Death By Over-funding

NOTES FROM THE TROUGH
Death By Over-funding
Surplus money breeds surplus needs, and a short cut to the morgue.

By Mahesh Murthy

The First Mail

"Net Was Never A Let-Down"

Wired Wisdom

The day-dreaming senior manager tells me: "I'd love to become an entrepreneur. But you see, I'm a family man, if it doesn't work out, I'd be on the streets." He goes on to tell me why he needs a large sum of money before he'd think of starting out on his own.

The weird part is that I haven't come across too many starving entrepreneurs. The ones who receive no funding get by somehow. It's the ones who get all the money that seem to go out of business in a hurry.

There's a little secret about starting a tech company in India. It's one that VCs don't seem to want to hear. Just this: that it is incredibly cheap to do so here, as long as you do it the 'real' way.

First, pick a city that gives you a supply of talent that will stay loyal at reasonable salaries. That may rule out Bangalore and Hyderabad, full of overhyped, overpriced mercenaries. You'll find the 'real' pay packets around India: Rs 4,000 or so for fresh grads, to even Rs 15,000 for bas with four years' experience in Mumbai.

Do the math, and you can run a company with 20 people on a payroll of less than Rs 4 lakh. If you're starting up, you can go from zero to about 40 people in a year at a total payroll cost of Rs 30 lakh. Add rent, machine rentals, sundries and such, and your entire cost for the year you build and test-market your prototype it will be less than $150,000 (Rs 70 lakh).

That's assuming, of course, that you're not a Harvard MBA who demands $200,000 salary to run your own company, like a few specimens would expect. I don't see why owner-CEOs should take home more than Rs 35,000 a month till their companies turn in a profit. Many good people I know take less.

During that first year, you're expected to get some business, maybe Rs 10 lakh a month, which can pay for your burn going forward. Which lets you hold out and wait for the millions in the second round without appearing desperate to every VC who screens your calls. It's going to take six months to close a round anyway-and somehow, VCs prefer to invest in profitable companies that don't really need their money.

If $100,000 or $150,000 (or even $250,000 to be charitable) is all it takes to start a company, why did VCs throw ten times that much at startups? A couple of reasons. One I call the 'Red Herring' Syndrome. If Red Herring magazine says startups need $2 million, who is to argue? Yes, it might be referring to Silicon Valley, not Siliguri, but so what? This syndrome goes further. Red Herring says, "optical networking is in", and that's what every VC wants to do. I believe different: if Red Herring reports it, and VCs want to rush in, it's already passé. VCs hunt in herds: today's stated Indian target is "it-enabled services companies." That, for me, is reason enough to stay miles away from such companies.

The second is the economics of the VC business. These fine ladies and gentlemen want to take good salaries home without too much of a risk. It takes a VC firm with 20 people some Rs 30 lakh a month to live well: Rs 4 crore a year. Now they make this money off a 1.5 per cent fee on the money they've raised. So they need a corpus of $60 million (Rs 250 crore) or more to pay their own bills.

Our friends are wise enough to realise that they can't handle more than 15 companies. Ergo, they need to invest an average of $4 million (Rs 18 crore!) per company. A huge disconnect with what startups really need. (And a huge sign we need more angel-stage investors in the country, not VCs.)

All this extra money goes into the firm's designer decor, business-class tickets, Oberoi dinners, 'market salaries', and high-priced entries to it conferences. Each, to me, is a sure signal of impending failure.

A Marwari friend's dad told me: only by staying stingy do you get rich. I couldn't agree more.

Mahesh Murthy, an angel investor, heads Passionfund. He earlier ran Channel V and, before that, helped launch Yahoo and Amazon at a Valley-based interactive marketing firm. Reach him at Mahesh@passionfund.com.

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