Mahesh Murthy does not look like your typical venture capitalist. Not for him the formal wear that you normally associate with fund managers. As Managing Partner of Seedfund, an early-stage venture capital firm with about ₹410 crore under management, he seeks out and invests in niche ventures.
He is forceful and articulate about his views. Some of which are not what you would expect of an investor in start-ups.
At the TiE Chennai’s annual conference recently, he shocked the gathering by arguing that all company valuations are arbitrary and that there is really no science to them.
Later, when you catch up with him for a chat and ask him if he really meant what he said or was he merely taking a stand in a debate, Mahesh vehemently says, “no, no. I truly believe that.” “I think there is a big un-talked about ugly, under-belly of valuation in India and elsewhere in the world,” he adds.
There are a large number of mid-size funds in India, he says, that have done particularly badly in the last 5-10 years. They have pushed up valuations by promising or giving assured returns to one another by investing in different rounds of a company’s fund raise. These are done because of the desperation of fund managers to show some movement. “There is nothing realistic or meaningful about these valuations,” he adds.
Mahesh asserts that valuations are quite often driven by randomness, as the funds have a certain amount of money to deploy. Each fund can only manage a certain number of companies, but because they have the money and a limited time within which to invest, they end up giving a higher amount to the venture than what it requires, pushing up the valuation. There is no logic to this, he says. Every time, a set of analysts will be asked to justify the valuations one way or the other.
He has been on the buy side as well as on the sell side and has invested in a large number of start-ups. “I have been investing since 1999. I have got 48 investments. I can tell you there is really no science to it, no matter what you claim. Actually, there is no science to a public market place. It is a sentiment driven price,” he says. He asserts that it is a fallacy to believe that there is a science to it. There is not. There is only a science to post facto justification, he adds.
Seedfund’s strategy What is Seedfund’s strategy in this kind of a situation? “We don’t have cadres of analysts sitting and doing regression analysis and fictitious discounted cash flow estimates. First of all, we know that every single estimate of the future is likely to be wrong. Our philosophy is relatively straightforward. It is a simple philosophy that believes in a couple of things,” says Mahesh. One, that increasingly markets are going to be unipolar. Which means that in any market for any product, there are only one or two large players with significant market share and the rest are way behind. He gives the example of Facebook in social networking, Google in search, WhatsApp in mobile chat, and Twitter in micro-blogging.
Therefore, contrary to popular perception, Mahesh says the truth is that monopolies are rising. “Our intention is to create the monopoly 80 per cent player in a niche. We want to build the absolute dominant leader in a niche because that guy will have an 80-85 per cent market share,” he explains. If not the 85 per cent market share leader, Seedfund would like to invest in at least the second player in that segment.
This means, he says, Seedfund cannot get into any established sector. It will, therefore, get into new sectors, “be the first, create that large leader,” is Seedfund’s strategy. For example, Mahesh mentions some of the companies in which Seedfund invested in – redBus, CarWale, MyDentish, Chumbak – were all sector leaders. “When you do that, you are likelier to get an exit. We have some companies where we are the dominant player, but we still don’t have an exit.”
Exit formula It is a necessary condition for you to be a dominant leader; it is not sufficient, it is necessary. “Our strategy towards exits is create that dominant leader in as many spaces as possible. Don’t do a number three or a number four company. They will never get anywhere.” Seedfund scouts around and identifies ventures that are in niche areas and backs them to become dominant players. He believes that there are enough and more every day problems that required to be solved and there will be no dearth of ventures to address these problems. “We keep looking for interesting ideas in multiple niches,” he says.
Life of funds Mahesh blames the fund structure that has been transplanted from the US into the country, for the distortions in valuations. The funds have a finite life of 7-10 years, from the time they are raised to the time the investors have to be given their returns. No company in India can give an exit in eight years. “We are in a sub-optimal fund structure in India. My next fund is not going to be this eight plus two or 10 plus two.” Because of their limited life, the funds are trying to push the company to give an exit before they are mature enough to do so. “Look at all the companies we respect in India. What company that you respect was ever built in 8 years,” he says.
Investors, especially family offices, says Mahesh, are prepared to wait for longer to get an exit on their investments. The investors understand and appreciate that it takes time to build a company in India, more so when you want higher returns on your investment. The other big issue on exits, according to him, is that unlike other countries, Indian corporates do not or very rarely buy Indian start-ups. A majority of acquisition of start-ups in India has been by overseas companies. That makes the exit situation bleak.