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The year 2020 has been a challenging year. I am sure almost all of you have a range of experiences in how the pandemic has impacted your personal and your business life. In my last write-up, I had shared with you our perspective and expectations on the time frame of business recovery and recovery of the private financial markets. I am pleased to say, that the developments have met and even bettered our expectations.
Notwithstanding the challenges, IvyCap Portfolio and the Funds have come out stronger and bigger than pre-covid. Given the technology bias in our portfolio, our portfolio companies have scaled beyond pre-covid levels, on the back of higher adoption and usage rates. At the fund 2 level, we also found very attractive opportunities in healthcare, technology, and the consumer space to invest in new companies. So, in retrospect, COVID has been a tailwind event for us.

Looking ahead, there are still several risks and challenges to face. The key question that we have now before us is what is the investment outlook for next year in the Venture Capital space?

Macro Drivers – Sustained strength in growth drivers with a risk of inflation
With the pandemic on the decline, the fundamental drivers of the venture-backed companies are very stronger. Venture activity in India is likely to become even more attractive as the year plays out. The predominant risk which is not factored in is the risk of rising interest rates and deleveraging and the risk of more potent mutations of the virus. Some of the key drivers are as follows.

  • The expectation is that with vaccinations in full swing in several countries, the risk of pandemic is diminishing. The assumption we are making is that the risk of a lockdown which seriously impacts the economy is low in India.
  • We expect the GDP growth will be strong across the world and particularly in India. This will lead to strong revenue growth for companies this year.
  • Fiscal and monetary policies across the world will continue to be supportive of the growth trajectory; with low rates, negative real interest rates with high liquidity, in general, provides a strong incentive for investment in the corporate and financial sector.
  • There will be a strong and sustained trend towards enhanced technology adoption thereby making faster adoption across B2B, B2C, and G2P. The adoption curve has shifted to the left resulting in online markets and B2B automation growing faster than expected.
  • Stock markets are at historical highs, and technology stocks have hit the stratosphere. This augers well for IPOs, exits, and M&A. Several Indian unicorns are likely to IPO this year, which makes venture-backed companies even more attractive. The secondary effects of this trend are likely to be felt in an increase in allocations towards private market investments. While some argue that stock markets are overheated, we feel that a correction in public markets is not likely to impact the longer-term investment cycle in private markets.
  • The Indian government has very prudently used the pandemic to unleash several reform measures which will disrupt various sectors and offer opportunities to private market investors across the various sectors.
  • There is a constant risk of inflation considering the price rise in oil and other commodities, driven by supply chain disruptions, low-interest rate regimes, and liquidity.

Venture Deal Environment – Sustained widening and deepening of opportunities

A sharp recovery in the investment in the venture space is already underway. We expect that the recovery will span across various stages of the venture capital ecosystem especially for quality deals. Expectations of valuations are likely to be higher for quality deals at various stages, hence investors will use their discretion in picking assets.
The big positive is the entry of Special Purpose Acquisition Company (SPACs) and IPOs of some unicorns as well as a larger appetite for M&A. A few successful examples of reverse mergers through SPACs and successful IPOs will change the perception of India vis-a-vis exits in the VC space. Besides, it will draw even more capital from LPs and angels into the venture ecosystem.
A summary of some of the key trends is given below.

  • Angel and early-stage ecosystem will continue to be very active
  • Across various stages, better quality deals will continue to attract funding at a premium
  • There will be an increased opportunity in cross-border deal flow in the technology space between India-US and India-Singapore. Funds that are well-positioned across these geographies will find themselves accessing an attractive niche
  • From the industry perspective, the range of attractive sectors will widen
    • Consumer (D2C brands, Consumer tech, Platforms, Supply chains) and Technology (SaaS, AI, Cyber Security, Mar-tech/Ad-tech) industries will continue to be attractive for investors given the secular trend in these sectors
    • COVID has up-scaled the operations of some industries like Edtech, Health Tech, Entertainment, Food Tech.
    • Gaming, Agri-tech, Defense, Biotech, Social Commerce and emerging Tech (applications for AR/VR, IoT, retail tech, communication) segments are likely to be sectors which will draw investor interest
  • Traditional PEs will become more excited with the technology space and is expected to continue to do more deals. Buy-out funds will continue to offer an exciting exit channel for Venture-backed companies.
  • From an exit perspective, 2021 promises to be a watershed year for venture space
    • SPACs provide an alternate exit route for large scaled-up venture cap companies in international markets.
    • A favorable atmosphere for IPOs will be created. In the domestic market growth in IPOs of VC-backed tech-driven companies will create an even greater interest in the VC asset class.
    • Expect platforms to increase their appetite for synergetic M&As
    • There is growing interest amongst secondary players in acquiring quality portfolios or fund GP restructuring. This will provide an additional avenue for exits to VC funds.

The venture space is exposed to macroeconomic risks, which can have a substantial impact on flows and valuations. Some of the key risks for this sector are as follows.

  • Risk of inflation and rise in interest rates can potentially dampen and might force de-leveraging and correction in asset prices if interest rates spike up. The jury is out on whether inflation risks will force the hand of
  • Any substantial increase in interest rates will significantly impact the buy-out deals in the ecosystem
  • If the market makes a significant correction from these levels, there is a risk of re-rating of valuations.
Thus, while the previous year had been traumatic in several ways for the industry it can be considered as the golden period for the VC-backed entrepreneurial ecosystem. This is indeed a time for boosting investment culture, and thereby focusing on building and scaling great companies.