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.” 

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