A Quick Guide On Building Your Startup Investment Strategy

Given that we work in the venture capital industry, every now and then, a friend/relative will call asking for advice. “Should one invest in a startup? Should I invest in a fund? What percentage of my wealth should I invest in startups?” 

We had a discussion with Gaurav Deepak, CEO and co-founder of Avendus,  Sheeba D’Mello of Prathithi investments, and Karthik B. Reddy Reddy of Blume Ventures on the subject.

The reason that startup investment is such a hot topic is because of the value we see in our lives with tech-driven solutions. Digital-first companies are changing the game with their innovation—they are attracting the best talent, thereby creating high-quality products. 

The growth potential is also high. India has 250 million families of which 10 million are digital first. They are the ones that shop at Amazon and Nykaa, and primarily subscribe to OTT platforms such as Netflix and Hotstar. This percentage is set to grow to 50% by 2030 as supply chains improve and experiences become better and more affordable.

As investors, we are witness to the change from e-commerce to UPI and satellite television to OTT. What is an HNI’s exposure to Digital India and why is this space exciting?

India’s Digital market cap is at $300bn. Before the current tech shock, it was $400b, which brings it to about 8-10% of India’s total market cap ($3 trillion public/ $600b private). This 8-10% share of the Digital market cap should increase to 25-30% in the next 7-10 years. If India’s market cap grows to $7.5 trillion by the end of the decade, at least $2 trillion will come from the digital space. We can expect 6-7 times growth from here. Just two years ago, this was $150b. This is why the world of digital is exciting to retail investors.

The fact is that a lot of people are deeply under-indexed. So, a correction is required. Investors can enter the industry at any point based on their appetite for risk. The question, therefore, is not about should or when. It’s more about how much and where to invest. 

Deepak, who advises a large percentage of HNIs, says that we should think of investments in terms of Digital. “Twenty percent of one’s financial assets should be in the digital space and every HNI should plan on getting there in the next 12 months. It’s best to invest across stages—early/mid/late, with one-third in each stage. Late stage investments can be the tech stocks such as Google and Infoedge.”  

He added that for early-stage investments, it would be best to invest through funds unless either one knows the industry deeply or it’s a close friend one believes in. “The quality of startups is a challenge. You would be competing against Tier 1 and Tier 2 VCs for the same deals and returns at this stage. Hence, it’s best to select a fund manager. And, pick that person carefully. This part cannot be stressed enough.”

At the mid-stage too, Deepak added, it’s best to invest through funds. In the late stage, one can go direct or through options such as Portfolio Management Services (PMS). “If an individual has INR 10 Crores as a total investible corpus, invest about INR 2-3 crores in Digital India, INR 1 crore through an early stage fund (seed/ pre-series A), INR 1 crore through a mid-stage fund (Series A/ B) and INR 1 crore through PMS/ Tech stocks.”

If an individual has INR 100 crores and keeps aside INR 20 crores for investments in Digital, then, says Deepak, keep INR 6 crores aside for investing in early-stage startups. “Go with two funds and invest INR 3 crore each. Split the rest across mid and growth-stage digital funds/ stocks. If one has INR 1,000 crores and keeps aside 200 crores for investments in Digital, they will then have INR 50-75 crores to invest in the early stage. In this case, you can pick 3-4 funds. All early-stage funds are not homogenous. For instance, Fireside will be more B2C, Blume will have a B2B and B2C approach.”

If your question is “How to pick funds”, the answer is that it would be best to spend a couple of hours every week learning about the space and then choosing your fund managers. A proven track record helps.

Our experience at early stage has taught us not to expect miracles before at least three or five years. In the early stage, it takes eight to 10 years to get liquidity. When you start a relationship, start with the intent of backing multiple funds with the same partners. Think your 5-7 year liquidity cycle through. Look at a minimum of three funds. By the time the third fund calls come in, your first fund will hopefully give back enough money. We are seeing glimpses of this with our funds 1 and 2. It feels magical because we don’t have to ask the investor for their hard-earned money again. It comes from the returns generated for them.

What about the correction in valuation?

There was an excess of funds that led to higher valuations. So, a correction is good. The capital market should give the right people access to capital so that they can use it well. Many may not get capital, and that might be for the right reasons.

We need to ask ourselves if we believe there is value creation potential in Digital over the next 10 years. A lot of us don’t need liquidity every day. Yes, the risk on the particular asset is high, but at a portfolio level you can balance it out. Most people are under-indexed today, so a right balanced portfolio construction is the right way to start.

Click here to read about how family offices got interested in startup investments.