Early last week a venture capitalist in Bangalore remarked to me: “I’m a bit concerned that our limited partners have not given us any kind of direction. We’ve heard of other firms in the US having annual meetings with their limited partners and being told to be cautious. Ours have not even said let’s set up a call and talk. I’m wondering whether that is good or bad.” We were chatting about whether limited partners, a high net worth and secretive community of individuals and institutions which lend money to venture capital funds, had been delaying the release of committed capital because of the US recession. More than 90 per cent of India’s venture capital money comes from the US, notably from Silicon Valley.
A couple of weeks ago, while working on a story (on the day job) on whether India’s private equity industry will remain flush with capital in the next 12-18 months, I came into closer contact with limited partners from across the US and Europe. The conclusion, in that story, was that limited partners themselves are scrambling to hold on to whatever money they have left and this means that 2009 will see the private equity industry strapped for cash. Read more about who exactly limited partners are and how their woes could trip India’s private equity party in an Outlook Business story here.
Venture capital is a smaller subset of private equity, chiefly in terms of the quantum of money involved. But if private equity gets squeezed, the same is inevitable in venture capital. They often share the same limited partners. The Silicon Valley is already in the throes of an acute funds crunch – earlier post — and India cannot escape getting scarred. So, not surprisingly, my friend in Bangalore is one of several venture capitalists in India today who are keeping close tabs on their limited partners.
In the next six months if you’re a startup in the market to raise Series A or B funding, chances are you’re in for a bit of a fight. From what I’ve gathered talking to six leading venture capitalists this week, limited partners have already become tighter with ‘draw downs’ — the term used for capital that is released to a venture capital fund when a deal is being finalized (a venture capital firm may raise a $100 million fund, but it gets the actual money on a deal-by-deal basis). If cutting a deal in 2007 took a couple of months, be prepared for a 3-6 month wait now. And even at the end of six months you may still not raise any money.
Based on what these six investors told me about their investment outlook for 2009, here are a few pointers on how venture capitalists will behave next year:
Gunning for Growth: Venture capitalists will move more towards later stage deals in more mature companies. The rewards are lower but so are the risks. This will help them to balance the imminent losses many are bound to suffer because of the scores of me-too investments in early-stage startups in 2007 and 2008.
Conserve Cash: Funds who raised money mid last year or early this year will sit on the cash till around June-July. Two reasons. One, they will wait for their limited partners to stabilize their own resources. Two, as the funding environment gets tougher, less resilient startups will shut shop and the really good ones will become easier to identify. That means better quality deals and at reasonable valuations.
Less for More: Investors will demand higher stakes but will fork out less money. If a 10 per cent stake was worth $2 million last year, now it will be worth $1 million.
Scale is King: Good ideas will be evaluated on the basis of their ability to scale and show high market impact. Businesses that don’t have easily identifiable mass usage markets are out. If you can’t explain to the investor how your idea will affect the lives of many hundreds of thousands of consumers and therefore earn him 7-10 times his money, don’t bother starting up.
Middle Class Values: Venture capitalists are looking for experienced entrepreneurs or serial entrepreneurs and folks who have senior level operating backgrounds in established companies. And they prefer entrepreneurs from classic middle class backgrounds — folks who don’t need a fancy corner office, are ready to roll up their sleeves and work hard and, most importantly, know how to stretch resources.
Is that depressing? The silver lining is that most of these venture capitalists are equally sure that they will continue to invest in young startups. You just need to get the chemistry right.
