The nuts and bolts of making money in fintech startup investing

Besides speaking about the – PETT framework, Varanium NexGen Fund's Aparajit Bhandarkar talks about how the AIF platform provides a lucrative way to earn outsized returns from venture capital investments.

31 Jul 2020

India has become the third-largest ecosystem in the world, behind US and China, in terms of startup investing. From having no unicorn (start-ups with $1 billion valuation) ten years ago, by 2019 India had one unicorn each month. This revolution is being led by the fintech space, which has as many as 56 unicorns out of the 474 globally. For every PayPal, Stripe, Ant Financial, Nets, Gojek in the world, there is a Paytm, Policybazaar, Pine Labs, Billdesk and LendingKart in India. Clearly, Indian startups have come of age, 

India is home to 4500+ fintech startups. There is a lot of money to be made, because startups get rich valuations and thus compound existing investments at a fast clip who have the risk appetite. But with each magnificent crown, comes an assorted set of thorns. Startup or venture capital investing requires deep expertise since startups, like every other thing, fail. In this article about the nuts and bolts of making money in fintech start-up investing, Varanium NexGen Fund's Aparajit Bhandarkar talks about how the AIF platform provides a lucrative way to earn outsized returns from venture capital investments. Read on.

Fintech Fits

The Indian government wants to deepen its tax-base and fintech startups fit the agenda. To tax more, there needs to be a digital way to do things. This is where fintechs make the dream of Digital India happen, with the help of the JAM (Jan Dhan, Aadhaar and Mobile) trinity.  

In the post-covid world, there is a need to separate the wheat from the chaff as far as startups are concerned. While entity level burn is no differentiator due to the early-stage of the nature of startups, it is business models and especially, those that are fully digital, which will see significantly lower impact since their ability to render services is not hampered. Due to the virus outbreak, there needs to be ample spotlight on the type of spending too that the startup caters too. For instance, indoor activities like OTT services and video communication have become essential services today while traditional shopping like that of apparel, consumer goods/electronics, etc, has become non-essential. 

Additionally, funding markets are expected to be weak for the next 6 to 9 months. At this time, startups that need urgent funding will face the challenge of survival, says Aparajit Bhandarkar. Historically, startups flounder when they fail to get timely access to funding or if their product/services do not get market traction, he adds. 

Lastly, companies with strong tech infrastructure have a strategic advantage over traditional business models. The trick is in identifying such firms early on. This is because startups can fail when they have the wrong team, get outcompeted or face pricing/cost issues.

Varanium's Aparajit Bhandarkar knows this space like the back of his hand due to his 17 years of experience in investment banking, investor relations and startup investments. Plus, he was ex-CEO of Dice Fintech Ace -- a fintech venture fund which had notable success in investments such as Moneytor, Trendlyne, Open Financial, Smart Coin, Aagey etc.

Even startup companies with a great product or service require funding. Without funding or profitable economics they cannot capture market share. All this along with the need for funding opens up a world of opportunities for VC investments in promising and select Indian startups.

Case for startup 'asset class'

In India, wealthy investors have access to a plethora of asset classes. Gold, which has shot to prominence recently, has actually delivered 2-3% annual return over a 30-40 year period. Real estate, though popular, is having a bad time as the slowdown situation persists.

Coming to equities, markets have see-sawed due to the crisis. Though some losses have been covered, there are expectations that the slowing economy or the rising market will catch-up with each other soon. When the liquidity super-cycle, started by central banks globally, dries up, it will be interesting to see the impact on equities.

Bonds as an asset class is are much safer, but cannot usually beat inflation. 

A well-rounded portfolio should have antifragile investments. "Author Nassim Taleb has talked about things that benefit from disruption. One of them is gold. The other asset class is startups. Startups are antifragile since they disrupt existing processes. Startups like Google and Amazon and Facebook were born out of the previous crises. In India, demonetization boosted the appeal of fintechs. What venture capital does is capitalize on disruptions. One of our startup investment i.e. Riskcovry has actually seen more growth, because due to the Covid situation, insurance is the only product that is selling in the financial services arena today," argues Aparajit.   

From a risk management perspective, venture capital derisks the overall portfolio.

The Varanium edge

Varanium is a $750-million global multi-asset boutique asset manager focused on emerging market strategies, India in particular. Its Founder & CEO is T S Anantakrishnan (Ex- Goldman Sachs, Shumway, Prime, Religare). The principal is Sajeeve Thomas (Ex- Citibank & Shinsei Bank). Varanium manages offshore money, PMS and AIF funds.  

The Varanium NextGen Fund is an AIF (Alternative Investment Fund). It plans to invest Rs 3-5 crore each in about 30-40 investments over 4 years. It is aiming to be a Rs 200 crore fund, with 6 year tenure/term, which can be extended twice for one year duration. The AIF management fee is 2% per annum, the hurdle rate is 10% return to investors, and carry is 20% (with catch-up). This is standard structure in the VC area.

"We aim to deliver 25-28% IRR, which is 3x-4x returns over the next 6 years. This is a conservative estimate. Our previous fund has given better than this. We launched this fund in October last year," says Aparajit, who has previously worked in positions like ex-Head of Strategy of Jio Payments Bank.

Varanium's investment philosophy is doing ‘capital efficient’ investments, focusing on startups validated by corporates, which decreases the failure rate significantly, thereby generating superior returns overall. The AIF has already invested in 2 startups (HomeCapital and Riskcovry).

Talking about the unique PETT framework, Aparajit explained that PETT stands for Product & tech, TAM, Team and Exit. In product and tech, Varanium looks at the quality of execution of the idea, differentiators/moats and competitive advantages. In case of TAM, overall demand for the product/service is seen along with revenue ceiling  and possibility of growth in customer base. "We also look at valuation and want to invest at reasonable valuations," says Aparajit. 

Easing the challenge of deploying capital in one shot, the AIF plans to take investor money in different tranches over the next 2-3 years. From 4th year onwards, the AIF will start returning money to investors. Taxation on the gains at the hands of the investor is about 24-25%.  

Lastly, investors should invest in products where the fund manager has skin in the game. Varanium has over 20% of the total deployed capital. In case of NexGen Fund, Varanium has committed to investing Rs 20 crore.

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