Slow and steady, be more wealthy: More start-ups eye private equity funds, bypass VCs

In June 2023, Bengaluru-based occasion-wear brand Koskii raised ₹61 crore in a series A round. What made it stand out was that it wasn’t a funding round led by a venture capital firm, but by Baring Private Equity Partners India.

Venture Capital (VC) has been the go-to option for most start-ups to raise funds. However, of late, a bunch of new-age companies seem to be approaching alternate options like debt-based financiers and private equity players instead of taking the usual VC route.

While one of the catalysts seems to be the prolonged venture capital funding winter, the brands which bypass VCs also feel that the PE route aligns with their business model given their strong focus on profitability over cash burn.

Filling the void

As per data from Tracxn, between 2021 and till date 321 companies have raised equity funding from PEs in India. None of these companies raised any capital from VCs.

“We are seeing private equity activity, which used to be limited to more mature and late-stage companies, happening across multiple new age companies,” says Abhiroop Medhekar, CEO and co-founder at Velocity, a revenue-based financing (RBF) company.

“These are companies which were bootstrapped initially. They would build for four or five years and then scale it to a level where PEs also found it interesting to come in and participate,” he adds.

A start-up funding trajectory typically starts with seed rounds and angel investments, and then go through multiple rounds of VC funding before it scales to a size that can attract PE players.

However, according to Medhekar, the recent funding winter created a void which is being filled by alternative financiers like debt investors and revenue-based financing firms, and towards later stages by private equity players.

The ecosystem went through a similar funding crunch around the year 2017. According to the annual Indus Valley Report 2024 by Blume Ventures, venture funding in India in 2023 dropped to pre-2017 levels. The report also notes how Indian PEs have delivered exits consistently unlike the VC players which haven’t hit that level of consistency yet.

The right fit

While VCs taking the backseat is one of the big factors driving the current trend, Medhekar also feels it’s a sign of the ecosystem maturing as companies are realising different types of investments need different types of capital.

“Across most consumer brands, the business is fairly stable – you are selling a product, you understand the margins, you are marketing across multiple platforms, you understand the return on that marketing spend. It’s a very predictable game. For a spend like that, founders are increasingly concerned about the dilution of equity and that early-stage investors coming in expecting a very high growth profile may not be a right fit.”

Umar Akhter, founder and CEO of Koskii, echoes similar sentiments.

“From the get-set-go we wanted the business to be profitable and we took it slow. We built a business which was robust from a unit economic perspective. What that meant was at the core of what we built, we built a profitable cash generating business,” says Akhter.

This strategy helped in making the company an attractive bet for PEs, he adds.

“Private equity investors are looking at companies that have a solid business, whose unit economics are strong and are already generating cash and then growing. So, for us, when we started looking for funding, our philosophy aligned well with that of Baring Equity.”

Aiming for IPO

Some of the other start-ups that chose the alternate route include student accommodation start-up Amber, assisted mobility brand Arcatron, and budget hotel chain Bloom Hotels among others.

For Amber it was a conscious decision to choose the PE route as Madhur Gujar, founder of the company, feels it’s tough to stay profitable when a company raise funds that come with expectations of fast growth.

“Due to the current uncertainty, more and more founders are shifting towards running business in a bootstrapped or profitable way. In this journey, RBF funds become very useful because if you have thin margins, traditional banks may not fund you as they need a lot of credit history, cash flow and so on,” he says.

Amber which sought financing from Velocity in its early stage raised $21 million in February 2024 in a round led by PE firm Gaja Capital.

“Going ahead, we want to run the business sustainably and profitability, A few years down the line plans like IPOs can definitely be on our cards; And PE firms have a lot of expertise in taking companies to IPO. So, that is an additional advantage,” Gujar notes.

Interestingly, many of these are Direct to Consumer (D2C) brands with a digital presence.

Wealth creation

Medhekar adds to this. “Every equity round at an early stage leads to anywhere between 15 to 25% dilution of the founder’s stake. And to IPO in India over the next seven to 10 years they have to scale their business to a particular revenue level. At this point their wealth creation is a function of how much stake they are left with in the company.”

According to him for a founder who bypasses the VC route and takes the PE path, the founder’s percentage stake in the company and overall wealth creation could be double or more for similar revenue.

“If you look at all of the recent start-ups which got listed, all of their founders have a very low stake in the company. But if you compare that with the more traditional listed companies in India, there promoters hold a significant stake because they have built the companies on the back of debt and late-stage capital,” he says.

Interestingly, many of the startups that raise PE money are direct-to-consumer (D2C) brands with a digital presence. According to Mukul Gulati, President and Chief Investment Officer at Zephyr Management, a New York-based PE firm which has its India office in Bengaluru, PE funds are also open to fintech (in particular, lending businesses) and healthcare delivery at an early stage.

“An experienced founder can attract institutional capital in these areas since the business models are well-established,” he says.

VCs to stay

While there seems to be an increasing number of start-ups considering the PE route, it’s however no sign of waning interest in VC money.

“Most start-ups in India continue to target VC/early-stage investors. Access to capital allows more rapid growth. Also, some founders may benefit from the advice and network that VC provides,” says Gulati. 

Also, not all start-ups can afford to bootstrap. For example, start-ups that are tech-heavy or are into software do not see consistent revenue at least in the initial days and therefore venture money becomes inevitable.

“For tech companies, I think PEs will still find it a bit difficult to build a point of view on their future growth profile. But consumer brands is a space that PEs understand quite well,” says Medhekar.