BT dot.com: What's On The VC's Mind?

BT DOTCOM: COVER STORY
What's On The VC's Mind?

With the dotcom crash still ringing their ears, venture capital firms are looking to consolidate their portfolios and invest outside information technology. The good news: there will be no cutting back on investments. a BT-ventureahead.com project.

The VC gravy train in the US has derailed. Consider this: between 1996 and 1998, venture capital investment totalled $40 billion. Then, investments soared to $46 billion in 1999 alone, before touching an obscene $87 billion in 2000. But in the first quarter of calendar 2001, investments tanked to less than $10 billion. Even if investments continued at the current rate, the money available to entrepreneurs will be less than half of what was last year.

Will the VCs in India follow suit? Apparently not. According to a survey done by the Delhi-based Ventureahead.com-a fundfacilitator and dotcom advisory-the VCs in India are happy to strike a contrarian note. The web-based survey-administered to 48 VCs, of whom 36 replied-throws up results that should warm the hearts of wannabe entrepreneurs.

Although a deceleration in economic growth this year is almost certain, more than two-thirds of the VCs expected some growth in the venture funding business in India. Three-fourths of them expect more venture money to flow into India, and 56 per cent said their own investments would grow over the next five years. Almost nobody said that investments would either stagnate or decline. As Pravin Gandhi, Director, Infinity Technology Investments put it: ''India will continue to attract VC money because competencies in technology and people, and entrepreneurship continue to exist.''

In the short-term, however, the VCs want to work on salvaging their existing investments, with an overwhelming 94 per cent of the respondents saying that they were scouting for M&As.

Consolidation of existing venture investments would provide them a means of balancing out portfolios, concentrating on core strengths, getting greater leverage in terms of investible funds, and generally improving the management of investments by having fewer but higher-value investees.

The surprisingly optimistic view of VCs in India could be a reflection of the fact that some international investors see more growth opportunities in India rather than in their own developed markets. A look at Foreign Institutional Investors (FII) seems to bear this theory out. In January to April, net FII inflows crossed the magical Rs 10,000-crore mark, helped by the fact that Indian stocks look undervalued in the immediate-term.

Urge to Merge

Lower current market valuations are prompting VCs to put off their planned exits, and focus on consolidation. But in case you were thinking that VCs are losing sleep over it, here's some news: they aren't. Why? With the IPO route closed, young firms have nowhere to go, but to the VCs, who in turn are forcing them to sell equity at rock-bottom prices. But since the long-term outlook for technology companies is bright, the VCs are hoping that they will hit pay dirt when they do get to exit.

Ergo, while a staggering 94 per cent of the sample funds said they were looking to merge their investment companies, almost half of them said they were not in a hurry to do so. As one pointed out: ''Many young VCs invested heavily last year and lost a lot of money. As a result, the industry has gone through a steep learning curve.''

Lacking exit, VCs are doing the next best thing: putting more money into the best of companies they've already funded. Two-thirds of them said that their planned investments this fiscal would be at least the same as last year's, if not higher. But there will be a sharp drop in the number of proposals they receive. Fewer proposals, higher investments? While that may seem an anomaly on the face of it, it is easily explained. First of all, most VCs expect the quality of proposals to be better. Therefore, the investments are likely to be proportionately bigger. Predicts Vivek Chaachi, Vice-President, Citibank Venture Capital and Private Equity Group: ''There'll be larger transactions, better valuations, and less fluff.''

That apart, the VCs say that they want to focus more on second-round funding to help their projects mature faster. At the same time, nearly three-fourths of the respondents say that second-round funding would take place as in the normal course, and no change in focus is planned on this count. The implication is that some of the planned increase in investment would occur in due course of business.

Changing Focus

With a lot of ''can-do-no-wrong'' IT companies falling from grace, a quarter of the VCs are looking for bets elsewhere. The survey indicates that the relatively new and small funds (upto $25 million) could be the ones looking for a change in focus. Some of the likely bets will be in biotechnology, manufacturing, and services.

But a majority-three-fourths-say they plan to stick to it. One reason for that could be the initial brief with which funds are set up. When the VCs go around finding investors, they commit themselves to investing in a few specific sectors. Besides, they build the required skills-set for dealing with such sectors and, therefore, prefer dealing with an industry they know.

Says Vimal Bhandari, Director, IL&FS Venture Corporation: ''We have been pretty focussed on our investments in the past, and we see no reason to change focus in the future. As investors, we like to have a certain consistency in investment policy, no matter how the business environment changes in short periods of time.''

That may well be, but start-ups will be hard pressed to coax money out of VCs. For one, investors are increasingly losing their appetite for risk.

Proof? More than a third them said they would like to invest more in companies that are expanding or nearing maturity. Apparently, given the rather gloomy economic scenario, this would enable them to make quicker exits and generate better Internal Rates of Return (IRR) rather than wait for a longer time to exit.

That, however, does not mean that start-ups are doomed. Explains Pankaj Sahai, CEO of Ventureahead.com: ''The internet is here to stay. Any business proposition that can make the internet faster, cheaper, and more popular is still a good candidate for funding.''

Exits emerge as a big casualty of the dotcom meltdown. About 45 per cent of the VCs surveyed are inclined to stay invested for a longer period, expecting the business climate to improve.

More than a quarter said they would not be able to achieve their exit target for 2001-02. But, worryingly, 23 per cent of the respondents felt they would need to create provisions for some investments. The upshot: earnings could be affected in 2001-02.

What's galling the VCs in India is that regulations are still constrictive in nature, and not sufficient tax breaks are being offered to risk-taking investors such as VCs. For instance, there is little clarity on offshore VC guidelines. Nobody knows whether an existing offshore VC can register with the Securities and Exchange Board of India (SEBI) or not. And if yes, whether the exit guidelines would be applicable to the past portfolio or not.

One VC had this suggestion to make: "Minimise regulations, reduce confusion between various guidelines, and give the exit price freedom to offshore funds."

Overall though, the funds seem to be confident about the resilience of Indian economy, and expect a fairly bright future for themselves and the companies they've funded. What that means is if you have a great idea, there will still be money wanting to back you.

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