I nod sagely.
They continue: Wish I’d taken money when it was available a year ago. And then they follow it up with tales. Like Uday Kotak, who turned down a $20 million valuation for one of his companies because it was too low, and then was forced to sell the firm for one rupee four months later. Tales are legion; everyone has one. They end by saying, “The country’s screwed if we can’t get more money in.”
At that point I disagree.
My issue is not that there’s too little money. It’s that there was too much damn money in the first place — and that screwed all of us up in India. You gave us the money — Thank you very much for it! — but we didn’t know what to do with it.
The most glaring demonstration was in a press release I came across a few weeks ago. A VC firm was “to invest in listed company at twice the market price.” This was presented as a feat of vision, bold strategy, and derring-do. While it may be all of that in some parallel universe, mutual fund managers and private equity people to whom I spoke were scratching their heads. They are used to doing private placements at a discount, not at a premium, especially in this market. Other VCs wondered what a VC was doing in the secondary — no, tertiary — market. If we wanted the stock so badly, why didn’t we just buy it in the open market and save our investors some money?
Why have VCs come to this point? You’ve probably heard that virtually every VC in India has moved away from early-stage and first-round investing. Now they say they’re only interested in companies that need a minimum of $5 million. This may seem reasonable in the U.S., but let’s do the math for India.
$5 million is about Rs. 24 crores. To invest Rs. 24 crores, I’ve got to value a company at a minimum of Rs. 70 to Rs. 100 crores, post. And the only way I can justify a value of Rs. 70 crores today is to look at a decent multiple of revenues. Even an outrageously high 10X will require revenues of Rs. 7 crores.
A company doing Rs. 7 crores in India — that’s probably a current run rate of Rs. 1 crore a month — will likely already have about a hundred people and be profitable. There is no other way it could have come that far: internal accruals would have been the only route. And typically, the only companies that can show these characteristics are IT services companies.
So, even at what might seem a piddling $5 million level, VCs are investing in medium-size, profitable IT services companies that are largely indistinguishable and may likely be body-shoppers or call centers. These aren’t the kind of firms that need the money to develop some new technology or market. (Which is what I thought VCs were all about, but then maybe I’m wrong).
What’s the best we can hope for these mid-size companies? That they grow up, merge, go public, grow to 8,000 people like Scient or Viant or MarchFirst and then fall apart? IT services firms are anathema for investors in the U.S., even our own golden boy Infosys is going through tough times. But that’s what we’re throwing our money at. Maybe somebody knows something I don’t.
Do Indian economics for India, not U.S. dollar economics. Indian salaries are in the thousands of rupees, not dollars. A startup here needs at most about US$200,000 to survive, revenue-free, for eighteen months. So, when we gave them all $2 million a year or two ago, everybody bought cars and homes and paid themselves U.S. dollar salaries. We all got burned. So, we moved upstream to $5 million-plus levels of funding. But I fear we’ll get burned here, too. Only worse.
The answer is not to throw more money at the problem, but less. Companies that need Rs. 20 crores that are already profitable can find money in the market. That’s where mutual and private equity funds roam. What expertise are you adding here?
Yes, you can do startups in India, but could you first please give us your expertise at starting technology companies? Fund managers who run VC firms here don’t have it. Second, can you please come with less money? A million dollars will start you five companies here.
What’s my prognosis? Do we need large VC funds here? Maybe, but certainly not to do what they’re doing now: stock market punting aimed at quick exits. What’s their role? I have a few ideas and will talk about them in a future article. Do we need angel and startup-level funds? Yes, desperately. But not at a Valley-like $2 million per company. Try one-tenth of that, but bring with it Valley-like levels of advice.
Mahesh Murthy is principal at Passionfund, one of India’s few early-stage investors.
si
