Thursday, December 07, 2006

Deal flow in India and not enough VC in general

Typical deal flow involves a new investor buying out an existing one as part of his investment. If I'm an Angel investor in a company that gets funded by a big VC, the VC will plough a part of the money to buy some of my stock, at the same valuation.

This happens hajaar in the US, but is practically unknown in India. While in the US they are even starting to talk about investors compensating (hold your breath) founders by buying some founder stock when they invest, in India most VCs will balk at even partial exits by prior investors.

Angel funding is only possible if there is a reasonable expectation of exits. In today's market a five year hold is probably the least you can expect to some exit event: M&A or IPO. Angels may have to hold even longer, since they fund the company from seed levels. VCs usually start buying in during year 2 - so they're ok with a three-four year hold. But angels shouldn't be expected to stay in forever - or at least, not with their entire money. VCs must understand the concept of deal flow and how it compensates earlier investors; actually, it's not that they don't understand, but it's a typical financial mentality to say "oh my god, this money won't go to the company, but to make someone else a profit, I won't pay.". That, in my opinion, is being very niggardly.

It can also be a fear psychosis, thinking "Why's this guy exiting?", but the answers to that are obvious. If a VC has done the right amount of due diligence, these questions have already been answered.

And if an angel eventually has like 5% of a company, it's practically too small for any level of control, and with more VCs in, there won't be board presence or even advisory roles for her (the angel). Letting them exit is just a better way to handle things.

But we have smart VCs here now, and I'm sure the negotiation table will start getting more and more open towards deal flows and partial exits.

Without partial exits, Angels will fear to tread into this space, and without Angel funding companies won't even be able to move to the VC level or even come to the VC with an expectation large enough for the deal to make sense. I mean you can go and ask a VC for $2 million today, because that's how much you have bootstrapped a company without funding. But 2 million is too small for most VCs to think about, with the huge liquidity of today. The right angels may have made the company ask for a lot more, and an angel exit alongside means that the VC can put in their minimum quantum (part for the angels, part to the company).

Now for the "entrepreneur" end. Why don't entrepreneurs run to VCs more often?
1) Stupidity: That "small pie big share" is less exciting than "big pie small share" is just not prevalent enough, mainly because everyone wants "big pie big share". If you can pull it off, BigPieBigShare is a great place to be. But to pull it off, you need NonDebtMoney and BigTimeContacts which VCs can get for you, and that means BigPie in less time than TheSpanishInquisition. But yes, SmallerShare. Even I have been guilty of this. Yes, I have been stupid.

2) They're Timid: So many people I know just don't have the balls to stand up and say they're good enough and they deserve it and they've done this. And when you combine "timid" with "to big an ego" it's complicated - first you have someone who's too scared to say "I am good", and when he does, and someone tells him "that's crap", he gets all flustered and unhappy. What you have to be is thick-skinned and frikking confident. And for heaven's sake, don't say "we" when you mean "I".

3) Urban legends and true stories: I've only heard bad things about VCs. Why? Because only the bad stories come out. If founders say they love their VCs and how "strategic" and "compatible" and other such words the VCs are to the business, you only think: "Saala, suck up kar raha hai because he wants more money". The bad stories somehow seem more spicy; there's a book called "BooHoo" which is a cry-baby book about's phenomenal failure after $100 million of funding. Guess who gets blamed.

4) Lack of respect: If VCs don't know your business you are bound to think about why you even bother to talk to them. It's easier to ditch them upfront, because then they will start the fishmarket haggling over silly things and piss you off. But what do you do when 90% of your VC universe is filled with prople who don't know XML from a bar of SOAP. Okay, that's changing. But it's still pretty lousy out there.

Having said that, I believe today does not have to mean tomorrow. Change is essential, and change is happening. In a few years, you will laugh reading this blog post and call it "those days".

1 comment:

Gautam Ghosh said...

KREC Surathkal? Cool !

I came there for a fest in `92, I think. Won third prize in the Just A Min speaking !