Saturday, September 1, 2001
Draper, an original Silicon Valley venture capitalist of the 1960s, took his legendary VC expertise and a $55 million fund (Draper International) to India in 1995. He hoped for investment success in India’s technology sector, with the help of partner Robin Richards. That fund is closed now, after six years of work and constant travel between the U.S. and India. The fund’s close has ended an important first chapter in the development of technology venture capital in India.
But how far has VC in India come?
The Draper International fund was unique, given Draper’s background and the fund’s pioneering entry into the Indian market. It was also very, perhaps surprisingly, successful. The result? Any of the growing numbers of ambitious individuals who want to invest in India and Indian companies must make the dutiful pilgrimage to Draper and Richards.
“We were the first,” Draper explains. But he and Richards were hardly careless and haphazard in their initial approach. They studied China, Indonesia, and Vietnam before settling on India predominantly. After all, Draper had experience in software. And, they felt, doing deals in anything but English would prove too difficult. They raised $15 million in equity mostly from individuals. They were able to add $40 million in debt at treasury rates from the Overseas Private Investment Corporation (OPIC), a government body. This meant that if limited partners were investing only $15 million, their investment, in fact, took on the characteristics of a $55 million fund. The odds, in short, were stacked in favor of high returns. And Draper International has returned more than 120 percent. Not bad.
A Foot in Two Continents
Being a VC in India often invokes exciting images of trailblazers running around the IITs, and through Hyderabad, Pune, and Bangalore, launching fast-growing startups. But the realities on the ground are far from simple. Venture capital in India presents challenges that would make the average Sand Hill Road investor pack up and go home. Draper and Richards are the first to point this out. Investing in India is not for the fainthearted.
“All I can say is that our companies would spend two days getting their water turned on,” says Richards, who was graduating from Stanford Business School and had just written a thesis on international venture capital when Draper recruited her to be his partner in 1995.
The new partnership at first looked at investing in and setting up Indian companies. They found two partners in India to work with the generally inexperienced entrepreneurs that they found. But what became clear quite quickly, it seems, is that setting up software product companies in India wasn’t exactly going to work. The technology and creativity could be located in India, but for any company to survive and thrive it would need to base its business, marketing, and sales operations near the action — in the U.S.
“Our guys would take us to a product company in Bangalore or Pune and we would try for the first six months to make a go of it over there. And then we quickly realized that we had to take the whole thing to the U.S.,” Richards recalls.
Of the companies that Draper International invested in, the majority were, or became, U.S.-based firms with a large proportion of their operations in India. Some firms, like Unimobile (formerly Gray Cell), were discovered in India and brought over to Silicon Valley. Others were already based in the U.S. when Draper invested.
In fact, the two partners would often discover deals in India for companies that were already based in the U.S. Says Richards, “You could be sitting in Bangalore and hear about 10 great deals in Santa Clara that you could be a VC investor in, but you’d hear about them first in Bangalore.” This became the model that Draper International keyed into. They chose to profit from the cost savings and technological strength of an India-U.S. nexus, while making sure that their companies grew to liquidity on the fertile ground of Silicon Valley. In fact of those based in India, only recently-troubled Rediff was a success on a Silicon Valley scale.
For the U.S.-based companies the hits just kept on coming. Notably, Prio was acquired by Infospace, Selectica went public, Ramp Networks was sold to Nokia after it went public, and Torrent was sold to Ericsson. Almost all of Draper International’s U.S.-based portfolio has found liquidity.
Investments in India provided unique obstacles. The concept of preferred equity didn’t exist in India; neither did stock option plans. Draper and Richards had to try to manipulate legal issues and set up common stock so that it would act like preferred stock. Draper International was the initial investor in Rediff.com, but when Rediff went public on Nasdaq, the fund was only allowed to trade the company’s stock on the Bombay Stock Exchange, because the investment had been made in India. In almost every way, doing business in India meant obstacles not familiar to U.S. venture investors.
Says Draper, “When the Indian government makes it a lot easier to incorporate or set up, then we’ll incorporate in India. They still make it too difficult.” But he also points out that progress since 1995 has been tremendous, and ultimately praises the current government for its role.
Venture Outlook
So what will happen now? Draper and Richards were ahead of the curve, but they’ve been followed by a number of much less experienced VCs. Funds like Chrysalis Capital raised several hundred million dollars on the promise of India as a brave new world of high-tech, and lost their shirts on foolish dot-com investments. U.S. investors in Chrysalis may never send money to India again, and more experienced VCs may thus find it harder to raise big funds. Softbank and News Corp tied up to found eVentures India, but that experiment seems to have been voluntarily scaled back.
Even Robin Richards admits that Draper International owes some of its success to perfect timing. “We were a moment in time,” she says. “You could have invested in Israel or anywhere in ’95 and ’96 and done very well.”
As funds like Chrysalis try to salvage their hurting operations and their credibility by investing in IT services and remote services firms, many questions continue to surround venture capital investment in India. Some smart money is going in. Indo-Ocean Chase Ventures and TDICICI were early movers with Draper International, and even co-invested in some of Draper’s deals. Intel Capital has been working solidly in India for several years.
Some newer entrants seem poised to have an impact. Som Das and K.B. Chandrasekhar are investing through e4e, Connect Capital, WestBridge Capital, Artiman Ventures and other serious funds are emerging. But the fundamental problem of building product companies, which are the bread and butter of VCs looking for rapid and large upside, still remains to be solved if India is to have its own Sand Hill Road.
Draper thinks it will happen some day, but admits, “that will be a while still.” Newer India-focused funds have become active investors in services companies, like call center businesses, believing that an investment in a services model can bring enough added value to beat heavy competition and provide a return. But a call center will never provide the upside that a product company can. And traditional IT services firms only become huge success stories when they organically grow to a certain critical mass. Infosys took more than two decades to build — not exactly the kind of investment VCs are going to make their living on.
Nevertheless, both Draper and Richards are optimistic. Richards says the emerging crop of Indian VCs will “make good deals and in the long run they’ll make money from those deals.” It’s clear, however, that there will be uncertain times ahead for the Indian VC industry, given that even the Sand Hill Road gang’s success rates and prospects have shrunk in the last year.
The proof will be in the returns. For now, the most successful will no doubt follow the model of finding talent in India and setting up the business in the U.S., while a bulk of employees remain in India to save on costs.
Draper recalls the early days of Silicon Valley, when Tommy Davis and Art Rock, and later Kleiner and Perkins, were on the cutting edge. “We would share deals,” Draper remembers. “We’d each take 20 percent, or Kleiner would find a deal and come to us and charge a little more, and we’d do the same thing with them.” How does Bangalore today compare with Silicon Valley in the early days?
Draper credits Stanford University with a major role in Silicon Valley’s success, and thinks that technology hotbeds and ecosystems will increasingly crop up around the IITs. “You’ll also see spin-offs from Microsoft in Hyderabad, or Wipro,” says Draper. “Before ten years you will see a really great non-services company come out of India.”
We’ll see if that happens. But Draper’s decision to go into India six years ago has ensured his place as a recognized pioneer on two continents. Draper International may have closed its fund, but the VC road to India still goes through Draper’s office. Despite progress on many levels, the road ahead may prove more challenging than it did in 1995.
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