February 23, 2024
Investors

Investors flock to small town ‘desi’ startups as funding surges. Here’s why VCs are going beyond metros


In India, Tier-II and Tier-III cities are often overlooked for building businesses but the trend is changing as investors are shifting their interest towards small-town startups. These small cities which hold abundant potential for entrepreneurship, approximately account for 37% of the country’s gross domestic product.

The latest report by Primus Partners, quoted by Forbes, revealed that about 90% of startups in 2023 emerged from Tier-II and Tier-III cities. These small-town ventures received around 22% of the total funding.

There has been a surge in funding for small-town startups. The report stated that about 44% of investors have made investments in startups based in Tier-II and Tier-III cities. The funding increased from 37,500 crore in 2021 and 75,000 crore in 2022 to Rs1,12,500 crore in 2023.

Investors are more inclined toward tech-based startups in small towns as about 64% of VC investments went for tech ventures in Tier-II and Tier-II cities, the report said.

Besides investment, these startups have also generated 50 lakhs in 2021, 100 lakhs in 2023, and 150 lakhs in 2023. Several state governments have launched initiatives to support local startups, including iStart Rajasthan, Startup Odisha, Startup Haryana, and others, in recognition of their contribution to job creation.

The report highlighted the critical role that digitalization and state and federal government initiatives, like the National Entrepreneurship Policy and Startup India Initiative, have played in facilitating the connection between investors and founders. More than 66% of investors get in touch with the founder via government networking sites.

Despite the increase in government support, many small-town startups also face obstacles in getting funds for growth. The report claimed that about 12% of these businesses received pre-seed funding, 10% got seed funding, and only 2% secured Series A funding.

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‘Technology, social media, business shows’

The startup ecosystem in Tier 2 and Tier 3 cities is primarily flourishing due to the technological advancements that have made it easier for businesses to venture into smaller markets, said Adrija Agarwal, founder of Sattva Ventures, adding that social media has also started to play a key role in leveling the playing field, allowing startups to reach wider audiences with minimal marketing expenditure.

“There is an evident cultural shift in these regions where entrepreneurship is increasingly celebrated, partly due to the popularity of shows like Shark Tank. More people are encouraged by this cultural change to be enterprising realizing that they have deep knowledge of their respective local market needs,” he said.

The Sattva Ventures founder stated that there are five reasons including untapped markets, cost efficiency, huge talent pool, government support, and improved digital penetration investors are eyeing small-town startups.

Vinayak Kamath, Co-founder and Partner of Hearth Ventures told LiveMint that there are possibly four factors at play – one is that there may be a hometown angle for the investor, they understand the geography and culture and derive comfort from it, some investors might also be successful entrepreneurs with roots in small towns.

“Second, the fixed cost of doing business is lesser therefore positive unit economics can quickly translate to positive cash flow; third, the focus continues to be on value rather than convenience, and hence basic business models like micro-credit, sustainable agriculture-inputs, micro-grids, solar pumps, etc. rather than a ten-minute subsidized grocery delivery etc,” he said.

Kamath also re-emphasized the importance of state government initiatives of catalytic capital that draws both entrepreneurs and commercial investors.

Funngro CEO Payal Jain attributed this surge to the transformative shift towards digital solutions and the increasing reliance on freelance talent. “As new-age platforms continue to acquire momentum in the marketplace, the technology sector is responsible for 70% of the funding inflow.”

“This success may be credited to startups’ fast adaptation to changing market demands. In addition, with the gig economy gaining prominence, startups using freelance talent have witnessed a 40% increase in funding compared to traditional models,” she added.

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