2021 proved that tier 2, 3 towns will pay for entertainment, education and other services, says 3one4 Capital's Pranav Pai

Pranav Pai, Founding Partner, 3one4 Capital, reviews 2021 and draws up 2022 trends for Moneycontrol. Illustration: Suneesh Kalarickal.

Pranav Pai, Founding Partner, 3one4 Capital, an early-stage venture capital firm, says the year 2021 will go down as the one in which India closed a tech loop—from ordering food to picking a stake in a delivery platform to be a partner in the journey of their favourite streaming platform, Indians bought stocks in services they used every day.

More than 40 startups turned unicorns, valued at least a billion dollars, during the year that also saw several successful IPOs, with startups like PolicyBazaar, Nykaa and Zomato seeing a bumper listing.

The IPO rush and growing participation of retail investors, to Pai, is an affirmation that Indian markets are efficient as investors favoured sound businesses. In an interview to Moneycontrol, Pai talks about the year that was for start-ups, India’s resilient capital markets and draws the technology road map for 2022. Edited excerpts:

By all yardsticks, the year 2021 has been a watershed for the Indian startup ecosystem. As an investor, can you tell me in detail about the factors that led to this enormous surge in funding and the creation of myriad unicorns?

Around the globe, markets had to reassess where the future would go from here. Tech companies had come forward and supported a social and cultural shift during the pandemic, in ways that no one predicted. Look at all the coordination run by tech on the ground, for example. The pharmacy coordination, the oxygen coordination, all the deliveries that happened—the startups proved that they are inevitably a deeper part of everyday life and they stood behind their employees with insurance coverage and benefits. People have realised that everything is going to be more dependent on technology in the future. Now, that’s the status quo.

Specifically, as a result of startups becoming important in society, previously held outdated beliefs about opportunities in India were disproven. For example, everyone thought that India’s total addressable market (TAM) was very small. The pandemic proved that people in tier-II and tier-III towns will pay for pharmacy, entertainment, education, convenience, brands, stocks, and more. It became clear that the Indian TAM was much larger than anyone assumed. The Indian investors had always said we will have paying customers everywhere but the mainstream investment circles believed that it’s going to be limited to the top 25 cities. So, the TAM expanded and therefore the value of market leaders in those markets had to grow.

From Licious to Nykaa, in the consumer-brand space, all of them have a massive number of customers now and that’s why they became unicorns so quickly.

Secondly, in the B2B space, everyone realised that Indian enterprises will also buy Indian software. For example, Darwinbox, BetterPlace and so many dozens of logistics companies. The procurement of Indian tech is now much more than what people assumed.

Thirdly, you saw entertainment and education come together, entertainment and investments come together. If you ask people what they are doing, they say they are listening to music or watching OTT, or they are investing, or they are learning, improving their skills or looking for corporate training.

Students got more familiar with edtech while schools were closed. So, all the categories have meshed into each other and TAM expanded very rapidly, which is why the market leader or companies that may become market leaders are in demand.

There was an enormous flow of capital into India.

Finally, yes, there is increased liquidity globally that got allocated to the private sector. When that happens, people also look for different geographies—where are the largest economies where you can allocate scale capital to? China extraordinarily had a difficult year on top of all this, which meant India’s weightage in global allocation increased. India is an open and welcoming market for global capital. All that put together meant more money into startups and more growth. Revenues grew, margins grew, user bases grew, a record year for unicorns happened and, I think, finally the whole loop was closed when we had very successful IPOs.

This year, we demonstrated that the Indian markets work. I think 2021 helped the ecosystem to prove that Indian markets will welcome Indian innovation.

There was also a cultural movement this year. You can order food on Zomato in the morning and if you are happy with the service, how it runs the business, or see your friends using it, you may buy the stock in the afternoon on another startup like Zerodha. So, you are using an IPO-ed app to buy an IPO stock. So that’s a cultural loop for the everyday Indian.

In the US, people always had that opportunity. You hear about crypto and that Coinbase is going for an IPO, so you buy that. Or you buy Netflix stock because you like using it or buy Google because you like what it offers. So, citizens there bought stocks of services they used every day. In India, we couldn’t do that for our everyday tech until recently. I think that’s a very important cultural movement in the country.

Our capital markets proved to be robust, stood the test and picked the winners on merit.

An important observation of the IPO markets is that, yes, we had successful IPOs but not every IPO succeeded. There were some unprepared companies that went for an IPO and their stocks didn’t do well, which meant the markets were working. The market was not just absorbing everything that was thrown at it. It’s a sophisticated market that has built-in decision-making. If the company is sound and the prospects are good, it will vote in favour and buy and the price goes up. If the stock is the opposite and the market doesn’t believe in it, it would vote against the story.

I must stress that Indian markets showed that we don’t need more regulation or controls. Let the markets work, they must decide on every company.

Good businesses will prosper, bad businesses will not. It’s a real-time cause for celebration for every Indian investor that our markets continue to express this sophistication. Many people didn’t believe it here, not just here, but all over the world but more so here. Of course, there will be corrections down the line, of course, liquidity will not last forever. That’s not any country’s fault, that’s how capital markets work; 2021 was a watershed year for so many reasons and I think all this was proven this year.

So, does that make India a unique story or is it just in sync with the global order?

To be honest, we were lagging when it came to tech IPOs. This doesn’t necessarily pull us ahead but finally brings us closer to parity. In the US, as I have said, their stocks, businesses, IPOs are very efficient and they support hundreds of IPOs every year. China, over the last decade, really established its ecosystem as well.

Hopefully, this decade we can establish Indian as a global-scale ecosystem. India can consistently send 20-30 tech companies every year for IPO. That’ll be, in my opinion, a very important achievement.

China has come down heavily on its startup ecosystem, especially edtech. Do you see regulations coming into the startup scene here in India or are these concerns a passing phase?

China, first of all, has a very different governance system compared to the rest of the world. So, I will refrain from analogies with China. But I can speak about India. India already has very strict, clear, and well-understood regulations for capital markets. They are working. We must focus on allowing companies to follow rules, grow, and list and let the markets work. This year was evidence of that.

In fact, I can say regulations have an even more important role in removing friction for better businesses to scale. If regulations play a role in making ease of business the number one objective, then we will flourish.

If all the pending choke points of the markets are eliminated then we will have an enormously productive decade. We have sophisticated regulators, a strong central bank and obviously, we have had banks which went through a very tough decade and are now starting with fresh eyes. So, the whole capital system is geared to support a very different decade and that’s our hope as an industry.

You talked of choke points that you would like to see addressed to improve the ease of doing business. Can you briefly list them?

I think the two large requests of the industry are well known. Number one is taxation where private investments are taxed almost double of public investments. Long-term capital gains, for example, for selling listed stocks is less than half of what it is for selling an unlisted stock. There must be parity here.

Globally, all developed markets have the same long-term capital gains rate for any stock, listed or unlisted. I think we should support a uniform tax rate. If on one hand, we are saying India’s startups are systemic priorities—they are creating jobs, improving livelihoods and society, building products, services, and the rate of innovation is changing, indigenous IP development is happening, they are absorbing our best talent, more Indian talent is staying back in India— we say all those are good things and then we tax them double, that is a mixed signal to the ecosystem.

We have double taxation on startup ESOPs as well—a major cause of concern for all startup employees. If we keep increasing these taxes, it will become a disincentive.

Secondly, for regular filings, GST, TDS, Form 64, patents, starting a company, there are still dozens and dozens of forms to be filled. Even though we have had a lot of announcements that digital signature is accepted, so on and so forth, on the ground, not every state, every city has implemented that. Understandably, it is an execution challenge in such a large country. This will go a long way in showing young entrepreneurs and SMEs that they matter to society and the economy.

Which is the next set of areas that you think will attract investments? Software as a Service (SaaS) had a good run this year.

Local consumption of fintech and SaaS especially is going to be an avalanche trend. Typically, for India’s SaaS companies like Freshworks and Chargebeesee, a large part of their revenues come from global customers. But then the next wave of SaaS companies, Darwinbox, for example, has their largest revenue base in India though they have hundreds of clients all over the world. You will see more local demand for Indian software. That will be the new vector of growth for Indian SaaS companies.

Similarly, for fintech, Indian banks will start consuming fintech very aggressively. There are a dozen or more fantastic fintech companies including Open and Zeta that are now soonicorns.

The first wave of fintech included companies like Paytm and PhonePe, payment apps, wallets and so on. The second wave will be more embedded tech and across the stack. They will co-operate with the banks, co-operate with the mainstream and build unique models. We will see even startups getting disrupted. Zerodha had disrupted the whole broking industry and now faces more competition than ever before from newer companies. You will see a continuous wave of local innovation in the fintech space in India.

Then the whole ESG (environmental, social and governance) theme in India is going to be much more mainstream. 3one4 was the first signatory from India as a VC to the global body for responsible investing in asset management UNPRI.

We are also seeing extraordinary innovation in climate tech. Everything—from electric vehicles to fast charging for mobility, to agritech—we are seeing some fantastic innovation in those areas. We have a unique opportunity now to leapfrog as a country. We won’t have to sell 100 million petrol cars before we sell millions of electric vehicles (EVs). For a lot of people, their first mobility buy maybe an EV. Just like their first phone purchase was a smartphone.

We are also big believers in the Indian regional language ecosystem. For too long, the Indian social media space has been dominated by overseas companies such as Facebook and TikTok. Now, the China app ban has created an interesting opportunity for Indian companies in this space. Some of the global social media players are also trying to localise. So, a lot of interesting India-first strategies will compete for your attention going forward.

How do you see the next two years rolling out for the Indian startup ecosystem? The past 18 months have been pretty good, do you foresee a correction?

For global markets, there’ll be a correction and that’s inevitable. Obviously, just like the world, India will also see a pull-out of capital. I’m happy to say, though, that many of our startups are better funded today and they have stronger balance sheets. They have raised money when the times are good and when the downturn does come, I don’t think it will hurt them as much as it typically would. There will be strong balance sheets and they can afford to keep their people, continue growing their business and continue to create value.

Take the pandemic for example. The year 2020 was a terrible year for investments globally. But how many startups have shut shop? I can’t think of too many. That’s an extraordinary sign of resilience in the ecosystem. I think India was not thought of as a resilient or deep startup ecosystem before, but it is, as the pandemic proved. Yes, a correction will come but the startups will stay resilient. I’m happy to say that it will be part of the DNA going forward. No one is taking the good times for granted.

Globally, we are expecting realignment geopolitically. We all know that India is continuing to build strong alliances. We are stating, at the highest level, that we will be an ESG first, sustainable-first, renewable-first economy. Those statements are really promising for innovation. This is going to spur solar-cell manufacturing, more local mobile and electronic manufacturing, more local investments in 5G, pharma manufacturing, hopefully, lower dependence on coal and oil and hopefully see increased adoption of electric vehicles. Irrespective of the macros, India is now committed to a trajectory that will invite global capital and will support scale innovation.