The Larger Question of EXIT

Date:   Monday , October 01, 2012

A venture firm that has just celebrated its 25th year, Canaan Partners is an early stage investment firm with $3.5 billion under management, investing in technology and healthcare companies. It has just raised its ninth fund of $600 million. Till date, Canaan has invested in over 250 companies with more than 135 successful exits. The investment capability of the firm ranges from $1million to $20 million. Rahul Khanna is the Managing Director of Canaan India and manages the firms investments in companies like Naaptol, Loyalty Rewardz and Equitas. He has over 15 years of investing and operating experience in ICT across India and U.S. Prior to joining Canaan India, Rahul was the founding director of Clearstone Venture Advisors where he was responsible for building the platform that would focus on early stage investments in India. He has an MBA from The Kellogg Graduate School of Management.

Focus on Investment Portfolio

Our philosophy is to be an early and active investor and involve in building the business, and at the right time when the company is ready for exit then we step out of the company. For us our focus continues to be investment in $2-5 million range and hopefully continue to invest in those companies through multiple rounds to hold our ownership level.

About 2/3rd of our fund is targeted at technology or IT, 1/3 at healthcare. However in India, our focus is largely on technology. We may consider healthcare in two grounds, i.e., healthcare and IT or healthcare and financial services.

The Current Trends

The consumer Internet space offers two areas for potential growth. From a transaction model point of view, the focus is ecommerce which is getting more specialized. Different models will emerge to service vertical and horizontal markets. We are excited about the fact that consumers are willing to spend provided that you demonstrate the value, show them range or flexibility that they typically donít find in physical stores.

On non-commerce side, people are going to consume more content on their phone or laptops, whether it is entertainment content or where they lack proper delivery system like education, healthcare and financial services content.

Mobile advertising is going to be a huge opportunity. The phone has significantly higher engagement to click to call, click to coupon, click to navigation making the medium much richer from an engagement perspective.

Investment Changes Post Recession

Technology sector has been impacted by recession. There has been period of uncertainty, volatility and the equity markets have not necessarily performed as well. The industry as a whole is largely dealing with the questions of exit. We have seen few companies that have lined up plans to go public but due to lack of either comfort around valuations or the fact that they were dealing with the volatile market decided to not go IPO.

The challenge is less on the investing side. We continue to see lot of innovation and growth. But are the Indian public markets willing to reward new concepts like Justdial or One97? We still have not seen such companies going public and with limited domestic comparables, itís still early to say what will happen when these new age companies go public.

Secrets India should Adopt to Compete with U.S.

In India, there will be an interesting tipping point for several small companies when the big companies start to appreciate the level of innovation that can be bought versus the level of innovation that needs to be made, which is the case in the U.S.

In some point SMEs will start investing in technology much more than they are doing today. That will be function of wanting to increase efficiency and productivity and with more and more software available on the cloud, there is going to be incredible opportunities for small organizations.

Lack of Acquisitions in India

There is a tremendous amount of M&A activities happening among small and midsized companies in the U.S. Unfortunately, in India we have not seen large technology companies acquiring the smaller one because often time there is a sense that the revenues are not on scale or the technology can be recreated in-house. There is a big gap in the small and midsized exits. The challenge is creating companies that end up being quite large to exit which is not the case in U.S.

The other fact of the matter is that most Indian tech companies that scale are still largely in the services business and so their focus continues to be around market expansion, adding more vertical capabilities.

Advice for Early Stage Entrepreneurs

We have seen two types of companies. One who is U.S. focused and builds products that will be served online to customers abroad. My advice is, make sure that you truly understand the competitive landscape. Sitting in India, it is very hard to realize how many people are harnessing the same opportunity.

Over the period of time, such business requires to have one foot in U.S. and one in India. Understanding the U.S. and European market, understanding how people buy, what are the buying cycles, how budgets gets created and allocated is a priority.

The other set of companies are the ones going for the Indian market. These companies should make sure that what they focus on have large enough opportunities as just solving a small piece of the puzzle are not going to make a large company. If we cannot see you becoming a large company, we cannot invest in you.

Factors Measured When Investing

Ours is a stage specific, but we put a lot of emphasis on the team; the DNA of the team, the prior experiences that they have, what is their insight to the market they are going after now, what is their ability to build an organization around them, and is this the team that can take the company to a critical scale.

Secondly, is there a mega trend that the company is riding? Finding a trend, whether it is the adoption of smartphones in emerging markets or the rise of electronic payments creates the momentum that is required to help scale companies at an accelerated pace.

The third would be some of the underlying dynamics around business, which is what the margins around the business are, therefore what the multiples would be, is it an exciting category from exit perspective, is it an opportunity to take a company public to get to scale or just a company where we can see trade sales happening?

Initiatives to Encourage IPO Ecosystem in India

The U.S. investor community has started to develop a much better understanding of the Indian technology and media landscape. There are lots of global investment banks that actually do cover India that have started spending more time in India educating their local partners on how technology related investments have played out in the west. There is a lot of knowledge building going on and lot of appetite for listing Indian technology companies from overseas investors for potential long term.

On the other side, the fact remains that taking a company public in India requires a significant track record of profitability and that may not change as it is a regulatory requirement and protects small shareholders.

People are choosing to incorporate companies that have a cross border angle outside of India. People are exploring, incorporating companies in Singapore or Mauritius, which makes it easier to list the company offshore. One of the things that we look at is how much of this company's business is in India and outside. If there is a significant enough portion that going to come from international business, then we try to incorporate it outside India, allowing for direct NASDAQ listing as opposed to if a company is incorporate in India, where first it has to list in India, then only it can list outside.

Being an investor, we also watch for a space for secondary investors who would like to come in and take our ownership if the company does not go public.

Priority and Road map

One of our priorities is to continue to make new investments. A third of our time is spent looking at new opportunities, another third of our time is spent managing our portfolio as we already have more than 10 companies in our portfolio in India and help them take to the next stage. The last third of our time is spent on developing the ecosystem which means being actively involved with industry bodies and new initiatives whether it is to do with incubators or accelerators or grassroots level activity. We are also trying to do a lot of work in education space around entrepreneurship and venture, helping different angel bodies. That is probably the best articulation on how we think about our business.

(As told to Anamika Sahu)