Deal volumes in IT/ITeS fall as VCs prefer stronger players

Slowdown in e-commerce and investors' preferring established IT players to start-ups saw venture capital (VC) deals in the IT/ITeS space fall 29 per cent between January and June this year. However, the good news is that deal value dropped only five per cent during this period.

According to Venture Intelligence, only 53 deals were reported during the January-June period, compared to 74 during the same period in 2012 and 68 in 2011. The deal value during these years stood at $200.47 million, $212.86 million and $310.83 million, respectively. Top five deals in this space were concluded during the first six months of 2011.

Industry experts say e-commerce, which has been a big focus area for VC funds, is slowing down and funds are now looking for other avenues of investment. One of the areas they are betting on is enterprise software, which attracted 11 deals between January and June this year, compared to five during the same period last year.

The lower deal volume is also being attributed to slower pace of investments in Series A and B rounds, compared to seed funding. Although VCs pumped in a lot of seed money, the pace of subsequent rounds of funding has slowed down.

Thillai Rajan A, associate professor, Department of Management Studies, Indian Institute of Technology, Madras, says the conventional IT services will attract less VC funding as the VC funds are looking for mostly established players, where the risks are comparatively lower. Bandwidth to monitor small enterprises is another challenge why VCs are showing a preference for established players.

According to Balaji K, founder and CEO of Aiway Inc, US, a software development company that is also into venture capital investment, there are two reasons for the slowdown in VC investment in the sector: One, there are no innovative products to attract the VC investor; two, with the economic scenario improving, VCs are looking at other emerging opportunities such as healthcare-related IT.

"With the US witnessing economic growth, the unemployment decreasing and the overall scenario improving, the investors are waiting for the healthcare reforms to bring in opportunities from healthcare related IT," says Balaji. There are huge opportunities for companies in cloud services and mobile applications.

According to another executive from a VC fund, conventional IT services will attract less VC funding, which has now become the domain of big companies because clients are signing outsourcing deals only with bigger companies.

Earlier, VCs investments into IT/ITeS sector was led by software services, which had global delivery model. This has now dried down due to scalability issues and limited exit options since there were fewer secondary deals and IPOs of such VC-backed ventures, points out Rajan, who did a study on "Venture Capital and Private Equity in India : An Analysis of Investments and Exits". This has reduced the enthusiasm among investors, he adds.

''In 2011, VCs infused a lot of money in e-commerce ventures that showed tremendous revenue traction, like 30-50 per cent growth month-on-month within a few months of operations,'' says the head of a VC fund.

Other companies into cloud infrastructure, Software-as-a-Service and mobile applications didn't demonstrate such high growth rates in their initial days. Yet, VCs are betting big on firms built around large data analysis.

The other good news is the trend (of slowdown in VC investments in start-ups) has opened doors for new investors into the segment, such as angel investors. The trend is visible, says Rajan.

Another development is the emergence of 'venture debt', which is tailor-made to meet the requirements of smaller entrepreneurs, brought in by the angel funds.

Almost 90 per cent of the funding in this sector was cornered by firms in online services, enterprise software, IT products and services, and mobile value-added services (VAS). Domestic consumption-based online players will also attract renewed investment interest this year, says one expert.