The Hindu Business Line : From gush to trickle

If you thought getting venture capital funding for your technology start-up would be a cakewalk, the repercussions of the global economic meltdown are sure to make you think again.

Inventus Capital, the venture capital firm floated by entrepreneur-turned-VC, Kanwal Rekhi, screened some 400 companies in the past year before deciding to fund only three start-ups.

Deeper scrutiny, fewer deals

A chat with some of the leading VC firms in India reveals that this is not an isolated incident. VC companies say decisions are taking longer because of the deeper scrutiny of applications, and the number of deals signed is fewer because the VCs are getting more selective with regard to the kind of companies they want to fund.

Therefore, while large-scale job losses and uncertainty in employment prospects have prompted a greater number of people to don the entrepreneurial robe, the VCs have become more risk-averse, resulting in lower number of start-ups getting funded despite valuations prevailing at an all-time low.

Reflecting such a trend, VC deals in India for the first six months of 2009 have declined by about 60 per cent, compared with the first half of 2008. Venture Capital firms invested only $117 million over 27 deals in India during the period, which is less than an investment of $413 million across 67 deals in the same period in the previous year, a study by Venture Intelligence, in partnership with Global India Venture Capital Association, says.

Sudhir Sethi, Founder, Chairman and Managing Director, IDG Ventures India, says, “The slowdown is not alarming. It is part of a natural process.

Because there has been an economic slump, investments will decline.”

He expects investments to pick up in 2011, tracking recovery in the global markets.

Eyeing other sectors

Another trend that could further reduce the amount of money in IT investments is that investors are looking to pump in more money in other industries such as renewable energy, healthcare, education and consumer-facing sectors where the return on investment is higher and quicker.

Though the IT sector attracted the biggest share of VC money all these years in India, several factors, including the limited size of the market for IT solutions in the country, are turning out to be deterrents for investments in IT start-ups.

Ashish Gupta, Managing Director, Helion Advisors Pvt Ltd, feels it is difficult to sustain a company that sells technology because there isn’t a good enough market for technology in the country. Also, customers often prefer to buy solutions from established multinational companies rather than from an indigenous start-up.

‘Why should I buy IT from a start-up and add more risk to my business,’ is what many buyers ask, says Gupta. However, companies that sell services based on technology have far better chances of success in the Indian market, he adds.

check list for entrepreneurs

So what does this mean for the IT entrepreneurs? To begin with, the market that an entrepreneur is trying to address (including the size of the market) assumes greater importance because it is one of the key parameters a VC would look at while taking a decision. Hence it becomes vital for the entrepreneur to correctly analyse the target market.

Also, the quality of the team is taken into consideration by the VCs, and hence it becomes imperative to have a good team in place.

“We look at what the team is like and what is the specific opportunity that a company is going after,” says Gupta. “A company is likely to succeed if the target market is big enough to allow it to make a mistake or two. If the market is very small it might be a problem.” The team must also be ready to make adjustments, he adds.

Rekhi says Inventus Capital is looking to fund companies that leverage and apply technology to address a larger market. The company made two investments in the recent few months.

One was in a company called Pilani Softlabs Pvt Ltd that promoted redBus, a bus ticketing service that offers consumers the convenience of booking bus tickets through phone, the Internet and through partners. In April, it invested in a healthcare start-up, Insta Health Solutions, focused on providing IT solutions to hospitals.

VCs are also likely to emphasise more on capital efficiency, and companies with higher capital efficiency would probably get funded, says Harish Gandhi, Executive Director, Canaan partners.

“Companies that can scale faster, require less number of people and have large market would be the preferred ones,” he says. At present, the interest is in sectors such as mobile and IT-enabled services, among others, he adds.

Sethi of IDG Ventures says there is greater stress on risk assessment because VCs want to become more de-risked.

The kind of risks they have to keep in mind while deciding to invest in a company include those relating to the quality, completeness and unity of the team, risks related to the size and growth rate of the target market, scaling risk, risk from competition and risk related to return on investment, among others.

“We have raised the bar for investment,” says Sethi. “For example, if we feel that the team of a company is not complete we tell the company to build its team before we can invest,” he adds.

Because of these factors it takes longer for us to decide on investments.

VCs hedge against risks

The venture capitalists are also moving away from investing in concept stage or seed stage companies, with the preference now being for early stage or early expansion stage companies. Generally, VCs invest more in concept stage, seed stage, early stage and early expansion stage, while the private equity (PE) players operate between early growth stage and mezzanine stage companies.

“Will I do concept stage investment now? No, it’s too risky.

The markets are down and I am cautious now,” says Sethi. “I would do selective investments in the seed stage companies. I would look at more early and early expansion stage companies,” he adds.

To counter the environment, VCs are also looking at sector diversification. IDG Ventures has chosen sectors such as business analytics, telecom, mobile, security, healthcare and medical devices, clean energy and digital consumer comprising Internet, gaming, e-commerce, among others.

The company is averse to investing in industries such as software products and engineering design and manufacturing.

Focus on portfolio companies

At a time when new investments have come down, VCs are spending more time with their portfolio companies. “Our priority is spending more time with the existing companies,” says Gandhi of Canaan Partners.

Sethi says about 50 per cent of their time goes into the portfolio companies. “We introduce them to new customers including global clients, help them with hiring, and introduce financial discipline in the companies,” says Sethi. While we always help them, the intensity increases during difficult times, he says.

“We have weekly updates, monthly reviews, and quarterly board meetings. There is a structured way of addressing the needs of a company,” he adds.

However, the dramatic turn of events in the global economy has made the investors in VC firms cautious. As a result, the VC firms that wanted to raise funds were impacted and couldn’t meet their targets.

Inventus, which initially planned to raise $125 million, could raise only $53 million, says Rekhi.

shamik@thehindu.co.in

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