising their first or second funds. For instance, India-based VentureSoul Partners and Singapore’s ThinKuvate recently announced their maiden funds.

At this level, winning LPs’ trust based on credibility is relatively easy. But when it comes to a third fund, VCs must demonstrate strong performance, especially regarding actual cash returns to LPs who invested in Fund I. VCs cannot secure a third fund if they cannot return the capital invested earlier. Fund III serves as a critical test.

According to Inc42 data, 20+ India-focussed funds worth $1.2 Bn were announced in H1 2024 (January-June). While the rise in new funds and micro-funds is encouraging, Murakami believes a natural selection process will emerge in the coming years.

Some GPs will successfully raise their second and third funds, proving their competence, while others may struggle, leading to a performance assessment of sorts. This trend is observed in every market, including Japan and the US, among others, and it is expected to happen in India.

Startups Should Leverage The ‘India Advantage’

Post-pandemic, the world witnessed a significant supply chain shift away from China, triggered by the escalating US-China tensions. The Russia-Ukraine conflict also won India its diplomatic spurs, convincing global majors that the country would stick to the principles of peace and stability to emerge as a major economy. In essence, India has positioned itself as an attractive destination for global investors and MNCs.

Although this is an opportune moment for growth, Murakami also sees a challenge. The supply chains of the US and China are 10 years ahead of India, which lacks the robustness and sophistication needed to service global markets.

“However, the demand exists, opening a new playing field for Indian startups. Whether they specialise in B2B or B2C, companies can capitalise on this shift, as India is well-positioned to create highly valued supply chain companies,” he added.

As the world is now geopolitically split into blocks under the US, China, or Russia, businesses are looking for neutral powers and strong economies as business allies. With India’s real GDP estimated to grow by 8.2% in FY24 to reach INR 173.82 Lakh Cr ($xxxx Tn), the country fulfils both conditions and is well prepared to explore the rising global opportunities. xxxx

“India maintains friendly relations with most foreign nations [blocks] without strongly aligning with one side. This strategic positioning is crucial for economic growth, allowing India to explore these alliances effectively. Consequently, startups can leverage these business corridors across all fronts,” added Murakami.

IPO Should Be The First Choice Of Exit For VCs

After working across the Indian startup ecosystem for nearly eight years, Murakami has identified a critical gap: A simplified IPO framework.

“In Japan, 50 to 100 startups go public every year because a specific IPO market has been designed for them. Japanese VCs consider IPOs the primary exit option, even in the early stages. But we didn’t see much IPO activity among homegrown startups until 2021,” he noted.

India, too, was willing to embrace a similar investment culture. In August 2015, capital market regulator SEBI notified a new set of listing norms (along with significant relaxations in disclosures) so that Indian startups could easily enter the public market via the Institutional Trading Platform (ITP) of national stock exchanges. But the ITP framework could garner little interest.

SEBI tried to revive the platform in 2019 by introducing certain amendments and rebranding it as the Innovators Growth Platform (IGP). However, market interest in the platform continues to be tepid.

Murakami thinks this is gradually changing. So far, 23 Indian tech startups got listed on the BSE/NSE. The latest was Le Travenues Technology, the parent company of the online travel agency ixigo, which made a strong debut on June 18, 2024.

In fact, the Indian capital market will likely see many new-age tech IPOs this year, with ventures like Swiggy, Ola Electric, FirstCry, Unicommerce, Ola Cabs, PayU and MobiKwik gearing up to go public.

“Nevertheless, there is room for improvement. Indian stock exchanges can be more startup-friendly when it comes to IPOs. Also, the country’s startup ecosystem is ahead of other Southeast Asian countries. Therefore, making IPOs the primary exit option may attract more global VCs,” said Murakami.

According to a Nikkei Asia report, Tokyo VCs like Genesia Ventures and Beyond Next Ventures have also shown interest in the third-largest unicorn generator. When the funding winter finally thaws, a new bunch of VCs may bring new investment themes and more capital to empower India’s emerging businesses.

[Edited by Sanghamitra Mandal]