In an interview with ETMarkets, Shankar said: “I think the next wave is going to come from tier 2, tier 3 cities, what I call the Dhoni moment” Edited excerpts:
Thanks for being part of the segment. Take us through the fund performance of Artha99 CAT 1 AIF.
Thank you once again for having me here. This marks the initiation of our second fund, building upon our prior experience with the first fund.The inaugural fund was structured as a proprietary fund, backed by our personal capital, in collaboration with a few friends from our school. The nomenclature “Artha99” derives from our school year of completion, which was 1999.
I’d like to provide insights into both these funds. In the first fund, we strategically allocated investments across diverse sectors, including Digital Yoga, Digital Transformation, Mapping Technology, and a player in the low-code, no-code sphere within the Shopify ecosystem.
This portfolio yielded multiple outcomes: firstly, we successfully exited one investment, the digital transformation enterprise, generating substantial returns.
Additionally, a couple of our other investments have successfully secured Series A funding rounds. One company is a typical startup, it’s not shut, but it’s still not exactly grown to the extent we anticipated.
Summing up the performance of the first fund, we currently exhibit an Internal Rate of Return (IRR) of nearly 70%. This remarkable figure can be attributed to a particularly lucrative exit opportunity.
Our investment in the UK-based enterprise, Futurice, materialized in March 2020, with an exit in December 2022, resulting in a remarkable 7x return within two years. The compounded impact of this exit, combined with the subsequent Series A financings, has positively skewed our overall IRR.
Among the remaining three ventures, two have successfully procured Series A funding, with one securing capital from a Silicon Valley fund named Finance Capital. Hence, we are doing well.
This gave us the confidence to raise a larger fund for our Fund Two. In our second fund, we have strategically invested in two companies. The first focuses on the electric motor Electric Vehicle (EV) domain, while the second centers around a hyper-automation AI platform. Both of these investments have done very well.
Furthermore, post us investing in the electric motor company, some marquee investors like Ashish Kacholia have also invested in the business.
In terms of valuation, we are currently undergoing a Net Asset Value (NAV) reevaluation as mandated by SEBI regulations. Initiated with an initial face value of INR one thousand, our latest valuation estimates, as analyzed by valuation experts, indicate an impending valuation of approximately INR 1200 to 1250.
This substantiates the positive trajectory of our fund’s performance. Worth noting is the expeditious pace of our most recent investments, accomplished within a six-month span commencing in January. This rapid pace, coupled with a pre-Series A strategy, has allowed us to secure around 20% of the fund.
Just to put things in perspective, we are getting our NAV revalued as per SEBI regulations now. So, we started off at a face value of rupees thousand.
I think from the latest estimates that we see from our valuation experts, it’s going to be around 1200, 1250. Hence, it’s been good given that they are recent investments, accomplished within a six-month span commencing in January. Thanks to the pre series A strategy, like we have about 20%.
How is the startup developing in India? Are we looking at companies that could become the next largecaps? Any segment which has more startups?
See, I’ll tell you, this is again a contrarian view. I believe that manufacturing in India is on the cusp of significant disruption. It’s not just about countering China or adopting the China plus one strategy.
What I see coming is a wave of entrepreneurs diving into old-school industries, leveraging technology to transform them. Think about specialty chemical or industrial manufacturing businesses – they might seem dull on the surface, but with tech infusion, they’re set for revolution.
And here’s the thing about these seemingly “boring” businesses – they’re built for the long haul.
I think that is going to be some segment which will definitely disrupt. And of course, you have SaaS.
It’s like what do you say SaaS is multiplying in various ways, can be disrupted. AI, of course, every week you have a new AI concept that is coming in as a fund.
We are sort of a bit distant from AI because we don’t know if anyone has timed it correctly or built the perfect AI product and we don’t want to write too many cheques there.
If you ask me, the ecosystem in India is actually pretty mind blowing.
Not only traditional centres Bangalore, Gurgaon, Bombay, Chennai are doing well. There are tier two, tier three is really in fact its heating up, a couple of weeks ago I was in Orissa.
We are looking at investing in a business there. The government’s initiatives and the ecosystem they’ve built are genuinely remarkable, some aspects even surpassing what the metros offer.
I think the next wave is going to come from tier 2, tier 3 cities, what I call the Dhoni moment. Till MS Dhoni joined and became a player of repute, it was all led by Bombay and Bangalore and Chennai and Kolkata you wouldn’t have too many players from the other regions.
But once Dhoni came, you see a big list of people like RP Singh, S Raina and the list goes on.
Stuff like that is going to happen in the startup ecosystem where tier 2 and tier 3 are going to generate a lot of potential unicorns and soonicorns. I think the ecosystem is very robust and everybody has a startup plan.
I’ll tell you, irrespective of the government or which party they belong to, everybody is focusing on this because they know earlier it used to be giving out loans to PSUs and to companies to generate employment.
But they all understand that the employment generation nowadays is going to be entrepreneurial. Hence, they want more entrepreneurs to come and do this. That’s why I’m very bullish, I’m sure you can see that.
You have an interesting portfolio mix and at the heart of it ‘India’ holds a special position. Why India?
When we set up this fund, we went to SEBI and got our registration done. They raised very pertinent questions. I must say that SEBI is a very professional organization that asks pointed questions about the why and what before granting a license.
I believe people are doing well with running SaaS-focused funds or AI-focused funds, or deep tech-focused funds, which is great. However, I also believe that India is like a buffet.
When you go to a buffet, you don’t choose to eat only the veg biryani or only the naan or only the sweets. You pick a bit of each and eat.
To put it jovially and concisely, the opportunities in each segment in India are abundant. So, being very sector-specific doesn’t help with portfolio diversification or expanding your reach across the country.
For instance, if you look at the SaaS market in India, it’s a $10 billion to $15 billion market – sizable, but there are almost 400 Alternative Investment Funds (AIFs) chasing that segment for investment. This is a positive thing, right?
However, the result is that with fewer deals to invest in and many investors, valuations are driven up, akin to the stock market. Investors end up paying inflated prices – 10% more, 15% more – due to the competition.
Artha 99, as a fund, believes in paying the right price. We don’t want to give a short end of the stick to anybody, but we would like to give the right price, so we feel the valuations are driven up.
In the US, the SaaS market is a $100 billion market, with plenty for everyone. Therefore, you can be a SaaS-focused or AI-focused fund there. However, in India, we are still on the path towards that level. Thus, in my opinion, it’s better to be a diversified fund.
So, that’s the strategy and India is India. Prior to setting up this fund, I was working for a US MNC heading the Asia business. I have run businesses in south Korea, China, Japan. Name it.
There is no market like India. You cannot go wrong here. When you’re in such a market, then you better be diversified enough. That’s why we’re sector agnostic and India is our theme.
What is an institutional pre-sale series? And, focus segments which Artha99 is betting on or looking for opportunities?
Okay, so why did we choose the pre-Series A stage for investment? If we look at the investing ecosystem and the stages at which we invest, there’s the seed stage, which is at the ideation phase, and then the angel or friends and family round, where a bit of ideation has evolved into a team and the base product is being developed.
Following this, most ventures proceed to the Series A stage, where the business gains some maturity, achieves a degree of product-market fit, and demonstrates traction.
In India, there are certainly enough Series A funds available. However, when we established our fund, we observed that trends in the venture capital market often originate in the US, which is currently the largest venture capital market globally.
Typically, trends that emerge in the US around 2010-2015 tend to reach the Indian market around 2018-2019. Instead of waiting for trends to catch up, we decided to explore what was already happening in the US market.
In the US, the pre-Series A segment was gaining significant traction. We aimed to understand why this stage existed and why it couldn’t be bypassed to move directly from seed to Series A. The insights were intriguing.
When investing in the pre-Series A stage, companies raise funds to build a bridge towards their Series A round. That means it needs working capital, it needs oxygen to further push its sales, build products, and more.
Since founders know that a Series A round is on the horizon, they exhibit flexibility in their fundraising approach. There’s no habit of giving four term sheets and saying, these four guys are investing.
If you want, you also give a term sheet, same valuation. People are willing to sit across the table and understand what the valuation is.
Why are we seeing this as value? Why are we not? It’s a very good discussion. We, as a fund, believe that whether the business is great or not, we should be in sync with promoters.
Okay, so that is one checkmark for me on Pre-Series A. The other thing is the right valuation. In addition to this, let’s say I invest on January 1 in a Pre-Series A fundraise with any company. The company, for its growth, has to raise Series A 18 months down the line.
So, what happens is my investors, the people for whom I manage money, tend to expect a multiple after 18 months from the time they invest through us, right? You might not achieve six times or seven times, but you can definitely achieve two times or two and a half times, depending on how the company has performed. This allows for a quick multiple.
And that helps your IRR as well because from Series A, Series B is expected to be much higher, provided the company performs (all the disclaimers apply).
Let’s say that once you invest, you don’t have a great sync with the promoter, and you feel that maybe you have misjudged the idea (It happens. Nobody is perfect). misjudgments can occur on both sides.
If you realize you’ve misjudged and they’ve misjudged, you have an opportunity to exit 18 months into your investment. You’re not stuck for the long run.
Considering all this, I think the Pre-Series A stage is a good stage to invest in. You can also play a significant role. Take Artha 99 as an example.
As a fund, we try to work with the teams we invest in on their sales strategy, hiring, and their next rounds. People are very receptive at the Pre-Series A stage, let me tell you, because they want the business to receive that boost to move towards Series A, B, and beyond.
We are more than willing to assist for all these reasons. That’s why we believe the Pre-Series A space is an extremely exciting space to invest.
How do you manage risk in the fund?
Excellent question. See, one way – okay, this might sound a bit contrarian – is that we try to identify what we don’t know, right? As an investor, it’s good to have knowledge about a few things, but you should certainly recognize what you don’t know.
So, as a fund, we openly acknowledge when we don’t understand a business entirely but recognize the potential within the space. In such cases, what do we do? We’ve assembled a Marquee mentor and advisory council.
Most of these members are investors who are part of our fund and have accumulated years of experience in different sectors.
For instance, our chairman of the Investment Committee boasts nearly 40-45 years of experience, having served on boards like LnT, Airtel, and others. His insights provide us with valuable visibility.
We also have sector-specific experts who collaborate with us. For example, the former CEO and CFO of McDonald’s offer their perspectives on retail tech and deep tech investments.
We’ve also enlisted the guidance of a couple of scientists in the biotech domain. When we put up our hand and say we don’t know, lot of people come and tell us this is their understanding.
Then you apply your investor mind to see, okay, these guys are saying this is how it’s going. This company is also doing this. Now, what can you do? Then you form a thesis.
So, the first thing that we do to mitigate our risks is what we don’t understand. We are very comfortable saying we don’t know this.
However, aside from this, there are other systemic risks we must safeguard against. This is where our comprehensive due diligence process comes into play, comprising three levels. One is of course, financial diligence. We work with the likes of BDO, big four to look at their numbers.
We have legal diligence. We have some of the Marquee advocates helping us with our legal diligence. But one thing that we still do internally is commercial diligence. You know, why is commercial diligence always in house?
We conduct this in-house because it allows us to engage directly with potential investees and customers. Through these conversations, we gain insights into their sales strategies. Our initial question is usually: “What don’t you like about them?”
When a potential investee is willing to facilitate connections and then step away from the conversation, it’s a positive signal for us. It demonstrates their confidence in their business.
Additionally, we learn from clients about aspects they feel may not be covered by the product. This feedback assists us in shaping our understanding of how the product should evolve.
Another significant risk mitigation strategy involves prioritizing integrity and ethics. We occasionally even conduct what might sound like a rigorous measure – forensics. However, this isn’t meant to be intrusive.
Instead, it’s about understanding backgrounds, assessing people’s reliability and factors like their willingness to honor financial commitments. They must carry the mindset that acknowledges the responsibility of returning the investors with exit.
We rely a lot on these things and then we put together and judge. So that’s how we do it largely.
Take us through the investment process before you put money in a company?
We operate within a well-defined pipeline or funnel through which deals enter our ecosystem. Our network spans investment banking, venture capital, and incubator ecosystems.
Given the burgeoning innovation landscape in present-day India, new ideas emerge almost daily, resulting in a plethora of potential deals. In today’s India you can find an idea generated almost every day. So, there are enough deals. In fact, the last quarter we saw almost close to 500 deals, out of which we picked 20.
Our approach involves examining our funnel and considering various factors. References often play a pivotal role, offering added credibility and exposure. Furthermore, our interest is piqued by the specific industry segment.
A key criterion is the segment’s growth potential. This helps us narrow down the selection to around ten or twenty deals for internal discussions.
Several filters guide our decision-making process. Given that we are a pre-Series A fund, we primarily target companies that either generate revenue or are on the cusp of doing so. I am very comfortable investing when there is revenue.
That means this company is capable of generating money before it takes my money. Although profitability might not be a prerequisite, a clear path to profitability or breakeven is essential.
The Third filter is of course what is the underlying. So largely we look at opportunities where there’s a digital underlying that the company is building because the acceleration in the segment is faster if you have a digital underlying.
If they do, a critical analysis follows: Are the prospective companies outperforming their counterparts? If not, it’s a no brainer. Nobody is doing this. They are doing it.
So, we filter these through these kinds of deals and then we have an internal discussion. We have a weekly pitch discussion with all our team nets.
With these filters in place, we engage in regular weekly pitch discussions involving our entire team.
From this dialogue, we select two to three deals that resonate with us. Even before progressing to the term sheet stage, we initiate preliminary steps, such as conversing with potential customers and conducting commercial due diligence.
This proactive approach ensures that we gather feedback early on, preventing wastage of time in case customer feedback is unfavorable. Subsequently, we compile our findings and present them to the Investment Committee (IC).
The IC gives me a tough time or a good time depending on the deals I show. And then ultimately, we go ahead and give a term sheet.
Then the actual diligence process starts. So, it’s pretty vanilla.
In some cases, if a deal captivates us to an extraordinary extent, we might expedite the process and extend a term sheet promptly, or even initiate diligence without delay. We are very quick in those kinds of things.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)