This article has been written by Ishita_Raghav pursuing the Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.
Introduction: venture capital funding
Venture Capital funding which is usually funded by Venture capital firms, high net worth individuals etc is provided in the form of institutional funding to start-ups during their expansion stage, however, in today’s times, this principle is not just limited to the expansion stage, but rather the venture capital financing is attracted (and proven beneficial) to almost all the stages of the business growth.
What attracts venture capital investors to invest in these small (and often risky) businesses is that they are exceptionally brilliant commercial ideas with revolutionary products/services and upgraded technology. Other than the primal and high returns, venture capital investors seek to gain influential control over the businesses in the long run and thus they invest in exchange of either equity shares or ownership stake or acquisition of voting rights. Moreover, for venture capital investors, diversification is an unwritten rule. They seek investments in multiple opportunities thus not limiting their own goal/ objective with the high and more realistic return.
Recent emerging trends in venture capital investments
- Zebra Trend
As against the famous “Unicorn” trend, the “Zebra” trend of funding is known for investing in companies that are profitable, sustainable, and beneficial to society. Zebra companies aim to generate annual revenue between $5 million to $1 million. They may not be techno-savvy companies but are often seen as technology-enabled.
The factor that aids Zebra companies to act as a goldmine is that they are more receptive to consumer’s growing demands and are flexible to change its course and functions in order to fulfill the same. Where the Unicorn companies like Uber can change the way of working and bring revolutionary products (and services), it is the Zebra companies that can boost up the local communities, economically. America’ Rockmyrun, is one such Zebra company that performs the way Spotify music app does, but it has the application more suitable and approachable for running enthusiasts and other sportspeople.
Zebra companies are realistic companies, they aim to strive for both revenue generation and culture inclusion, together, without killing the other objective.
- Cryptocurrency trend
Much similar to other traditional investment markets, cryptocurrency investments establish a gateway of entry in the cryptocurrency market. The cryptocurrencies or the blockchain industry is relatively much newer in age and thus curtails high-risk factors as compared to other industries, especially considering the fact that, these days, technology scams are also rampant.
In the United States of America, venture capital firms sign up for cryptocurrency investments through the execution of Simple Agreement for Future Token (SAFT). SAFT documents are offered by cryptocurrency developers wherein the SAFTs are considered as tradable securities and the tokens issued have to comply with securities regulations of the territory. The Supreme Court of the United States, by taking a progressive stand, announced the Howey Test, wherein the Securities and Exchange Commission v W.J Howey Co, determines the validity of a cryptocurrency transaction be considered in lieu of regulations.
So how different is cryptocurrency investment from traditional investments? The crypto-induced start-ups that seek funding must foremost, organize for a well-prepared pitch along with a working product that can influence the decisions of these venture capitalists. In other words, as these investments are not easy to decipher, businessmen should develop a white paper that can act as a road map for investors.
Another advantage for start-ups that have already gained VC funding previously, is that they automatically obtain a higher standing as against other upcoming investments, which are often nothing short of scams promising a higher return to investors. This is because prior investments create reassurance and reliability and further protects and promote the image of much riskier crypto start-up companies.
Interestingly, in order not to miss out on golden opportunities, many VC firms in the States have rather enthusiastically invested in cryptocurrencies. Major crypto VC firms in the US include Galaxy Digital (founded by former billionaire Michael Novogratz), Digital Currency Group, Yeoman’s Capital, Pantera Capital, and Winklevoss Capital (now one of the billionaires in the market) amongst the others.
The growth of cryptocurrencies as seen in other countries make us believe the great potential it can have in India. When opportunities allow, Indian investors must join the bandwagon.
- SAAS sector
Even with the pandemic leaving an effect in almost every industry, Software As A Service (SAAS) investments have proved to be beneficial for many players in the market. Rather the ongoing pandemic has increased the demand for more cloud-based models that are efficient and economic at the same time. The demand is challenging corporations to transform into digital space, which in turn is increasing the consumption of SAAS and other cloud service providers.
What makes this technology product different from others is that the SAAS products allow users to use the application (or platform) directly on their computer device via an internet connection, for running and updating, without the need to download it. The highlight of this investment is that there are so many services that can be run by SAAS technology, thus the game is not just limited to few dominating players but rather the playground is available quite easily for entrepreneurs, which means, good opportunities for investors.
In India, the esteemed “India Venture Capital Report 2021”” made an observation last year that the country has noticed continuous and growing investments in technology and SAAS products. So much so, sectors including SAAS, consumer tech, fintech accounted for 75% investments in total as compared to the previous year’s investment at 65%. Further, it is predicted by certain private companies that Indian SAAS companies will further continue to increase 6 times in profit by the end of year 2025. The SAAS investments in India, both in vertical SAAS (example, Zenoti) and horizontal SAAS sectors (example, Freshworks) have been catching attention from global investors such as SoftBank, Tiger Global Management, Falcon Edge Group, and the like.
More recently, the investors are keen on actively investing in more “more focussed” investments that can achieve greater allocation of illiquid assets and wider portfolio rather than traditional investment schemes. The success in thematic investments depends upon a deep understanding of the long-term economic, political and social impact of these investment opportunities.
Previously, thematic investors were considered as highly risky as they contained restrictive portfolios, however, in recent times, investors have undertaken creative ways in gaining advantageous thematic investment.
As for the advantages to investors, thematic investments do prove to be beneficial in many forms, such as, it envisages opportunities for investors to focus on hot trends where capital can be diffused in higher range; due to extensive research on the ongoing trends, detailed and thorough research is required which ultimately creates value addition in these investments. To make the very best of thematic investments, venture capitalists often rely on step by step procedure, such as-
1) Defining and considering the thematic trend
This is the primary stage where an internal assessment is undertaken to consider all the available investment trends with possible gains that can be achieved from them. Factors that should be considered in shortlisting the trends in stage are, whether is it short-term or conjectural? What could be the material implications upon the success of such businesses? Are the general public and researchers enthusiastic about the developments of these possibilities?
2)Multiple and greater impact of trends
Instead of merely focussing on the implications of one theme over a region, it would be beneficial for investors to consider the conjectural and multiple impact of business over more than one region or society. In other words, investors should be able to identify and revenue generation of one sector over other subsectors.
3) Selection of themes
Prioritizing themes at this stage is important. Factors such as, investible value gaining from these themes, the ability of the theme to be differentiated from the other, if the theme is within the current portfolio and investment policies.
4) Creating an investment thesis
The investment thesis here discuss the practical aspects of the investment theme where a thesis should be formed describing how and why value would be created in a certain investment period of time. Later on, a thesis should be formed regarding the industry impact by the success of the trend.
5)Building the Portfolio
The last step would be creating a scan and screen process highlighting the best possible theme with distinctive features, potential targets compared against the success rates of each trend with another. Depending upon the size of the portfolio, further facts like complementary assets can be considered.
- Portfolio Diversification
Portfolio diversification is a technique to reduce risk that is otherwise possible due to concentration of investments in either one sector, firm or industry. The investment in this category is not just limited to shares but also in stocks, assets, and bonds. That being said, it is again a no guaranteed solution of higher return, but it can definitely save investors when they make long-run investments. For example, if an investor’s portfolio only encompasses stock of the airline industry, any drastic change in the airline policies or pilot’s going to strike will have the drastic capacity of reducing the market value of these investments. However, if the same investor had few stocks invested in other transportation systems, the damage caused by the airline’s loss can be counterbalanced when people prefer such other transport for their means. With the same principle, investors choose to diversify their funds to not just be limited to one sector but in all possible angles that can be complementary to their invested sectors.
Alternatively, when investments are invested in very different (rather opposite) industries, the loss caused by one company can be compensated by the growth in shares of a completely opposite company.
However, there are some obvious troubles while engaging in diversified portfolios such as the ability to handle multiple portfolios. Besides, diversified portfolios can prove to be expensive as not all investment vehicles will cost the same. Thus, it is not enough that an investor stays content with multiple investments in different companies but keeps a close eye on the developments on these shares. Investors must stay abreast to the changes in their invested companies and realized when to move out
In India, many venture capital firms are making skyrocketing investments in various business avenues which are slowly and surely showing the good results. The very famous venture capital firm namely, Sequoia Capital India, often invests in healthcare, consumer, and financial sectors and has recently invested in Practo, JustDial, iYogi. Whereas, Blume Venture, has been recorded to invest in Carbon Clean Solutions, EKI Communications, companies that are largely focussed on the internet and software sectors. Another recommended venture capital firm, Accel Partners, has invested in Bookmyshow, Flipkart, BabyOye companies.
Needless to say, the hope and growth of India in investing in venture capital looks bright, making opportunities for upcoming investors more beneficial.
- Edward Chin, ‘Forget Unicorns. We Need More Zebra Startups.’ (Linkedin.com, 2019)
- Christian Beck, ‘5 Trends Transforming The World Of Venture Capital – Better Product By Innovatemap’ (Better Product by Innovatemap)
- Anatol Hooper, ‘Venture Capital Financing In Crypto, Explained’ (Cointelegraph, 2019).
- Neha Alawadhi, ‘India Got VC Investments Worth $10 Bn Last Year, 7,000 New Startups: Report’ Business Standards (2021).
- Stephanie Holloway, ‘7 Hottest Trends You Should Invest In’ (Hive Life Magazine, 2020)
- Priya Rajan and Hower, ‘The Rise Of Global Saas From India | Silicon Valley Bank | Silicon Valley Bank’ (Svb.com, 2021)
- Maricel Sanchez, ‘5 European VC Firms Focusing On Saas Startups That You Should Know | EU-Startups’ (EU-Startups, 2021)
- Vincent Bérubé, Sacha Ghai and Jonathan Tétrault, ‘From Indexes To Insights: The Rise Of Thematic Investing’ (mckinsey.com)
- Nick Lioudis, ‘The Importance Of Diversification’ (Investopedia, 2019)
- J.B Maverick, ‘Concentrated Vs. Diversified Portfolios’ (Investopedia, 2020) .
- ‘Venture Capital Funds: Top 10 Venture Capital Firms In India’ (Coverfox Insurance).
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