Let me begin this article by indicating that the fact that I am in the venture capital business is completely by accident. My career path is more a bunch of step functions than a linear progression. It was a cold call from my former partner Guy Kawasaki that convinced me to transition from a business development role at Mattel to investment banking and eventually venture capital, fields that I knew virtually nothing about. Again, it was complete coincidence that in October, 2006 I happen to sit next to Raj Atluru (partner at DFJ), on the TiE-ISB Connect panel in Hyderabad.
That’s when the conversations began for a potential transition from the US to India culminating in my joining DFJ in June, 2007, exactly eight years to the day after I started my tenure at Garage Technology Ventures (fka Garage.com).
Garage was a $20M seed fund investing primarily in the western United States writing $500k cheques and reserving an equal amount per company. DFJ, on the other hand, is close to a $700M stage agnostic more global fund. Differences between the two funds are many and all of them are of an order of magnitude (size of fund, size of partnership, size of initial investment). At Garage, given the pure seed stage investment criterion, we knew that an exit was going to be 7-8 years away.
The exit expectation at DFJ is closer to 5 years on average. At Garage, there was no choice but to look at companies that could be extremely capital efficient requiring no more than $10-$15M in overall capital, where $1M investment could yield $10M upon exit with an overall goal of turning a $20M overall investment returning $60-70M. DFJ is looking to turn individual $10M investments in companies that could require $50M or more in overall capital, into $100M returns and turn a $700M fund to return over $2B.
It’s relatively easier to find capital efficient deals where a $100M exit can be a phenomenal outcome for a fund like Garage. Investing $1M for a $10M return (assuming a 10% ownership), would be considered fantastic. For DFJ, a $100M enterprise value upon exit would be a non event. Assuming DFJ owned 20% of a company upon exit, and wanted $100M returned to the fund, requires the enterprise value of the company to be $500M. Historical performance of venture funded exits in India doesn’t paint a rosy picture of multiple $500M+ exits within any VC portfolio.
The key to DFJ being excited about India is not what has been, but rather what can be. From a VC perspective, India is where China was perhaps 8-10 years ago, a fairly nascent venture capital landscape with a lot of unknowns and relatively few exits. But then came the multibillion dollar exits like Baidu, Focus Media and others. That same potential is what keeps firms like DFJ bullish on India over the longer term, and continues the migration of Sand Hill Road to Bangalore, Mumbai and Delhi.
The transition from Garage to DFJ has required a mindset reboot. I have had to go from a seed stage tech investor with capital efficiency as a mantra, to thinking much bigger, both in terms of overall investment but more importantly on the overall return to a large DFJ fund. . Take, for example, our cleantech portfolio (which includes 26 companies across three different DFJ funds).
These companies often are the antithesis of capital efficiency requiring tens of millions of dollars or more, but the prospects are creation of multiple billion dollar companies. Investing $30M in a company in that sector has the potential of returning $200M for a net return of $170M makes a $9M return ($10M return on $1M invested) for Garage look like noise.
A combination of a desire to show liquidity sooner, along with diversification into fairly capital intensive sectors, has led many VCs to raise larger funds for late stage investments. As a result, a spotlight has been placed on the question, “where does an entrepreneur go to access seed capital?” It’s a good question, but one that does not have an easy answer, and it’s a dilemma not unique to India. US had the same seed stage gap, and that was precisely the niche that Garage filled. Kudos to funds like Erasmic (now Accel India) and Seed Fund for doing the same in India.
Even though funds have gotten larger, often the fund teams have not grown accordingly. As a result, it is simply not possible for VCs to manage a larger number of early stage investments given the bandwidth required. So, VCs are either moving to later stage completely where the risk is reduced and more capital can be put to work, or doing a combination of a few early stage but primarily late stage investments. DFJ is an early to mid stage investor primarily, but makes opportunistic late stage investments. Interestingly enough, almost all investments made by DFJ in India have been Seed or Series A.
The other aspect of the mindset reboot is to try and prioritize to a certain extent based on $ deployed and ownership in a given company. My personal tendency has been to help all DFJ companies equally irrespective of the investment size and ownership %. That behavior is complete contrary to the role of a portfolio manager, which is what VCs are.
VCs are in business to make returns and be in the top decile of the industry. The way to do that is to make sure one walks away from bad investments sooner, and doubles down on the “winners”. Reality is that many of us in this business tend to spend time trying to revive or turn around the “non performing” investments rather than focusing on potential home runs.
I am still in the early stages of learning what it’s like to be part of a large fund. The fact that a single investment from DFJ can be larger than the entire Garage fund is something that often boggles my mind. But it has also given me a much better understanding of the overall VC value chain from seed to early to mid to growth, as well as challenges and criteria for investment for the various funds.
Often entrepreneurs accuse VCs of become more risk averse and acting more like bankers than risk taking investors which has created icons in the VC industry. The reality is that in most VC portfolios, 1/3 of the investments will be completely written off; 1/3 may return the initial capital or make a little bit; and the remaining 1/3 will be the true performers. I, for one, cannot predict which companies fall in which category from our current portfolio.
Garage and DFJ have both been equally rewarding. Although there are obvious differences in personalities, processes, investment criteria, investment horizons, geographical reach, fund and investment sizes, there is a stark similarity – They have both blessed me with the opportunity to interact, on a daily basis, with passionate entrepreneurs who are much smarter in their respective fields than I can ever hope to be.