The Hindu Business Line : Have idea, seal deal

Venture Capital (VC) investment in India during the first half of 2008 has not been affected by the turmoil in the global financial markets. There is no significant squeeze on valuations witnessed in the VC segment, says Arun Natarajan, CEO, Venture Intelligence, a research firm on VC.

VC firms invested $200 million in 30 IT companies during the first half of 2008, compared with $258 million across 39 investments during the corresponding period last year.

While IT companies continue to account for a majority of investments, it is quite significant that the proportion of non-IT investments — both by activity and value — has now climbed up to 40 per cent.

VC investments are increasingly focusing on alternative energy, media, retail and other consumer demand-led sectors, he says.

Three years ago, IT used to garner 80 per cent of all investments. Now, says, Natarajan, “The magnet of the Indian consumer boom is drawing away VCs to Chinese restaurants, to Out-of-Home (OOH) companies, to those engaged in education.”

Tough environment

Entrepreneurs chasing VC money will have tough days ahead with valuations beaten down.

“Yes, valuations of early-stage companies have decreased a little bit, but of later stage companies with revenues have gone down along with valuations of public companies,” says Jai Das, Partner, SAP Ventures. A number of VC/private equity (PE) companies are looking for good investment opportunities.

But good deals are competitive. VCs are looking at the slide in public market valuations and being rational about what they are willing to pay.

For companies that do not have a good team, market focus and solid differentiation, it has become very hard to raise financing in the current environment.

Up for grabs but…

With over 50 funds having been started in the last two-three years, there definitely is a lot of money to be invested. While there are a large number of deals, many of these are not quite ready for institutional investment. As these companies mature a bit, there will be a steady stream of quality deals, feels Pradeeep M. Tagare, Director, Intel Capital.

The industry downturn is also good for the investors and entrepreneurs. For investors, the valuations are reasonable, and for entrepreneurs, it (downturn) forces them to focus on business fundamentals instead of assuming easy access to capital.

The effect of the public markets’ crash is trickling down to the private companies. There seems to be some disconnect between entrepreneurs who still expect ‘pre-crash’ valuations and VCs who are adjusting to new market realities. The average PE ratio has decreased by 30 per cent to 35 per cent. This has to be somehow reflected in the private companies’ valuations, says Tagare.

Towards fairer valuation

As always, during every downturn, the quality of deals becomes better and better. Good ideas and good teams stand the test of time and become visible in the venture industry, says Joydeep Bose, Director, Corporate Business Development, Investments and Acquisitions, Cisco Globalisation Centre East.

One positive effect of the downturn is that valuations are becoming more reasonable. As too much money was following too few deals earlier there was an irrational exuberance demonstrated in the market primarily driven by several new non-VC/PE style funds. Now there are several mezzanine rounds coming up for fund raising by good companies — with solid fundamentals, product IP and revenue — who are looking at strategic partners. As for valuation, there is a (much needed) correction in the market.

A few investors are adopting a more ‘variable convertible valuation’ to hedge their bets. One recent deal in which Cisco was involved saw a reasonable ‘variable multiple-based valuation’ with a floor value (to protect the entrepreneur) and a ceiling (to protect the investor). This is a win-win for both the investor and the entrepreneur, he adds.

Team matters

The total VC environment has changed in the last couple of years. ‘Risk aversion’ has gone up and spilled over to India as well. VCs are a bit more careful in evaluating companies. For instance, many entrepreneurs entered Web 2.0 and social networking, but they could not get VC funds, feels Avnish Bajaj, co-founder and managing director, Matrix Partners India.

“We believe that more than just the valuation (of a company), it is the team and quality of the company that are important. We want to back a team. By (VC) owning too much, the company’s valuation will go down in the long term,” he adds. It does not matter whether the company runs a Web site or is into software development. The team should become a Rs 400-500 crore company in the long run, says Bajaj.

Bajaj’s advice to entrepreneurs is to start the company with funds from high net worth individuals or angel investors, and then tap VCs with a good success story. This will make the company more attractive for a VC, than going to the VC in the first instance and not succeeding.

VC interest remains strong in the IT sector, is the general view. The performance of the publicly listed companies speaks for itself, while the US slowdown and decline of the dollar have hurt the sector. Increased domestic IT consumption is an area of growth and will continue to be for the next few years, says Tagare of Intel.

The US meltdown has impacted the IT sector, but the growth proposition holds good for most leaders. “Please do not forget that the coming of age of the Indian IT sector was only aided by the US meltdown in 2000, apart from Y2K. So short term, it may not be such a crisis for this segment after all,” says Bose of Cisco.

Industry-affiliated versus others

Have industry-affiliated VCs such as Cisco Ventures, Intel Capital, SAP Ventures and the like done more in the VC arena than pure VC players such as Carlyle and Sequoia?

Not really, feels Natarajan of Venture Intelligence. Pure financial VCs have always been more active than corporate investors. The share of corporate VC in the overall VC pie has been small so far (less than 15 per cent), but there is a pick-up with players such as Intel, Nokia, Siemens, Google and Yahoo becoming more active in the market.

These investors typically co-invest with financial investors, for instance, Yahoo with Canaan in Bharatmatrimony.com, and do not necessarily compete with them.

Both types of VCs are helpful to their portfolio company and play different roles. Financial VCs such as Sequoia and Carlyle are helpful in building a company’s management team and developing a product/service strategy. Industry-affiliated VCs are helpful to the company by leveraging their (SAP and Cisco) ecosystem to help the company. Also, some of these industry-affiliated VCs might also acquire the portfolio company, says Das of SAP Ventures.

raja@thehindu.co.in

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