NBFCs – Private Market Valuations

The financial services space contributes 15% to the GDP; its size is comparable to the expansive manufacturing space, which includes sectors like FMCG, apparel, pharma, chemicals, etc. and contributes 18% to the GDP. The space further encompasses a diverse set of sectors – housing finance, consumer lending, nano and microenterprises lending, SME lending, insurance, wealth management, payments, and technology providers.

Financial services also form a dominant part of the funding universe for VCs and PEs today. Over the last 5-6 years, more than ₹2.3 trillion has been invested in the space, which is ~20% of the overall funding universe. Not only is the space appealing from a private funding perspective, but it also boasts high success rates for companies that have gone public through IPO. This indicates its ability to create sustainable and attractive long-term businesses.

In the last 4 years, in financial services has followed a similar pattern as the overall PE/VC funding in India, witnessing record levels in 2021 and 2022 and correcting in 2023. Despite the correction, the total deal value in 2023 was ₹40,166 Cr, which is 20% higher compared to pre-Covid levels in 2019.

This increase was primarily driven by the lending sector, which grew by 64% in 2023 compared to 2019! The significance of this growth becomes even more apparent because some of the categories, such as payments and insurance saw their deal values plummet by ~40% in the same period, primarily due to the absence of late-stage deals (Series D and above).

Going down another level to ascertain the factors behind the growth in lending, one can see that early (Seed and Series A) and late-stage deals were the primary drivers. Although late-stage deals exhibited a growth of 45% in the 2019-2023 period and had the highest portion of deal value as usual, it is the movement of early-stage deals that is particularly interesting. The deal value in this stage grew 165% to ₹2,593 Cr. in 2023 compared to just ₹975 Cr. in 2019.

Now let’s dive deeper into the funding increase that we have seen in lending, an increase that has been driven primarily by NBFC models. Overall, NBFCs are among the major contributors to deals in lending, with ~95% of the lending deal value in 2023 coming from NBFC deals. Even the companies that start out as intermediaries or distributors in lending eventually opt to backward integrate into becoming the institutions that “manufacture” lending products. This trend can be seen in the funding patterns for lending. In 2023, the early-stage NBFC share stood at 78% (from 66% in 2022), with a significant shift towards NBFC models in growth and late-stage accounting for 97% (up from 65% in 2023). This is also a consequence of regulatory nudges by the RBI including the FLDG coverage cap of 5% and the promotion of co-lending model.

After witnessing a deal value of ₹10,820 Cr. in FY22, NBFCs have seen their funding decrease over the last two fiscals. Although this is consistent with the broader funding scenario, there is one aspect that stands out in the case of NBFCs. Growth and late-stage funding have remained buoyant at ₹4,384 Cr. in FY24 compared to ₹5,128 Cr. in FY22. A trend of this sort, even during a funding winter, showcases the perpetual confidence growth and late-stage investors have in the viability of NBFCs. This investor confidence is well deserved, as these businesses successfully demonstrated resilience when the pandemic stress-tested their books. This is further substantiated by the fact that the median deal sizes of NBFCs jumped from just ₹19 Cr. in FY20 to ₹72 Cr. in Another trend in this space is the consistent dominance of consumer-lending NBFCs compared to business-lending NBFCs in terms of deal volume, which is typically 2-3-fold higher for the former compared to the latter.

Another important dimension to examine is exitability. NBFCs have a good track record when it comes to listing in public markets. For instance, in the last 10 years, 369 NBFCs received funding from private markets, and of these, 35 got listed. This implies an IPO success rate of 10%, which is a very good percentage, especially considering that categories like internet-first commerce companies have an IPO success rate of 0.4%.

To summarise,

  1. Financial services have had a healthy funding flow despite the correction. The key driver for this is the lending category.
  2. Funding growth in lending was primarily due to early and late-stage deals. Early-stage deals in lending have grown primarily due to NBFC activity. This is expected to provide strong momentum for growth-stage funding in the next 2-3 years.
  3. Growth and late-stage NBFC deals have withstood funding winter as their deal yearly stage was only 15% in FY24 compared to FY22 (The peak before funding winter), whereas early-stage were reduced by more than 50%, reflective of investor confidence in fundamentally strong businesses.
  4. NBFCs also remain attractive to investors from the perspective of exitability – historically reflecting a high probability of IPO success.
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