Opportunity in adversity

The image of a knife through a butchered pig’s head isn’t a pretty one, but this was the image on the third slide of Sequoia Capital’s presentation to over 100 Chief Executives of investee companies made on October 10 in Silicon Valley. Sequoia is as blue-chip as blue-chip venture capital investors can get— Apple, Google, Paypal, Yahoo!, YouTube, and Idea Cellular (among others) in India, are some of the companies that it has invested in. Its investment of $11 million in YouTube being valued at over $500 million in two years when Google bought the video-sharing site is the stuff of legends.

So, when Sequoia says “R.I.P Good Times”, the venture capital world wakes up and takes notice— even 8,000 km away in Delhi, where, a few days after this presentation, The Indus Entrepreneurs (TiE), a network of entrepreneurs, was holding its annual summit. At a joint round table organised by TiE and Business Today, panellists exuded some amount of confidence, though Baring Capital’s Rahul Bhasin warned that the bad times were far from over. The following days proved Bhasin right as global stock indices crashed and the venture capital market went into a tailspin.

Changed environment
That the investment environment has changed the unstated balance of power between venture capital funds and those needing funding is beyond question. Avnish Bajaj, Co-founder & MD, Matrix Partners, a VC firm, recounts how, nine months ago, when Matrix was scouting for a suitable investment opportunity, it zeroed in on a company requiring early growth stage equity. Bajaj and his colleagues tried calling the promoter, who did not take the calls, and left mails that went unanswered. “All we got was 10 minutes with the finance head for which I flew down and we were interrupted at least five times in that period,” he says. Cut to October 2008 and the scenario was completely different.

That same promoter called up to schedule a meeting where he spent two-and-a-half hours with Bajaj’s team; the finance head spent twice that amount of time. The deal, however, did not materialise due to the deteriorating fundamentals of the business in which the company operates.

If this sounds drastic, then more of the same is in evidence on the valuation front. There is realism in the air now, especially in the private equity markets. However, for venture capital, cheap valuations were never the big driver for deals. “We make money because there are great outcomes. While nobody minds lower valuations, it is not a big concern for us,” says Alok Mittal, MD, Canaan Partners.

Trouble spots
According to the veterans you are in trouble if…

• There have been substantial misses on capital calls at VCs supporting you
• You are not cash flow-positive
• You have not figured out your business model
• You are waiting to get second or third round funding

Road to salvation
• Be conservative on:
Spending
Growth assumptions
Earnings assumptions
• Focus on quality and on customers
• Lower risk

Cash is king
The worst hit will be the marginal companies and those that aren’t yet generating revenues. Kiran Konduri, Co-founder, askLaila, a local search firm based in Bangalore, which raised $12 million (Rs 60 crore at current rates) last year and now is adequately funded for the next couple of years, believes that entrepreneurs without a clearly defined path to revenue will face major problems in finding money. “The truth is that it is hell out there. There were a lot of marginal businesses in several sectors that got funded over the past few years. Today, the problem is that even businesses that have a decent idea and show good revenue potential may not get funding,” he says.

Apoorva Ruparel is one such entrepreneur. The Co-founder of AirMe, a Bangalore-based firm that has developed a mobile photography application, has given up. “We went to 15-16 top-notch venture firms, and while many of them said: ‘great idea’, none of them was willing to put in money.” He adds that several other firms are desperately hunting for funds across the country.

“If you are an unfunded start-up, or a funded one that is bleeding money, you will find it increasingly difficult to survive,” says Sanjeev Bikhchandani, Chief Executive Officer, InfoEdge, which operates the popular job portal Naukri.com. “This is not about the survival of the fittest or the survival of the firm with the best idea or technology,” says P.V. Sahad, Editor, VCCircle.com, a popular website that tracks the industry. “Today, it is all about the survival of the richest.”

In other words, cash is king; and only those that have it can expect to pull through. “The simple plan for survival in today’s environment is revenue, revenue and revenue. If you have an esoteric business plan with revenues due three years later, then change it. Build a sales organisation to get revenues today,” Bikhchandani says.

The long road
K.P. Balraj, MD, Sequoia Capital, feels the financing environment will remain extremely difficult for the see several funds and companies close down due to lack of access to capital. According to our estimates, over 50 per cent of Indiafocussed venture funds shut down or exited the business in the last downturn. A repeat of that trend will have a significant negative impact on start-ups and companies currently in the market for VC financing,” he says.

Sahad concurs. “Venture funds will find it increasingly difficult to raise money; the large pension funds in the US and the large companies that contributed to new funds have seen their cash reserves decline. At the same time, the exit route—via the IPO route—has dried up,” he says.

The current environment is probably the worst in terms of investor sentiment, and Balraj says it feels as bad as the 1997 Asian currency crisis.

“The environment is clearly not conducive to trade sales or IPO exits. Our sense is that many IPOs will get pushed to 2009 or 2010. In our India portfolio, I expect SKS, Indecomm, Applabs, Coffee Day, Bharti Telesoft, Carzonrent, Tutorvista and others to look at IPOs in 2009 or 2010,” he adds.

In any case, VCs are known for their “patient capital” so the risk of delayed exit is clearly a known one. But the coming shakeout may actually provide some companies to get into acquisition mode.

A survivor of the 2000-01 meltdown, InfoEdge, which is now a listed company with cash in the bank, may actually become a white knight for distressed entrepreneurs and investors. “The right asset at the right price,” Bikhchandani jokes, before adding seriously: “For someone like us, the price will be better in six months than it is today.” Adds a Microsoft India spokesperson: “We take a long-term approach to our business growth. As always, if and when an acquisition option makes sense for our business, we will evaluate it.” Jay Vikram Bakshi, Chief Executive Officer, Digiqom, a public affairs consultancy firm, which also advises VC firms, believes that times are as bad as in 2001. “The “drag along” clause, which VCs incorporate in agreements with investee companies to force them to sell out under some conditions, will pose problems for entrepreneurs,” he says. This is already happening. Adds Sahad: “At least two large online travel agencies and one large Internet firm are on the block, thanks to investors.” However, with some entrepreneurs still demanding high valuations and people like Bikhchandani not willing to pay exaggerated valuations, there has been little activity other than a lot of meetings.

It Isn’t all gloom and doom
Not all investors are, however, worried. Arvind Sodhani, President, Intel Capital, wrote an email to all investee companies saying: “…We invested in your company because you demonstrated a compelling value proposition that should be attractive to customers even during a downturn. History does repeat itself and we learnt from history that great technologies and products will win in an economic downturn. Innovation does not stop during slowdowns…” Amitabh Saran, Founder & Chief Executive Officer, BuzzInTown, a local listings website in which Intel Capital invested earlier this year, says Sodhani’s letter left him in good spirits. “Times are tough and some of the emails from venture capital firms doing the rounds have a very negative tone. This email, on the other hand, was very uplifting and re-affirmed the company’s faith in us.” Bikhchandani says the biggest reason for his survival (through the previous meltdown), was his commitment. The committed entrepreneur will come out of the crisis stronger than before because those who were in this only for valuations will drop out of the game. Adds Mittal: “I do not think it is doomsday. Good businesses will still get funded. And the India story remains strong and secular.”

That is evident from some recent announcements. Bangalore-based mobile value technology provider TeleDNA Communications recently raised $10 million (Rs 50 crore) from the Mauritius-based Peepul Capital. Sure, some of TeleDNA’s business plans over the next few months have been hit by the news of the expected downturn, but that has been offset more than adequately. “We will get our new facility at a lower cost than our existing one. Moreover, we can now get new people on board at much better (lower) salaries,” says Praveen Nallapothula, MD & CEO TeleDNA, who is planning to hire about 50 people.

Then, SKS Microfinance, a leading MFI, and parabanking services firm Manappuram Finance, both companies in which Sequoia has invested, have raised $75 million (Rs 375 crore) and $30 million (Rs 150 crore), respectively, proving that it is, indeed, still a market for good companies. “But entrepreneurs will have to be prepared for much longer fund-raising cycles and lower valuations, given that the equity markets have corrected by 60 per cent or more,” says Balraj.

Sequoia, incidentally, doesn’t expect its pace of investments to change. With $2 billion (Rs 10,000 crore) capital dedicated to the Indian market, it is, by far, the largest VC in India. “Generally, we invest in 5-10 companies every year through our VC funds, and in 5-8 larger companies through our growth and private equity funds, I do not anticipate our investment pace to change. We are long-term, patient investors and generally take a 5-7 year view on investments,” says the Sequoia MD.

Microsoft, which has a global programme, BizSpark, to help entrepreneurs and early-stage startups, adds that though the VC community is cautious, it is still looking out for investments in the right companies. “The best thing to happen to the India IT ecosystem is the proliferation of start-ups. It has expanded the industry portfolio and we believe this trend will fuel further growth in domestic IP consumption. According to the NASSCOM Product Study 2008, these start-ups have the potential to contribute up to $4 billion (Rs 20,000 crore) to the domestic IP pie over the next five to seven years; and from what we’ve seen, VCs recognise this,” the Microsoft spokesperson adds.

The Importance of plan B
“There is need for Plan B—what if funding does not happen? But then, that is equally true in good times,” says Canaan’s Mittal. Thus, it is important to work out the scenario in terms of the revenue cycle and cash flow management.

Hence, business continues, but not as usual. VCs are increasingly focussed on their existing portfolios, while entrepreneurs are reviewing their cost structures, keeping an eagle eye on the impact of the slowdown on their customers. “We are also working with our portfolio companies to help them postpone fund-raising or achieve cash breakeven earlier (than planned),” adds Mittal.

“There is good money and there is bad money,” says Sodhani, somewhat philosophically. “While times are difficult for venture firms, I do not believe that good money will go away anytime soon.” And, as Mittal says, that means it may actually be a great time to launch a new business as the competitive risk is quite low. The bottom line: Everybody will need to make sacrifices to survive. At the end of the day, as they say, it’s all about money, honey!