The world needs more entrepreneurs like Varun Khurana. And companies like Khurana's need better access to later-stage capital and support.
A successful Silicon Valley veteran, Khurana returned to his native India to launch a series of companies, including Grofers, the country’s leading on-demand delivery service. Khurana’s latest venture is Crofarm, a company that taps the power of advanced logistics, apps and software to connect small farmers and agricultural cooperatives with the small retailers that sell their goods.
Crofarm was launched to transform India’s notoriously inefficient agricultural supply chain, which results in tremendous food waste and lost potential income for Indian farmers.
“With Crofarm, retailers place orders in the evening and the farmers know how much crop to pick the next morning,” said Morgan DeFoort, co-founder and managing principal of Factor[e], a venture development firm that invested in Crofarm and supports other early-stage disruptive technologies in areas including energy and agriculture. “That gets the crop delivered without going through the cold chain [meaning the refrigerated supply chain] because we move fast. It’s farm-to-market in 24 hours, versus six times that in the informal Indian supply chain.”
While there is a vast opportunity for innovative startups to tackle massive global challenges, such as delivering energy access to the approximately 1 billion people who need it, a round of seed funding and an intriguing idea is hardly enough to make headway.
Crofarm benefited from Khurana’s vast experience and the leadership he was able to provide at the seed stage. The company has been able to prove its idea in a real market and is now ready to scale up. However, for startups like Crofarm that have early success in the seed stage, the Series A funding they desperately need to scale often isn’t readily available.
Avoiding the "zombie pool"
Far too many startups aimed at addressing the globe’s most pressing problems can flounder because, although they’re ready to move beyond seed funding, there isn't nearly enough of the subsequent funding they need to make a meaningful, large-scale difference.
“In capital-intensive sectors like energy, agriculture and transportation, and in difficult markets like emerging and frontier markets, we need to be thoughtful about who we fund,” said DeFoort. “We can’t waste capital letting 10 people fail and one succeed. We have to be smart, do way more due diligence, pick two or three that have a good chance, and then provide much more support at the front end so you don’t have a massive pool of fundamentally un-scalable companies competing for very limited funding at the mid-stage and growth stage.”
Which is exactly what is happening in the broader seed-investing sector. According to Wing Venture Capital, in 2010 the average startup went through 1.4 rounds of funding before reaching the Series A round of investment. By 2017, the number of investment rounds prior to the Series A rose to 6.3. Concurrently, far more companies that complete a Series A today are now generating revenue compared to 2010.
While startups in sectors traditionally funded by venture capital have options to find Series A funding when they’re ready, Factor[e] has observed that impact ventures don’t have those same opportunities. Follow-on investment for promising ventures after seed funding is rarely available, because too much impact investing goes to seed rounds. The result is that promising technology startups that could make a measurable impact in people’s lives are hamstrung.
“Part of a healthy ecosystem is that bad ideas and teams that execute poorly need to go away.” said DeFoort. “If there’s only enough seed money to survive, you get this swollen zombie pool of early-stage companies lurching from seed round to seed round. It is a very expensive way to capitalize a new sector.”
The Series A gap
This distorted investment ecosystem with a noticeable Series A gap has other negative ripple effects as well. One of the most important is that vital commercial investors enter later than they might otherwise, because there simply are not enough high-quality investment opportunities to attract their attention.
Without commercial investors, the world’s biggest problems will remain unsolved — the amount of investment capital required to close the energy access gap, drive agricultural productivity, and provide sustainable transportation to the world’s growing populations is staggering. Philanthropies and governments simply cannot achieve it alone.
“Where there exists an opportunity to provide a service like water, electricity or transport at a price that is beneficial to both the consumer and the investor, we have to prioritize and enable private investment,” said DeFoort. “To reach scale, we have to drive toward a goal of building ventures that can attract smart commercial money, which means you have to provide solutions that can be widely replicated to achieve scale.”
The success of the solar home system sector is a good example. “Solar home systems have a nice story of attracting commercial capital and achieving substantial scale over the last few years, and I think there’s a lot to be learned as we try to replicate that success with adjacent technologies and new sectors,” DeFoort said.
Off-grid solar investments doubled between 2012 and 2016. The money has continued to roll in. In January, one of the larger startups, Off-Grid Electric, closed an impressive $55 million Series D. Off-Grid Electric is one example of a company that was able to rise to the top of the heap and attract the attention of institutional investors. But it — and a few peers in the solar home system sector — is largely an exception at this time. To replicate this success, DeFoort argues that the impact ventures sector needs a more focused approach to identifying and de-risking companies alongside early capital.
“In the home solar sector, it’s not one startup shouldering the burden of selling all the systems,” he added. “We have seen healthy competition based on low-cost PV, the decreasing cost of batteries, pay-as-you-go platforms, and high-quality execution. Now we need to find the next five technology ventures beyond solar home systems that can follow a similar path. It may sound daunting, but it’s easy to forget just how risky the solar home market felt just a short time ago.”
A different due diligence
Factor[e]’s approach to finding the companies and technologies most likely to achieve the kind of scale required to tackle problems like energy access involves a lot more due diligence at the beginning of the process and a lot more support post-investment. This level of early focus helps prevent a bottleneck as companies seek middle- and later-stage financing.
“We’re very aware that we use valuable concessionary resources with very high opportunity costs to launch companies,” said DeFoort. “We believe impact investors should be extremely thoughtful about the companies and technologies we back and avoid investing in anything that we are not collectively prepared to support with larger rounds if the team is successful at the seed stage.”
That in-depth due diligence process includes having boots on the ground in the markets where Factor[e] has investments, like India and East Africa. “What we said as an organization is that we would love to see more founding teams, which combined great technologists coming out of world-class universities and national labs with great entrepreneurs who are rooted in the markets we are working to affect,” said DeFoort. “Instead of wishing it existed, we decided to make it happen.”
As an investor and a technology broker, Factor[e] does just that with its hands-on approach, marrying technical expertise with working closely with its portfolio companies to guide their development so that they are primed for Series A growth.
Most recently, the approach has expanded to include an aggressive effort to cultivate entrepreneurs who can thrive in developing markets, including Factor[e]’s Entrepreneur in Residence (EIR) program. The initiative is driven by the idea that, while many cutting-edge technologies that can deliver energy access to millions are likely to be developed in the U.S. or Europe, their success in the marketplace requires savvy and sophisticated business leaders who deeply understand their customers and can navigate the challenges of building a successful company that attracts funding beyond seed rounds.
Factor[e] is currently recruiting entrepreneurs in East Africa — with a special focus on attracting female candidates. Bringing more women into leadership positions is critical. Women are disproportionately affected by limited access to modern energy solutions such as clean cooking options and electricity. One off-grid solar company, Fenix International, found that female clients brought in more referrals than their male counterparts.
Factor[e] will pair the EIR with a new technology or idea that has great potential. “We want to align them with one of those technology ideas and say, 'Pitch us a company doing this in three to six months. Then we will fund you, and you will go from EIR to leading a company,'” said DeFoort.
DeFoort hopes that this active recruitment and training of entrepreneurs in Africa and Asia serves as an example for others. “We are doing this because we want to create ventures that have a unique ability to out-compete in the market,” he said. “We think there is an overlooked opportunity to elevate African talent and, in the process, build world-class, sector-leading teams. We aim to prove the model to the broader investment community.”