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The Indian investing arm of New York-headquartered private equity firm Zephyr Management plans to hit the road to raise its fourth fund by the end of 2023, says Pankaj Raina, Managing Director of Investments and Research at the firm. 

Using its $100 million third fund raised in 2020, Zephyr Peacock India has backed six companies—including education financing company, Shiksha Finance; working capital provider for light commercial vehicles, Loanzen; farm diversification platform, Aqgromalin; agri commodity trading platform, POSHN; supply chain platform for construction industry ZippMat; and FMCG distribution platform, Ripplr. The firm, which typically invests in seed-plus, Pre-Series A, and Series A rounds, plans to back around 14 companies in total before raising the next fund. 

Among its earlier investments, Singapore and Chennai-based digital logistics company 20Cube, which focuses on emerging markets, recently announced going public in the US market via SPAC (Special Purpose Acquisition Company). Zephyr Peacock plans on partially divesting its stakes in the company through secondary share sales after the listing. The fund will also divest its shares in study-abroad student loan provider, MPOWER Financing, through the secondary sale of shares. 

The new fund will continue to focus on small and mid-sized enterprises across the broad sectors of food and agriculture, financial services, and infrastructure ancillaries, Pankaj said in an interview with YourStory. 

Edited excerpts from the interview:

YourStory [YS]: What is Zephyr Peacock India’s investment thesis?

Pankaj Raina [PR]: As an institution, we focus on small and medium businesses (SMBs) in the private market in emerging and frontier markets. We have been in India for just over a decade now and already have a sector-oriented strategy.

The three sectors we are present in are large markets such as food and agriculture, infrastructure services, and financial services. A large part of what we have been doing in the last two years has been digital models in these three sectors.

We start early in our investing journey, and try to invest between $7 million and $10 million—depending on how the company fits in the portfolio and which year of the fund we are in. 

YS: Do you continue to deploy actively from the third fund? How many more companies do you plan on backing?

PR: We have invested in six companies so far and three are in the pipeline. We have room for another four to five investments. Once the fund is largely committed, we will work towards the next one by the end of next year. 

YS: Will the fourth fund be significantly larger than the third? If so, why?

PR: The size of the transaction is changing even in the early stage and the size of Series A rounds has been increasing sequentially from 2007-08. It is a function of inflation, market dynamics and a lot of dry powder, which is available with seed-stage funds. Many early investors want to join early to reap the benefits but round sizes will go up, as will our cheque sizes by 10% to 15% as time progresses.

There is an inflation expectation and India is getting expensive in terms of cost and valuation. Even raising local money will have to keep up with the rise in currency exchange.

So, the size of the new fund will not be significantly larger than the third fund—around $120 million to $130 million as compared to the $100 million third fund. We hope to bring in a mix of Indian and foreign limited partners (LPs) to the new fund as well. 

YS: What are some of the new sectors you are evaluating for your portfolio?

PR: Business-to-business (B2B) in agriculture, supply chain fulfilment and logistics, consumer-facing food industries, climate-smart agritech, and plant and animal biotech are some of the sectors we are mapping.

In the electric vehicle (EV) category, we are looking at play which will enable distribution – say fintech play for various stakeholders. We are not looking at EV manufacturing and distribution, but we are interested in recycling batteries and battery management systems (BMS) in the category because it is a significant cost to the vehicle.

In the fintech space, we are mapping the SaaS (software-as-a-service) play targeting lending institutions for compliance, NPA management, risk and digitisation of lending collection, wealth management, customer retention, and the acquisition process. 

These are some of the additional areas we will be backing from our third fund.

YS: At a time when the focus has shifted to the path to profitability from growth, what do you look for in potential investments?

PR: We come in early with product-market-fit (PMF). The unit economics multiply as you scale which helps in improving the value of the credit note. We will not support a business if we think that the unit economics is not sustainable and you can make that error while investing early. This is why we map the industry and track it over a defined time frame to help us make better decisions.

A good business can be defined by fundamentals or by valuation, and it takes time for the two to converge. A business which generates significant free cash flow wouldn’t want to dilute. Rather, I would encourage the business to figure out cash flows. 

YS: How has your exit pipeline been from the India investments?

PR: We have seen all three exit scenarios. Two of our companies from the last fund are filing for a public listing in the US. We sold our stakes in NBFC Varthana to ChrysCapital Advisors, and we sold our business in Maverix to Curefoods. There is room for LPs to make money and we want to be as careful about investing, based on our guiding elements.