PUTTING IN THE BIG BUCK

What is venture capital?

• Venture capital investors, “venture capitalists” or “VCs” provide capital to young companies that can not raise capital from public share markets and can not or do not wish to raise capital through bank loans.

• These firms typically are either early stage ventures which have not yet become profitable.

• Investments are typically held for 3 - 7 years.

• Investors typically expect annual returns between 30% - 50%+ depending on the risk of the investment.

• Investors are typically actively involved in their investments through seats on the Board of Directors.

Various Investment Classes for Investors

Perceived Investment Risk

Seed Capital

Venture Capital Equity - Early

Mezzanine Capital

Private High Yield

Leveraged Bank Debt

Venture Capital Equity - Late

Buyout & Later Stage Equity

10.0%

20.0%

30.0%

40.0%

50.0%

Tar

get A

nnua

l Ret

urn

on I

nves

tmen

t

1.0x

2.0x

2.5x

5.0x

10.0x

Mul

tipl

e of

Inv

estm

ent

History of venture capital

• Started in the US in the post World War II years

• The war effort spawned many technological innovations that began to be commercialized in the early 1950s

• In the late 1950s the US govt gave incentives for VCs to spur technological innovation

• Booming stock market in 1960s gave huge returns to VCs; Digital Equipment IPO; sector became popular

• 1970s was a bad phase for VCs; in the early 1980s high profile IPOs of Genentech, American Express and Apple Computers rekindled interest

• 1980s bull run led to too much infusion of money, returns dropped, investors exited

• From the early 1990s, the biggest ever bull run in VC investing started, ending recently with the tech crash

Economics of Venture Investing

• 3 out of 10 investments are successes

• Typical return on the successful ones is 5-10 x

• Average return on VC investments is 20-30 % historically

Value add by venture capitalists

• Strategy

• Customer Relationships

• Further fund raising

• Mergers and Acquisitions

• Legal and corporate affairs guidance

Proposal Pyramid

1000 proposals received in the year

100 get beyond first read10-15 investigated in depth

2-5 get funded

Bottomline : It is very, very difficult for most companies to receive venture capital financing.

What do investment firms look for?

Reasons to make the investment

• People

• Idea

• Business Plan

Reasons to reject a proposal at first glance

• Investment size

• Geography

• Industry focus

• Poorly prepared or presented proposal

What do investment firms look for? [contd.]

• PEOPLE– Experience

– Execution skills

– Complete management team – technology, sales, finance, hr

– Passion, self belief, resolve

What do investment firms look for? [contd.]

IDEA

• Unique? - not so important

• Executable? – important

• Defensible competitive advantage? – very important– Patents

– Customer Relationships

– Sector knowledge

– Supplier Relationships

What do investment firms look for? [contd.]

BUSINESS PLAN

• Competitors mapped out

• Customer’s needs fully understood

• Product/market focus

• Competitive Advantage

• Prior financial history

• Future costs and revenues worked out in detail

• Risks

Learnings from the tumultuous previous two years

• What happened?– Initial success of internet and technology firms led to a gold rush– A plethora of poorly thought out business models got funded– Each customer segment was serviced by multiple technology vendors,

including startups, rendering each of them unviable– When stock market valuations adjusted for the reduced attractiveness of

these businesses, all investors lost money

• The fallout– Investors very cautious in technology ventures; interest spreading to

other sectors– Almost no appetite for start ups. Preference for ventures with existing

revenues and customers– Longer diligence periods on each investment– Valuations much lower than last year– Refusal to fund copy cat ventures

Learnings in India

• Export based growth more robust– B2C internet ventures were disasters

– Software products for the Indian market not remunerative enough

• Sales and management weakness– Understanding of customer needs and processes

– Cultural skills

• Strength in services– Huge technical pool available

– Cost advantage

– Project management skills available

• The challenge of productionizing – Difficult transition from technology to product

Current areas of interest for VCs in India

• IT enabled services– Business Process Outsourcing

– Call Centres

– Outsourced research, legal services etc.

• Pharma

• Biotech

• Consumer Goods and Food– Transitioning regional brands to national brands

– Processed food opportunities

Embarassing Home Truths

Alternatively titled “managing your VC”

• Most VCs are not technologists. They can not understand the nitty gritty of your product or technology.

• VCs are here to make money – as much as they can, not as much as they “should”. He has a responsibility to protect the money he has invested.

• All but the best and boldest VCs are vulnerable to the herd mentality

Nothing ventured, nothing gained!