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Indian Venture Capital: Age of Reckoning

Posted on Wednesday, Oct 23rd 2013

Ashish Gupta left Silicon Valley to partake in the bonanza that venture capital in India was supposed to create. He founded Helion Capital, a $605 million fund that has been in business for a while.

The style of venture capital that Ashish and his compatriots at Sequoia, Accel, and others wanted to practice was the classic Silicon Valley model of putting $5 – 20M to work per technology company that is ready to grow at a furious pace.

The trouble is such companies are few and far between in the India of 2013.

Recent Success

India’s startup ecosystem is celebrating a recent success. Founded in 2006, online bus ticket seller Redbus is making big news due to its acquisition by Naspers for $137 million this year.

The venture capital industry in India has had a somewhat frustrating run. With too much money chasing too few deals, and with mostly rather slow-growing businesses, Indian venture capital is struggling to come to terms with the fact that the classic western VC model doesn’t fit India all that well. Redbus, although a successful company in its own right, has taken seven years to build $10 million in revenue. The American version of the VC model expects a $100 million company in that timeframe. And that explains the recent exit. Helion, the main VC in the company, has had difficulty deploying its capital, and is contemplating returning money to its American limited partners.

Naspers, the acquirer, is not a purely financial firm. It is looking to build a portfolio in the Indian Internet travel sector, and as such, this is a strategic acquisition for the company. Naspers is okay with a slower growth rate than what the classic western VCs are looking for. Hence, Phani Sama and his team can continue to build value and organize the still largely unorganized bus-ticketing sector.

Value vs. VC

You have heard me worry about the divergence between building value and solving problems vs. fitting into the VC model of hyper high growth and uber TAM. I am personally thrilled to see Redbus find a new owner that allows them to continue building value, notwithstanding the fact that their growth rate doesn’t fit the VC model.

I am also relieved to see that Phani and his team managed to operate the business in a tight, capital-efficient manner, getting to profitability relatively quickly, without having to rely on raising a lot of outside capital to survive. It gave them options.

For Indian entrepreneurs who are playing in the angel/venture ecosystem, you need to keep all these points in mind. Even if you succeed in raising some capital, you have to worry about growth rates. Also, you need to keep an eye on profitability. If the growth rate is super high, you can count on venture capital. If not, better take what you’ve got, build a profitable company, and stop depending on outside capital. If VCs see growth rates slow down, they won’t invest more.

India’s Internet penetration is slow, e-commerce growth rates are slow, logistics and infrastructure are still not reasonable to add velocity to commerce, and the adoption of online credit card payments is also sub-optimal. All this adds sand in the gear as the industry tries to accelerate.

As entrepreneurs, you need to keep a few simple rules in mind: First survive, then get comfortable, then try to get mega rich.

Under no circumstance should you lose sight of the need to survive first and foremost.

What about the VCs?

Well, they are struggling with the lack of exits, and the lack of fundable deal flow. Both are problems. Both will continue to be problems for the foreseeable future.

Part of the reason behind the deal flow problem is that the seed capital eco-system is inadequate, so VCs looking for mature deals to invest $5M in are sitting there sucking their thumbs.

The exit issue is more complex. The Indian IT majors don’t acquire product companies because their DNA is services, and they believe they can build any kind of services business organically.

The US IT majors are nervous about India’s volatile job markets, regulatory complexities, lack of IP protection, etc. and hesitate, also, to acquire Indian companies.

Thus, most of the exits in India have to be IPOs, which means the company has to get to a certain scale.

Parag Dhol of Inventus Capital, a $75 million fund, says: “$500 million+ exits (MakeMyTrip, JustDial) will remain Six-Sigma events in India for a while. Hence we shoot for $100 – 250 million exits and choose capital efficient companies (like redBus) to make the 10x that we seek. This model, we believe, does not work beyond $150 million fund-size in the Indian context. Hence we intend to stay “small” forever.”

I have always believed that VCs were making a mistake in trying to jump in with large funds without a seed capital ecosystem, and without a large network of seasoned entrepreneurs.

In July 2006, I wrote a piece called Too Much Money, Too Few Deals, observing that the large amounts of venture capital flooding into India would find it difficult to deploy because of the lack of fundable deals. I had highlighted the need for small seed funds, not large venture funds. Well, today, in 2013, after seven years of water has flowed under the bridge, what I predicted then is actually unraveling.

Ladies and gentlemen, the great country of India – the great emerging market powerhouse – has, currently, ahem, ~50 venture fundable startups in its belly.

Opportunity

However, there is a clear opportunity for $50-$75 million funds to play in the market, bridging the gap in seed capital, but operating as VC funds, not angels. In other words, if you want to become a VC in India, for the next five years, until a real pipeline develops, go raise a $50 million fund and do Seed and Series A investments. Ensure that your portfolio companies become profitable within a capital efficient structure.

Chances are, in five years, you can exit to larger strategic funds looking to invest in India in later stage, lower risk deals. Not so different from RedBus exiting into Naspers.

This also means, no big management fees that VCs at large funds tend to enjoy.

However, if you enjoy building companies, and have a passion for technology, this may be the best option in front of you.

Other than, of course, being an entrepreneur!

Related Readings
How To Navigate the Seed Capital Gap in India
Seed Investors In India: Why So Few?

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