India-focused funds sitting on highest-ever unallocated corpus of $12.9 bn

India-focused private equity and venture capital (PE/VC) players are sitting on unallocated capital of $12.88 billion — the highest since at least 2016 — according to investment data firm Preqin.

VCs focusing on India are holding unallocated funds, or dry powder, of $6.81 billion, according to Preqin data. This is one of the highest levels of dry powder that India-focused VCs have held at the end of a year. They held $3.7 billion at the end of 2016. The figure recorded this year is 20 per cent higher than the 2021 number and almost 39 per cent more than the 2020 figure.

The story is similar for PE funds. They are sitting on a dry powder pile of $6.07 billion, higher than the $3.52 billion at the end of CY16 and even the $4.73 billion at the end of CY21.

Globally, the year 2022 was the worst for start-ups in general. For start-ups in India, the funding winter meant a drop of almost 40 per cent in funding year-to-date and the number of investment rounds has shrunk by 32 per cent. 

But does this mean that 2023 could be different, given the unutilised capital?

“Entering 2023, we believe that there may not be a significant rebound in the near future given the macro environment is still uncertain with regard to the path of inflation and interest rates worldwide. Hence, PE/VC valuations are likely to remain weak as they track public markets, which are still relatively depressed and volatile,” said Angela Lai, senior research analyst at Preqin.

“Currently, we expect fundraising to slow across PE/VC through to 2027 compared to the very exceptional results over the last few years. We expect the slowdown in fundraising observed in 2022 to continue into 2023, and that a meaningful pickup could occur from 2024,” she further remarked.

Anand Prasanna, managing partner, Iron Pillar believes a large pool of unallocated funds may not necessarily drive investments. “Investors can always go back to the normal investment cycle of investing funds across 3-4 years and hence I don’t expect unallocated funds to drive additional investments meaningfully. The key driver will be companies showing better unit economics, companies growing into higher levels of valuations set in 2021, and reduction of global macro risk,” he added.

The other interesting data point is the number of funds looking to raise funds. According to the data from Preqin, PE/VCs are on course to raise about $27 billion of funds. About 56 PE funds with an India focus are looking to raise $14.91 billion and about 146 VCs are looking to raise $12.8 billion.

But experts believe that fundraising, too, won’t be easy. Limited Partners (LPs) are also getting cautious. “From both, fundraising numbers, as well as our investor surveys, we have observed a pullback of LP sentiment towards VCs as a whole in 2022.  In addition to the overall risk-off sentiment, the mark-downs in public markets have led to a denominator effect, which is increasingly limiting LPs’ flexibility to make new allocations,” added Lai.

For Bhaskar Majumdar, founder and managing partner of Unicorn India Ventures, the focus for 2023 is two-fold — manage a sustainable growth of the portfolio companies, and aim to close the raise of its third fund. “LPs are now looking at track records for GPs. New fund managers will find it a struggle to raise funds but fund managers with established track records, especially in returning capital, are being sought after,” added Majumdar.

Silver lining

Indian start-ups find themselves in a unique position, especially with China no longer the most preferred nation for investors, say experts.

China has been the hotbed for venture capital investments in Asia. In the five years leading up to 2021, China-based venture capital deals accounted for 68.8 per cent of all activity in the region, and China-focused venture capital firms have always attracted the most capital from investors in Asia, says a Preqin report.

This is changing fast. In a November 2022 investor survey, China was overtaken by Southeast Asia and India as the best emerging market opportunity in venture capital. Only 19 per cent of investors are now citing China as an attractive investment destination. Meanwhile, Southeast Asia and India were seen as attractive investment destinations by 43 and 45 per cent of investors, respectively.

Lai points out that when it comes to emerging markets like India, there is an increasing preference towards the seed and early-stage strategies where ticket sizes are smaller and the time to exit is typically longer. This allows for more time to work on the business, while the external market environment is volatile.

Majumdar of Unicorn India Venture agrees, especially since they have been investing in early-stage start-ups. “We feel early-stage VCs like us are in a pole position, provided the businesses are doing well and stacking up. There has been a shift of power back to the investors and the entry price point for investors has become more rational. From the sector perspective, the digitisation story of India continues unabated and we are seeing opportunities across all sectors,” he added.