VCs love start-ups—But why are they turning away from MSMEs?

Economic Times

14 hours ago

ETtech In FY24, India's VC funding returned to around $13.7 billion, a 1.4 times surge from the levels of 2023.
Entrepreneurs in India's micro, small and medium enterprises (MSME) sector have been facing significant hurdles in accessing capital from traditional banking and institutional sources, primarily due to stringent eligibility criteria, high collateral demands, and complex application procedures. As a result, angel investors and venture capitalists (VCs) have emerged as key alternative options for the sector to address the funding gap.
However, the penetration of angel investment and venture capital funds in MSMEs here lags global standards. According to experts and industry players, India's angel investment and venture capital ecosystem is still in its early stages, trailing global benchmarks in size, scope, and maturity. In 2024, less than 5% of India's 63 million MSMEs received equity funding, as per a report by the MSME Ministry.
MSMEs in the country, particularly those in manufacturing and services, have been struggling with challenges such as low scalability, low digital penetration, and high-risk perception. With limited access to institutional capital, they primarily depend on self-financing or bank credit to overcome these changes.Amit Mittal, Founder & MD of Chandpur Paper, says India's MSMEs receive very little angel and venture capital finance, while technology-oriented start-ups get most of the investments.In FY24, India's VC funding returned to around $13.7 billion, a 1.4 times surge from the levels of 2023, as investors regained confidence and investments in the technology sector saw a jump, according to a report by global consultancy Bain & Company released earlier this year. Angel investments contributed $500-700 million during this period, but less than 10% went to traditional MSMEs. This highlights a significant funding gap for non-tech businesses.
Echoing Mittal's view, Pushkar Mukewar, CEO & Co-founder of Drip Capital, says the Indian MSMEs face several challenges when seeking institutional or equity capital, including limited financial documentation, lack of formal credit history, low investor awareness about non-tech MSME sectors, and geographical disadvantages. 'Traditional VC or angel investors often see MSMEs as high-risk and low-return due to their fragmented and informal operations.'How the things can get better
Jaydeep Birje, CEO of Leo Engineers, also believes that the government's efforts via Startup India, the SIDBI Fund of Funds, and the Credit Guarantee Scheme are slowly pushing the needle.'Some early-stage investors are also now expanding their scope beyond tech to more inclusive, impact-oriented MSMEs,' says Birje.Mittal emphasises that many MSMEs lack awareness and preparedness for equity funding. To boost access to funding, India needs to foster co-investment models, incentivise MSME-centric investors and develop digital matchmaking platforms. 'Mentorship and outreach in tier II and tier III cities can improve investor readiness. A focused ecosystem approach is essential to channel meaningful capital into this underfunded yet vital sector,' adds Mittal.Arvind Singh, Founder & CEO of Quest OntheFRONTIER, notes that the landscape is evolving, and changes are already underway.'In 2025, angel investing in India is more structured and accessible than ever, driven by government initiatives like Startup India and the abolition of the Angel Tax (effective April 2025),' says Singh.A section of experts say that investors are now focusing on MSMEs with strong digital foundations, including robust online presence, e-commerce capabilities and technology adoption. This shift is driven by the recognition that digitally mature MSMEs are better positioned to scale and attract further funding. Additionally, the growth of angel networks and platforms has increased access to investors for MSMEs, including those in tier II and tier III cities, experts add.
'Multiple government schemes, such as the Startup India Seed Fund, MUDRA loans, and the Credit Guarantee Fund (CGTMSE), aim to provide MSMEs with access to capital, mentorship, and regulatory relief. The government is also encouraging sector-specific funds and Alternative Investment Fund (AIF) capital deployment into non-tech MSMEs. Exit pathways for VCs have improved, with streamlined M&A approvals and enhanced IPO regulations, increasing liquidity and making it more attractive for investors,' says Singh. According to Arvind Singh, India's MSMEs are poised for better access to angel and venture capital funding in 2025, driven by policy reforms, a thriving investor ecosystem and digital and technological readiness. While challenges remain—especially for non-tech MSMEs and those outside major urban centres—the overall trajectory is strongly positive, he adds.Similarly, Mukewar highlights that non-dilutive financing models are gaining popularity as a means to address the funding gap for MSMEs; options such as supply chain finance, invoice discounting, cash-flow-based lending, and marketplace seller financing are emerging as scalable solutions. 'These models leverage transaction data rather than collateral or credit history, making capital more accessible and relevant for MSMEs focused on exports, trade, or e-commerce. Scaling such fintech-driven models with supportive regulation and wider adoption can unlock meaningful capital access for India's MSMEs,' adds Mukewar.Singh believes there is a need to increase awareness and improve access for MSMEs to various financing options. 'Some countries, like Singapore, set up MSME support centres in the industrial clusters. Second, the government should encourage and incentivise/subsidise the MSMEs to go digital and automate their business processes, leading to the formalisation of their financial operations and also improving productivity,' says Singh.Singh suggests that finance providers, including banks and NBFCs, should leverage digital platforms and data-driven credit assessment tools and reach tier II and tier III cities and rural areas, thereby expanding funding access to MSMEs in underserved regions. This integrated approach can enhance efficiency, fairness, and inclusivity in MSME financing, says Singh.