Any VCs in the family?

Industry watchers have some advice for entrepreneurs — tap family and friends because VCs don't want to fund pure start-ups.

Neha Kapoor

DURING a seminar on the Indian venture capital (VC) industry held here recently, a member of the audience posed a question to a roomful of VCs, ``How many delegates present here have invested in start-ups this year?''

Not surprisingly, there were hardly any hands that went up in response to the gentleman's question.

A reaffirmation, probably, of what is already acknowledged within the VC network. Even though there are no consolidated figures available to corroborate the same, the writing is pretty much on the wall for any start-up looking for funds. ``It is very difficult to say what the exact level of investment in start-ups is as funds have different objectives. However, what is clear is that in India the total amount of funds available for start-ups has reduced. What happens in such situations (post-dotcom bust and slowdown) is that VCs prefer to invest new rounds in the existing companies in which they have already invested in rather than make new investments,'' says Sanjaya Kulkarni, Managing Director, Indian Direct Equity Advisors.

Is there a paucity of funds, then, or of innovative ideas backed by strong business models?

Kulkarni says that funds have not run dry but there is no pressure to invest. ``Given that many companies funded by VCs are not doing well, any new company in the same space has a difficult time in convincing why it will succeed. For instance, so many travel portals are not doing well, so how can you justify that a new portal will succeed? Hence the number of deals has reduced drastically while at the same time VCs have raised the bar and are looking at deals more closely.''

G. Kanti Kumar of Global Technology Ventures Ltd adds, ``The IT services market is growing but the odds are in favour of the larger firms with brand-name recognition. In the IT product market, the decline in telecom investments and slow decision- making process in other sectors has delayed market penetration. As a result of these factors, the risk levels for a start-up have increased considerably.''

``There is comparatively less enthusiasm now among technocrats to branch out on their own and VCs are also closely examining the feasibility of start-ups. But funds are available and deals are still happening. The companies that are still surviving are the stronger ones who are attracting capital,'' says Kumar.

A tongue-in-cheek reaction comes from Mahesh Murthy of Passionfund, an angel investor, who agrees that it has little to do with paucity of funds: ``The funds are all sitting in banks in Mauritius, earning four per cent -- probably the only reliable returns that VCs can depend on these days!''

``VCs are simply not investing in start-ups -- and there are some fundamental reasons why. First, each VC operation is modelled on US VC operations: the principals and staff are re-compensated, so a VC operation with about 15 people will cost about Rs 25 lakh a month to run. This Rs 3 crore a year or more has to be met by fund management fees. Typically, VCs take 1.5 per cent a year (down from 2.5 per cent they commanded last year) with a carry part of returns beyond 20 per cent. None of the VCs expect any returns really, so they have to live off the 1.5 per cent. This means that to meet a Rs 3-crore internal bill, a VC has to have a fund corpus of Rs 200 crore.''

``Also, VCs know it's too much effort to manage more than a dozen companies, hence you land up with 200/12 or an average investment per portfolio company of about Rs 16 crore. Now this is simply far too much money for an Indian start-up which needs only about a crore or so for the first 18 months.''

Murthy adds that most VCs have realised that they may not have the stomach to deal with start-ups which, coupled with the economics, forces them to invest large sums every time they do so.

So, at what stage of a company's lifecycle are VCs investing in? ``Most VCs are investing at the expansion stage,'' says Kulkarni, adding, ``We have always invested only in the expansion stage and never at the start-up stage because our investors have mandated us accordingly.''

According to Murthy, ``Today, the only VC funding I see is pre-IPO or in an increasing number of insane cases, post-IPO. This level of funding is the only thing they can do, given the unnaturally large funds they are handling, and also given the fact they are pure financial investors not strategic or advisory in any sense. Further, VCs seek quick returns, hence you are beginning to see them invest in private placements or directly buy from the stock market.''

A solution he offers is to create small boutique funds that don't have large expenses, emphasise quality over quantity and getting them run by people with hands-on operational experience. Until then, he says, ``there are no takers for start-ups because Vcs have become more like mutual funds. And, no there is no shortage of ideas: I guarantee you that I still see good ideas every week — but there is nobody to fund them. My flat-out advice to entrepreneurs is simple; find funds from family and friends because there are no VCs left in India.''

nehak@thehindu.co.in