We will continue to invest in and around businesses that obviously have transaction activity, but more and more are starting to think about media and media spends as a place to make their living. Mr Rahul Khanna, Managing Partner, Canaan Partners
In the midst of the economic slowdown, you would expect the venture capital industry to also feel the heat and be affected.
Not so, says Mr Rahul Khanna, Managing Partner, Canaan Partners, a leading venture capital firm. “Venture,” he says, “continues to be an exciting place to be, because most of our investments tend to be on the consumer side.”
In this recent interview, Mr Rahul, an MBA from the Kellogg Graduate School at Northwestern University and who has over 15 years of investing and operating experience, talks about the venture capital industry and Canaan’s strategy. Excerpts:
With the economic gloom that we are hearing about, what is the investment scenario like for venture capitalists like you?
Last year was quite big for the industry. We had a billion dollars coming into the country in venture capital, about 50:50 in tech and non-tech. Coming off that fairly big year, Q1 has still been pretty good.
We haven’t seen investment activity in venture slow down as much. Private equity has gone a little bit slow. Part of that is a function of the macro-economic climate. Part of that is also because PE probably got started a few years ahead of venture, and is now having to demonstrate exits.
Many of our peers in the private equity world are finding that this is not a great time to exit.
It is a function of where the public markets are, a function of some of the regulatory questions on exits, whether taxes have to be paid.
Venture continues to be an exciting place to be, because most of our investments tend to be on the consumer side.
Most of our investments are not involved with infrastructure or where Government has a significant role to play. Most of us don’t invest in real estate.
Our sectors of interest are sectors where there is significant double digit growth.
Can it be interpreted that the economic situation has not really affected entrepreneurship?
Absolutely. I think we have crossed some kind of wall. Growing up entrepreneurship was not a choice people made. It was often forced upon them or you couldn’t get a job and ended up doing business.
Increasingly, people are finding that entrepreneurship can be a choice and it can be a fairly exciting choice depending on what industry they are in, what degrees of freedom they had previously, and once they have tasted blood as an entrepreneur it is hard to go back to corporate land.
What has happened is with the Internet, people are starting opportunities that are global in nature.
While we still haven’t seen a lot of big outcomes of Indian companies going after global opportunities, we are starting to see a lot of small companies playing the cross-border angle, saying we are going to build the product or service in India and take it global.
It is not about labour cost arbitrage, it is fundamentally about saying I have got a great, competitive product and I can sell it, thanks to the Apple store or the Android ecosystem.
The Internet is a great leveller and some of these distribution platforms are suddenly making opportunities available that weren’t available five-six years ago.
Which do you think are the hot sectors as far as venture capitalists are concerned?
Last year, e-commerce was the flavour of the season. We are seeing more focus on services, online services — education, healthcare, financial services. We are finding that people are looking at it as an alternative efficient channel for delivering content, music, multiple things.
There is some amount of energy built around the Internet as a channel for content and programming. Which also means that advertising led models start to become a little bit more promising.
As far as we are concerned, we will continue to invest in and around businesses that obviously have transaction activity, but more and more are starting to think about media and media spends as a place to make their living.
I will give you a very good example. Classifieds is a very big category. We have been invested in Bharatmatrimony for a long time.
That company is now at significant scale. When you start to see companies that are doing tens of millions of dollars in revenue, then you feel that you have reached some critical mass.
Could you tell us something about Canaan and the funds it manages?
Canaan has just completed 25 years as a fund. That makes us one of the older platforms in the world in venture. We continue to stay focussed on early stage. We just raised our ninth fund of about $600 million.
We have $3.5 billion under management, with three funds that are active. We don’t do a geography specific allocation. We have a single pool of capital and that money gets deployed across three geographies — the US, Israel and India.
We have traditionally been able to deploy anywhere between 10 per cent and 15 per cent of our fund in India.
With this new fund, hopefully we would continue to keep that pace and exceed it a little bit. So, out of this $600 million, may be a $100 million will be invested in India. The three areas of focus for us — one is largely the consumer Internet space, both fixed and mobile.
The second is enterprise technologies, enterprise services but delivered as platforms.
We run a large platform for the payments in loyalty space in the country.
We like to run those platforms and we think they create significant network effects and we think there is value in that. The third, which is slightly contrarian, but we keep finding interesting opportunities is in cross border.
We backed Ashok Soota’s Happiest Minds last year.
We think there will be a combination of IT services companies but also product companies that can go global from India.
What kind of stake do you pick up in the companies you invest in?
We are typically Series A investors and for us a Series A investment means 25-35 odd per cent.
As an exception, we would go up to 40 per cent or down to 20 per cent.
Occasionally, we have done a Series B deal and where we may do as little as 20 per cent. Generally we like to lead. In most of the deals we have done in India, we have been the lead investor. And that’s been our philosophy from day one.
What would be your exit strategy in India? You have about 10 investments here.
What we found is that the best returns on our investment have come from taking companies public.
Ideally if we can take a company like Bharatmatrimony public, it is the management’s call, but as shareholders and investors, our bias is if we can create a public outcome — it creates a sustaining entity, there is value that keeps getting created going forward, that would be the preferred outcome.
If we cannot get an IPO, then we would look at strategic sale. If there are inbound interests and people are willing to pay to enter the market and they don’t necessarily want to spend that time building brand, the second option is a strategic sale.
The third option is for us to exit our investment to another financial investor.
That has happened in the past. We have seen a lot of our private equity colleagues moving their ownership to another larger investor.
Canaan started investing in India in 2006. Our investment would typically be $2-10 million. We have gone up to $15-20 million, depending on the size of the company.
We are a large fund. Part of the luxury we have is we can start small, but if needed, we can pull in resources from the larger pool.
You are not anywhere near your first exit in India?
Nowhere near, unfortunately. I think most of our investors understand that India as an asset class is a seven-eight year journey.
Probably, our first investments are getting to the five-six year mark and hopefully depending on the state of the markets, on how the stars are aligned, we should be able to get something out in the next 12-24 months.