Operation Venture Capital

It is the hottest thing

happening in the IT industry front today. With stories of instant

riches hitting the headlines every now and then, the Indian

entrepreneur has at last arrived, or is almost there. And it is the

IT industry that is seeing the rush of people and capital. It is the

latter that has taken predominance over the former. The result is

growth in the otherwise nascent Venture Capital (VC) industry.

Indian success stories sprouting in the Silicon Valley have

definitely had its impact on the Indian scenario, and the VC funds,

not to be left behind in the race, have also hopped on to the

bandwagon. It is a classic case of too much money chasing too few

projects! The success of earlier investments made by the VC funds

has also added to the excitement and with these investments

generating handsome returns, VC funds have not looked back. But the

glitch in the whole episode is the dearth of good projects or ideas.

“There is plenty of cash, but it is available only for good

projects,” seems to be the VC’s cry. 

The Indian VC

evolves

Venture capitalists have been in existence in India

for over a decade. It all started with a seminar organized by the
World Bank in 1988 to increase awareness about venture capital in

India and the Central Government coming out with guidelines for VCs.

However, then, only certain financial institutions were flush with

money—institutions which took the initiative to set up funds. The

scenario did not change until a couple of years ago, when foreign

institutional investors came with offshore funds. Today, we find a

complete turnaround and it is the offshore funds that are making the

maximum investments. Global players, who bring in global expertise,

are increasingly financing the venture capital needs. There is a lot

more awareness today about what the VCs can do and how they can help

in improving, restructuring, planning and even drafting a business.

Gone are the days when the VCs were looked at with skepticism,

thought of as external players not to be trusted and who did not

have any role in value addition. 

Says Kiran Nadkarni, MD,

Draper International (India), which has closed its funds and is only

managing investments, “Offshore funds made an advent as the rupee

funds became low because of the risk portfolio.” There is no doubt

that venture capital is risk capital and it is not mandatory that

all investments will lead to success. The offshore funds having

exposure to the foreign market, do not find it difficult to invest

huge sums of money. But the interesting aspect is that, with the

success stories coming up in the IT sector, there is greater

awareness that venture capital investment in sunrise industries is

essential for nurturing and catalyzing its growth.

Change in

mindset

When we speak of the change in mindset, the first

question that comes to our mind is—has the Indian entrepreneur
arrived? For, the whole premise of VC awareness rests on the

hypothesis that people have started taking steps toward

entrepreneurship. To say that the Indian entrepreneur has arrived

will be making a tall claim, but one can say with certainty that he

or she is almost there. From twenty-somethings to fifty-plus—TS

Rajesh of Graycell to Ashok Soota of MindTree—there are

entrepreneurs who have come out of the straitjacketed mindset to set

out on their own. As Vijay Angadi, MD, ICF Ventures, says, “There is

a paradigm shift in the mindset of the Indian entrepreneur. In the

seventies and eighties and even the mid nineties, it was just one

industrialist or businessman who used to run the show. It was a

clear case of brute force.” People have slowly started realizing

that entreprenuership is not a dirty word anymore and cannot be

looked down with contempt. It is more of taking up the challenge and

doing something on your own. As Muneesh Chawla, VP, IL&FS

Venture Corp, says, “The VC industry cannot develop on its own.

Other industries should take the initiative to develop it.” And that

is what we see is happening.

But unfortunately, it is

dearth of good ideas, rather than lack of funds, that is acting as a

bottleneck. Ideas are plenty, but projects that can be successful

are few and far between. “Only one out of nearly 50 projects that

are brought before the VCs get the funds. The VCs are looking for a

needle in a hay stack,” says Venkat Subramanyam, Founder-Director,

Mantra Consultants, Chennai, which focuses on venture capital

syndication for IT companies. An interesting facet that has to be

taken into account is the advent of internet, which has generated a

plethora of opportunities. 

The internet

factor

And with the internet era setting in, age or

experience has not hindered young entrepreneurs. Bangalore-based
Graycell, founded by TS Rajesh, has an average age of around 25

years among its staff. Graycell, a net-driven company, has launched

a global brand in internet-to-mobile communications. While on the

other side, the ‘dream team’ of Ashok Soota, Subrato Bagchi and N

Krishna Kumar with MindTree Consulting, have come out with a

high-end consulting venture. It is definitely a harbinger of things

to come in the future.

Interestingly, there have

been entrepreneurs with no IT knowledge approaching VCs with ideas

for net-driven companies. The VCs are also not averse to such

proposals as long as the persons concerned have the domain

experience. “It is the domain experience that matters, not knowledge

of IT, in the internet-driven age,” says Poornima Jairaj, Sivan

Securities, Bangalore, who are the first to give an entire seed

capital for a software start-up, Kshema Technologies Ltd.

Though, there is a lot of

noise being made, it is not enough to catch the eyeballs of the VCs.

“The days of catching the eyeballs by making a noise is over. It is

the idea that matters and the brand that one builds,” says

Poornima. 

One can see the trend as early as 1996, when a

four-member team of professionals working with BFL Software Ltd
decided to float their own software company. The motivation was not

to make money but to own a company. It was a classic case of the

employee being the owner and this motivation alone made them knock

at the doors of a VC—Sivan Securities. (See Case Study)

Another

note-worthy aspect is that though there has been no progress yet on
the concept of a professional CEO managing the company, the

technocrat-entrepreneur is not averse to it. The mindset earlier

was, if the idea is mine, why should someone else come in as the

CEO. Usually, the technocrats have brilliant ideas and concepts, but

when it comes to making their business success, they fail to execute

it. It is here that the professionalism and expertise of the CEO

matters the most. “Ashok Soota heading the MindTree can in a sense

be seen as a professional CEO heading a company. The VCs were

instrumental in bringing together Soota and the rest of the team.

But it is definitely an exception,” says Poornima. The general

feeling among the VCs, though, is that the concept of a professional

CEO heading the company is yet to catch up. 

There is a sentimental

value attached to a company that is still prevalent in the Indian

mindset. And entrepreneurs are no exception to it. That is one of

the reasons that we do not see the sell-out of a successful company,

unlike in the Silicon Valley where ventures at the pinnacle of

success have been sold out by the founders, who then go ahead to

start another venture. Sabeer Bhatia, Vinod Khosla, Gururaj ‘Desh’

Deshpande, to name a few, have proved it time and again. Indian

entrepreneurs stick to their company and any mention of selling out

provokes an extreme reaction. But as one of the VCs said, “There is

sentimental attachment as of now, but it will slowly disappear and

we will see sell-out of successful ventures taking place.” But it is

on the part of the VCs to change the mindset of the entrepreneur by

showing him the right path and giving him the correct guidelines. As

AV Jayachander, President, ICICI Venture, says, “It will happen, it

should happen and the VCs should make it happen.” 

Entrepreneurs’

grouse

Though it may seem all rosy from one end, the

entrepreneurs are still to come to grips with the grind of going
through a VC funding. The usual complain that props up from the

entrepreneurs’ side is “it takes a long time to get the funds”. It

takes nearly three to four months at the earliest to get the funding

through. “What if someone else starts up a business on the same

lines, while we are still negotiating with the VC for funding?” asks

an entrepreneur who is in talks with VCs for funding a net-driven

company. ‘Speed is God and Time is Devil’ as far as the net ventures

are concerned. This has even prompted some of the smaller companies

to take the public offering route rather than approach VCs. A senior

official of a company, which is planning to come out with an initial

public offer soon, says, “We wanted to approach the VCs, but they

take a long time to process. It takes nearly one month for them to

even say whether they are interested or not in the project. So, we

decided that a better way was to approach the public rather than the

VCs.” But Sudhir Sethi, Director, Walden-Nikko India Management

Company, is of a different opinion. He agrees that the VCs take a

long time to make a decision whether to go ahead with the project or

not. “VCs are careful. Nearly 70% of their decisions are based on

softer aspects, like whether the chemistry between the entrepreneur

and the VC’s match or not. If I were sitting on the board of a

company, I would like to know the people better. But the end result

is that there is quality and value addition to the company,” says

Sethi.

Another fact that comes to

light is that if one VC shows an interest in the entrepreneur, other

VCs also line up to fund that project. But if one or two VCs turn

down the proposal, the others don’t even dare to touch that project.

Interesting it may seem, since all of these VCs have different

investment strategies and principles, but when it comes down to bare

facts, it is the ‘herd mentality’ that is quite evident. An argument

surfaces that since most of the VCs do not have a technological

background, they are not in a position to understand the business

that the technocrats are talking about. However, Koppar, who went

through the whole process, has a different opinion about it. “One

has to go through the whole grind. There is no shortcut to it,” he

says. Definitely, time is essential, but that doesn’t mean that one

can cut short and speed up the process. “For, VCs bring in a lot of

discipline and outside view to the company,” says Angadi. However, a

silver lining is on the wall as the entrepreneurs have discarded the

age-old concept that the VCs will take over their business, and will

sit on the board and ask unnecessary questions. But the ego part in

the entrepreneur to give up a board position to a VC is pretty

evident. “Taking a project to a venture capitalist for funding is

like a five-day cricket test match. Lots of patience is required and

when the whole process goes through under the inspection of a minute

lens, there is more value addition to it. And it is worth the wait,”

says Subramanyan.

Investment

trend

The clear trend of VC investment that is being seen is

the onset of the net-driven era. And with that, one finds more and
more start-ups happening, with the VCs willing to fund these

companies. It is also a clear reflection of the young entrepreneurs

making a mark on the net space. “If Silicon Valley could do it, why

can’t we?” seems to be the question in the minds of the young

entrepreneurs. The success stories of KB Chandrashekar, BV

Jagadeesh, Vinod Khosla and the latest in the lot, Gururaj ‘Desh’

Deshpande, have definitely prodded the young entrepreneurs back home

to take up the challenge and come out to the forefront. This also

calls for caution on the side of the venture capitalists to take a

careful look before they go ahead with the funding. 

VCs may

also have to cope with failure. But unlike the US, where even if an
entrepreneur fails, one can always go back and try out some other

business where one can get funds. In India, a single failure spells

the end of your venture. In the Silicon Valley, entrepreneurial

ability is not measured by the number of times one has failed, but

the attempts that have been made to start a venture. India

definitely can boast of Pradeep Kar of Microland, who had the

courage and the guts to wind up a business and go for a new line of

business. But that is where the comparison stops. One Pradeep Kar

cannot change the mindset or the investment trend of the VCs. What

India needs is more of Pradeep Kars—people who will not take one

failure as the end of all their entrepreneurial

abilities.

The VCs are well aware that

not all projects they invest in will succeed and they are not only

ready to accept it and account for it, but are also not deterred

from making further investments. The Silicon Valley experience has

certainly proved that it is possible and can be done. In the Indian

context, though it has not been that aggressive, there is no doubt

that as the new millennium approaches, the VC community will see a

paradigm shift where it will be ready to invest even small amounts.

The current trend of investing a minimum of Rs2 crore and thereby

increasing the expectations and valuation of the companies does not

augur well for the VC community. In addition, the high rate of

returns that the VC expects in a short-term period may in the

long-run force the company to try and bite more than it can chew.

The risk is that there is no sustainable revenue being shown and the

ability to adapt to changes in the global market is missing.

The

trend is clearly towards investments being made on ideas and people.
The entrepreneurs are also looking at global expertise and exposure

to foreign markets through its partners overseas. It is a healthy

mix of the two that is going to sustain in the long run and

eventually end up being successful. As a result, what we find is

that more and more specialized entities are emerging. There is no

other alternative but to move into niche areas and catch the

attention of the VCs. “The net is the next Holy Grail,” says Angadi.

It is pretty evident that the knowledge-based venture-funded

companies are the order of the day and these are the companies that

are going to make an impact on the economy and the stock market.

“Like the Industrial Revolution, the Internet Revolution will change

the way of life. India will definitely leapfrog into the big arena,

bypassing some of the obsolete technologies to come to terms with

the latest. Indian entrepreneurs will certainly learn and benefit by

the mistakes made by their western counterparts. And this is a good

thing to happen,” says Poornima.

New

directions

The simple fact that the pool of funds in

cumulative terms available for VC activity in India has increased to
Rs2,988 crore in 1998 from Rs2,559 crore in 1997, with investments

going up to Rs1,256 crore in 728 projects in 1998 from Rs1,000 crore

in 1997, clearly shows the way that the VC sector has been moving.

Over and above that, there has been an increase of almost 20% in the

project sizes for 1998 compared to 1997. And predictably the largest

gainer has been the IT industry, receiving Rs324.23 crore of

investments made till 1998—25.86% of all investments. In the IT

industry alone, it has been the software and services segment which

has garnered the largest chunk of 19.98% or Rs250.89 crore for 100

projects till 1998, while the hardware and systems segment garnered

5.86% or Rs73.54 crore for 30 projects—another indication that

software and services are the cynosure of the VC

funding. 

As TC Meenakshisundaram,

Investment Manager, Walden-Nikko says, “The software services

industry is well understood by the investing community and most

companies are getting good valuations based on a few success stories

like Infosys. Net-based companies have become the favorites of VCs

because of its exponential growth.” The simple reason is that

India’s core strength lies in enabling technologies. “It is

difficult for Indian companies to go for shrink-wrapped products

like those from Microsoft and Oracle as it requires deep pockets to

build brands at a global scale over a sustainable period,” says

Meenakshisundaram, justifying the trend towards the software and

services’ driven companies. However, Hetal Gandhi, President,

IL&FS Venture Corp, believes that there is not much distinction

in prioritizing investments between internet-based products or other

products. “The only discernible trend is investment in technology

companies, and in this area, investors are also opening up to

start-ups. There are some investors who are very focused,” he

says. 

What’s ahead

for VCs

All said and done, there is no doubt that the VC

industry will thrive. The cyclical changes that affect the stock
markets will certainly make a dent on the VC community. Start-ups

are the trend and that too in the internet arena. IT is a

capital-intensive industry, and though the failure rate in the

ventures may be as high as 60-70%, it does not add up to much

compared to the investments that are being made. Money is there and

it is there in plenty. But more weight is put on the chemistry of

people and ideas. As Hetal says, “Irrespective of the project and

target markets, we perceive each investment as an investment in

individuals. We seek management teams who will successfully lead and

build dominant companies of tomorrow and who are able to demonstrate

sound business practices over time. Above all we seek a commitment

to growth, and a sense of fair play and integrity.” As David Packard

said, “Most young companies die of indigestion, not

starvation.”