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What Early-stage Investors Are Looking For In Entrepreneurs Hailing From Tier 2 and Tier 3 Cities Entrepreneurs from these cities have a deeper understanding of the local markets, local customer needs, and the challenges that exist in their respective regions and build unique solutions

By Bhargavi Vijayakumar

Opinions expressed by Entrepreneur contributors are their own.

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50 per cent of recognised startups in India are from Tier 2 and Tier 3 cities as per Govt. reports. If that's not an indication of the growing trend of startup activities outside of the metros and Silicon valley of India, consider this fact - 27 of about 300 Soonicorns in India are from Tier 2 and Tier 3 cities (as per data from Tracxn).

These cities offer certain inherent benefits to founders like lower cost of living and a growing talent pool, making them attractive options to incorporate and run firms. For example, due to the tech talent pool, Jaipur and Coimbatore have been emerging as key cities in the startup ecosystem outside of the main 6 cities.

However, founders and startups from these cities are also becoming increasingly attractive to investors. In a year where overall funding in the Indian startup ecosystem dropped by over 1/3rd vs 2021, funding of startups in Tier 2 and Tier 3 cities grew by over 10 per cent in 2022. As per data from Tracxn, in 2022, 13 per cent of the funding has gone to startups from Tier 2 and Tier 3 cities in India vs 7 per cent in 2021.

There are many factors that are driving this interest from investors:

Unique solutions for local challenges:

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

The emergence of larger markets:

Due to the digital / internet penetration in India and improved infrastructure, larger markets are emerging in Tier 2 and Tier 3 cities in sectors like agriculture, and renewable energy apart from e-commerce. This enables startups based in these cities to cater to huge untapped markets and potentially grow into larger businesses. Additionally, the startups from these cities could leverage first mover advantage before the cities come under the radar of established players, thus presenting a big opportunity for growth and market domination.

Increased governmental support:

Prime Minister Narendra Modi during India's 76th Independence day address said, "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 who lives in Tier-2 and Tier-3 cities, or in villages and belongs to poor families. These are our youngsters who are coming 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 coming out of these cities amongst Venture Capital funds.

Leveraging local skills and infrastructure:

Certain towns in India are hubs for certain skills and know-how. Founders in these cities have the edge to tap into this pool of skilled individuals and their knowledge base to build firms that offer better quality products that are cost-efficient. Wooden street from Jaipur is a case in point for this.

Challenges of Investing in Founders from Tier 2 and Tier 3 Cities:

Investing in startups from Tier 2 and Tier 3 cities also comes with its share of challenges. Despite the increased interest from venture capital investors in startups from Tier 2 and Tier 3 cities, founders from these cities still have to put far greater effort to access capital for their subsequent funding rounds. Many times it's the angel investors in these geographies who not only write the first cheque for these startups but also help them get discovered by Venture capital funds.

Founders in these cities also would have to go the extra mile to gain exposure and access mentor pools that are otherwise available to entrepreneurs building in the top 6 cities in the country. They also face difficulty in hiring senior talent as they grow their business. All these might pose obstacles to the growth of the startup and potentially make them 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 have a wealth of untapped potential and offer unique advantages for founders in terms of prospects for innovative solutions and operational benefits. The founders from these cities also bring unique experiences and customer insights to the table, which put them in a favorable position to build disruptive solutions in these cities

Bhargavi Vijayakumar

Co-founder and partner, Java Capital

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