What early stage investors look for in entrepreneurs from Tier 2 and Tier 3 cities

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50 percent of recognized startups in India, from Tier 2 and Tier 3 cities as per Govt. reports. If that’s not an indication of the growing trend of startup activity outside of India’s metros and Silicon Valley, consider this fact: 27 of India’s 300 or so Soonicorns are from Tier 2 and Tier 3 cities (according to data from Tracxn ).

These cities offer certain inherent benefits to founders, such as a lower cost of living and a growing talent pool, making them attractive options to start and run businesses. For example, thanks to the pool of tech talent, Jaipur and Coimbatore have emerged as key cities in the startup ecosystem outside the top 6 cities.

But founders and startups from these cities are also becoming increasingly attractive to investors. In a year where total funding in India’s startup ecosystem fell by more than 1/3rd from 2021, startup funding in Tier 2 and Tier 3 cities grew by more than 10 percent in 2022. According to data from Tracxn, in 2022, 13 percent of funding has gone to startups from Tier 2 and Tier 3 cities in India versus 7 percent in 2021.

There are many factors driving this investor interest:

Unique solutions for local challenges:

These cities offer unique opportunities for early stage investors as the startups from these cities often focus on solving specific and local problems. Entrepreneurs from these cities have a better understanding of local markets, local customer needs and challenges in their respective regions and build unique solutions. Patna-based DeHaat, which provides agricultural services to farmers, and Indore-based Gramophone, which helps farmers achieve better yields through input planning, kuku.fm, founded by IIT Jodhpur graduates, which claims 70% of its user base from Tier 2 and Tier 3 cities in India are proof of this.

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The emergence of larger markets:

India’s digital/internet penetration and improved infrastructure are creating larger markets in Tier 2 and Tier 3 cities in sectors like agriculture and renewable energy apart from e-commerce. This allows startups based in these cities to target huge untapped markets and potentially grow into larger companies. Moreover, the startups from these cities would be able to take advantage of the first mover advantage before the cities get under the radar of established players, presenting a great opportunity for growth and market dominance.

Increased government support:

Prime Minister Narendra Modi said during India’s 76th Independence Day speech, “Today we are witnessing the structure of Digital India. We are looking at start-ups. Who are these people? This is that pool of talent that lives in Tier-2 and Tier -3 cities, or in villages and belongs to poor families. These are our young people who come before the world today with new discoveries.”

The various initiatives launched by the central and state governments namely Atal Incubation Centres, Kerala Startup Mission and Madhya Pradesh Startup Policy have helped create a supportive ecosystem for entrepreneurs in these cities. These initiatives also improve the visibility of startups emerging from these cities among venture capital funds.

Leveraging local skills and infrastructure:

Certain cities in India are hubs for certain skills and know-how. Founders in these cities have the advantage of leveraging this pool of skilled individuals and their knowledge base to build businesses that offer better quality products that are cost efficient. Wooden street of Jaipur is a good example of this.

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Challenges of investing in founders of Tier 2 and Tier 3 cities:

Investing in startups from Tier 2 and Tier 3 cities also poses challenges. Despite the increased interest of venture capital investors in startups from Tier 2 and Tier 3 cities, founders from these cities still have to make much more effort to access capital for their next rounds of funding. Often it is the angel investors in these regions who not only write the first check for these startups, but also help them get discovered by venture capital funds.

Founders in these cities should also go the extra mile to gain exposure and access mentor pools otherwise available to entrepreneurs building in the top 6 cities in the country. They also struggle to hire senior talent as they grow their businesses. All this can hinder the growth of the startup and potentially make it less attractive to investors.

Despite the challenges, investing in founders from Tier 2 and Tier 3 cities in India is an excellent opportunity for investors and cannot be overlooked. These cities hold a wealth of untapped potential and offer founders unique advantages in terms of innovative solution prospects and operational advantages. The founders from these cities also bring unique experiences and customer insights, putting them in a favorable position to build disruptive solutions in these cities.

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