Seizing the silver lining: investing in indian start-ups during downturns

IN THE COMPETITIVE stage of the Indian start-up ecosystem, the pendulum of fortune swings with a rhythm that investors must learn to dance to. The current scenario is one of downturn, with funding for Indian start-ups plummeting to a five-year low.

In the face of adversity, however, a counterintuitive strategy emerges—the notion that downturns might just be the best times to invest in start-ups. As Warren Buffett wisely advises, “Be fearful when others are greedy and greedy when others are fearful.” This mantra holds particularly true in the unpredictable world of start-ups, where opportunities often arise amidst economic challenges.

In Choppy Waters: Funding at a Five-Year Low

The heartbeat of any start-up ecosystem is the availability of funds. In recent times, Indian start-ups have faced a drought in funding, marking a five-year low.

This downturn, fuelled by various economic factors and global uncertainties, has sent ripples across the entrepreneurial landscape. However, seasoned investors are quick to recognize that within every challenge lies an opportunity, and the current state of funding may just be the bedrock for the next wave of successful ventures.

Warren Buffett’s investment philosophy has been a guiding light for many successful investors. His timeless advice to be fearful when others are greedy and greedy only when others are fearful holds profound relevance in the current start-up investment landscape. While the general sentiment might be one of caution and risk aversion during downturns, enlightened investors see these moments as a chance to acquire valuable assets at a bargain.

Amidst Churning Seas, Fund Managers Prepare for the Swell

Contrary to popular belief, fund managers are not sitting idly during periods of funding drought. On the contrary, there is a surge in activity among fund managers who are actively setting up new funds, accumulating dry powder to be strategically deployed during the downturn. This proactive approach signifies a belief in the cyclical nature of markets and the understanding that economic downturns can present unique investment opportunities.

Entrepreneurial history showcases a compelling narrative of the success stories that emerged from the ashes of economic downturns.

Giants like Apple and Microsoft found their footing during the recession of 1975, while disruptive platforms like WhatsApp and Airbnb were born in the aftermath of the 2008 financial crisis. This pattern is not exclusive to global markets as Indian start-ups have also demonstrated resilience and innovation during challenging times.

Several factors contribute to the rationale behind investing during downturns. First and foremost is the attractive valuation that start-ups command during such periods. Venture capitalists (VCs) seize the opportunity to acquire significant stakes in promising ventures at a fraction of their perceived value in more prosperous times.

This discounted entry not only minimizes investment risk but also maximizes potential returns when the market eventually rebounds. Additionally, only the most robust and proven founders can weather the storm of funding winters.

Downturns act as a natural filter, allowing only the cream of the entrepreneurial crop to survive. Investors, therefore, find themselves backing founders who have the tenacity and strategic acumen to build enduring franchises and, in some cases, unicorn companies.

Exemplary Returns: A Glimpse into the Past

The idea that market downturns can lead to exceptional returns is not mere conjecture; it is grounded in the empirical success of numerous venture capital and private equity funds. Taking a closer look at the 2010-2012 vintage years, which coincided with a period of economic uncertainty, reveals that some of the Indian VC/PE funds from this era have delivered outstanding returns.

For instance, Blume Fund I, launched in 2012, has defied the odds and delivered a gross return of 4.6x to date. Projections indicate that the fund is expected to reach a total gross return of 5.4x by the end of its term. These success stories underscore the potential for lucrative returns when investors adopt a contrarian approach and navigate the challenges of economic downturns.

As the Indian start-up ecosystem weathers the current storm, optimism abounds for the future. Diligent investors are closely monitoring the landscape, recognizing that the 2023-2024 vintage years could become some of the highest return-generating vintages for Indian funds. The cyclical nature of markets suggests that the current downturn will eventually give way to an upturn, bringing with it a new wave of investment opportunities.

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Views expressed on Outlook Start Up on Jan 25, 2024