India's high-flying start-ups are getting a dose of harsh reality

Key Points
  • India's once-celebrated start-up industry may be a deflating bubble
  • Many metrics point to increasingly cautious investors, demanding more bang for each buck they spend on a start-up
  • No more than 1,000 significant start-ups have been founded so far in 2017 — compared to over 6,000 in 2016, industry insiders said
Interns at work at start-up company in Bangalore. In the basement of a Bangalore building, hundreds of young Indians sit and type furiously, all dre

If there's an idea, there will be funding. That's been the reality for India's start-up community for years — but it might be ending.

India's start-up dudes — largely male, young engineering graduates or dropouts —are being jolted out of their fantasy world as investors tighten their purse strings and demand a greater bang for every buck they spend.

India is the third-largest start-up hub in the world, according to industry group Nasscom. It saw a peak in funding in 2015 when close to $6 billion was invested in new companies, according to research company Venture Intelligence.

Start-ups were originally seen as job creators and innovators who were solving India's problems. But that reputation has taken a hit and investor confidence in the sector is the lowest it has been in two years, industry insiders said.

Days of 'super funding' are over

"Millions of dollars were being given away to young graduates, who got used to playing with other people's money and not sharing any risks," said Sunil Kalra, an investor who has invested in over 80 start-ups.

Kalra told CNBC that, just two years ago, he found at one of the prestigious Indian Institute of technology campuses that half of the graduating batch had decided to sit-out the regular job placements as they wanted to become entrepreneurs. "That percentage has drastically come down now," he said.

Kalra added that he's also changed his investment strategy, looking to back "mature entrepreneurs with deeper credentials."

In the first nine months of 2017, about $3 billion has been invested in companies less than 10 years old, a steep fall from the 2015 high, data from Venture Intelligence show. No more than 1,000 significant start-ups have been founded year-to-date compared to over 6,000 in 2016, industry insiders said.

A survey conducted by the IBM Institute for Business Value released in May this year concluded that 90 percent of Indian start-ups fail within the first five years of operations, as Indian entrepreneurs largely have yet to display unique business models — they're still inclined to emulate successful global ideas.

Older start-ups like online retailer Flipkart and app-based taxi survey Ola, though iconic names in India, were borrowed ideas. But now, investors are looking at Indian entrepreneurs to change their "copy paste" model. According to the IBM survey, 77 percent of venture capitalists said they believe many Indian start-ups lack "pioneering innovation based on new technologies."

"The days of 'super funding' are over. Replications [of a foreign idea] are not getting money," said Rishabh Lawania, co founder of Xeler8, which represents a Chinese fund looking to invest in India.

Valuations get realistic

Valuations of companies that are raising their first round of funding have also come crashing down. In 2015, anyone with a serious idea for a start-up could hear a valuation from potential investors between $1.5 million and $3 million, according to Amit Singal, CEO of Startup Buddy Services. This year, he said, assessments for similarly meritorious ideas are down more than 50 percent from those levels.

"Start-ups were overvalued in 2015. Now investors are not looking at an idea alone. They want to see a growth plan that can deliver returns in four years. Earlier they were willing to wait for up to 10 years," Singal told CNBC.

No wonder then that early stage funding in start-ups is down 37 percent in the third quarter of 2017 compared to the same period last year, according to Venture Intelligence.

"What's worrying these guys [entrepreneurs] is that the bar for an early-stage start-up has just been raised considerably by their predecessors who have themselves raised a lot of money to get ahead. It is difficult for technology-led early-stage start-ups to achieve profits. They have a steep investment stage. This is why early-stage funding is so critical," said Santosh Dawara, an entrepreneur and one of the founders of the Pune Open Coffee Club, an informal platform open to anyone connected with the start-up industry to meet and brainstorm.

To invest or not?

While there is no dearth of funds in the market, investors don't know where to put their money.

"The flavor of the month keeps changing. First it was e-commerce, then travel-tech and edu-tech. This makes investing interesting, but also confusing," said Kalra. He added that venture capitalists have raised billions of dollars and are under pressure to spend it.

"There is more venture money, but it is chasing fewer, more mature deals," said Dawara. The number of deals until October 2017 is down by almost 60 percent compared to total deals in 2016, according to data from News Corp VCCEdge.

"An individual investor would close 15 deals in a quarter in 2015, now that is down to just four," estimated Lawania of Xeler8.

Some of the companies that raised money this year were the big players like Flipkart, Ola and hotel aggregator Oyo Rooms. "The older start-ups like Flipkart are spending a lot of money and not making any. But 20 years from now, no one in India is going to go to a store. E-commerce is a long bet and investors with deep pockets are making such bets," said Kalra.