With most traditional exit routes blocked, VCs look to innovative measures to optimise their returns.

By Ashutosh Sinha

First, the facts: in January, Intel Capital divested its 4 per cent stake in Rediff.com to Warburg Pincus; in March, venture capital firm eVentures found a buyer for its stake in tech-community site netpilgrim.com; and a few weeks later, the same veecee midwifed the merger of Delhi-based NetAcross and the Singapore-based xchange21, both companies that operate in the e-consulting domain.

"Partnership is the best strategy in a suppliers' market" MANISH MODI, Chief Executive, NetAcross

This isn't about venture capitalists playing God. Nor is it about mergers necessitated by market forces. This trend-we've given you three instances, haven't we-is all about tired venture capital firms pulling out all stops in an effort to maximise the value of their holdings, maybe as a run up to the exit-process. If the word exit appears strange when used in the veecee context, let's elaborate: the only way venture capital firms can pay back their investors is by exiting the companies in which they've invested at the appropriate time. In mature markets, this happens by way of an IPO, but if a public issue isn't possible, then they have to think of alternate exit routes. Neeraj Bhargava, the partner of eVentures downplays the exit aspect. ''A common veecee can act as a catalyst'', is all he will say.

Another venture capitalist, Pravin Gandhi of Infinity Ventures is more forthright. Commenting on the Intel-Warburg deal, he says: ''This wasn't something that happened earlier, but we will see more of such deals now''. In its purest form this kind of veecee play will take the form of swaps. One venture capital firm, with investments in a particular vertical segment, may trade holdings with another with, say, investments in a specific geography. Experience has shown that a focused strategy may stand venture capital firms in good stead. If new economy mouthpiece Red Herring calls Vinod Khosla of KPCB the ''best venture capitalist on the planet'', it's probably because all the man's picks, like Cerent, Siara Networks, and Lightera have been in the networking technologies space.

Swapping isn't unknown in other markets. With the IPO market drying up in the US and the veecee learning curve becoming steeper, swapping is certain to become a far more common phenomenon.

In some cases, a merger may preclude the reason for swapping: a merged entity could find it easier, on the strength of size and stronger cash flows, to go for an IPO. ''Moving towards exit through listing is certainly a primary reason for such consolidation,'' admits N. Subramaniam of Barings Equity Partners. Subbu, as he insists he be called, drove the Mphasis-BFL merger. On their own, each of the merging companies would have taken longer to list.

"A Common VC can act as a catalyst in mergers" NEERAJ BHARGAVA, partner, e-ventures

Mergers are a-click-a-dozen in the international domain. Those of Pacific Century Cyber Works and Hong Kong Telecom; Healtheon Corp, Webmd (online health information and services) and Medcast (health industry news provider) have shown the way things fall. There's no denying the merits of merging two floundering or middling companies: a merger is the easiest way to cut infrastructure- and working capital-costs. ''Consolidation has a strong financial logic,'' says Nikhil Nath, a Partner at incubator Antfactory. ''If you can create a viable entity by consolidation, it makes great sense''. In many cases, consolidation works by simply reducing the number of players in an already crowded segment. Better still, the merged entity, with the combined resources of two former competitors, has a greater chance of making it. Indeed, that seems to have been the driving logic behind the mergers of smartbahu.com and icleo.com, both women-centric portals, in June 2000, and planetcustomer.com and productorium.com in July 2000. If some of these deals haven't had the desired results, says Hetal Gandhi, the CEO of IL&FS Venture Capital, that's because the logic to come together wasn't very strong in the first place. ''Some dotcom deals are happening in desperation''.

The perfect way to effect a merger would be to assess the relative strengths and weaknesses of the two merging entities. There was compelling cause for the BFL-Mphasis merger says Subbu because ''we had over 25 compelling synergies where the two companies could complement each other.'' In the case of NetAcross and xchange 21, this complementarity is geographical in nature; the former has a dominant presence in India, and the latter in South East Asia. ''The best strategy in a suppliers market is partnership, not competition'', says Manish Modi, the Chief Executive of NetAcross.

Venture capital firms may sometimes drive mergers simply because the broader service portfolio of the merged entity, or the diverse domains in which it operates helps de-risk the business. That was perhaps the reason for veecee Global Technology Venture's decision to press for the merger of two companies in which it had invested: Karna Technologies, which operated in the e-commerce space and Global Edge, which worked in the wireless telecom domain. ''It's a question of size and range, especially if you are in the tech services business,'' says Gandhi of Infinity.

From the veecee-perspective swaps and mergers make great business sense, but the companies being traded or forced to merge would do well to look at things a little more carefully. As long as it is the agenda of the investors that's driving consolidation, warns the CEO of one dotcom, ''companies better watch out''.
  

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