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Jolly's Volley: The Case For A New Investment Bank

09 September, 2011

I recently met a couple of sharp investment bankers who have moved from the USA to India, chasing the same growth story that has brought tens of thousands (including yours truly) back to the motherland. Their intent is to set up another boutique advisory firm focused on fundraising, possibly M&A, etc. etc. It got me thinking a bit about how the new breed of repats can truly help the Indian venture ecosystem, which has led to this particular piece for your collective enjoyment…

As the VC ecosystem has developed and the deal flow/deal closure rate has accelerated (by the way, there are many deals done which are simply never announced), it has created a need for a new service provider, but one that VCs are probably not all that comfortable talking about. As Cheech and Chong once said in an Oscar-winning, gripping docudrama, “Let me splain.”

Currently, there are probably 15-20 early-to-mid-stage venture firms in the country (the actual number may be higher, given the new funds which have been/are being created). Each firm has somewhere between 10-30 investments now (some are well north of that number). If we assume 20 as the median, there are probably somewhere around 400 early-to-mid-stage Indian venture-funded investments at this point, and clearly, the number will rise significantly over time as new funds enter India, and existing VCs raise additional funds (and there are several out there, speaking with LPs right now).

If we assume that there will obviously be syndication and double-counting, the actual number of unique investees is probably 200-250 in India. Given the nature of the VC business, there will be some rock stars, some in the middle and some that will fail. Although I haven’t done the historical analysis, my gut says that roughly 25 per cent of a given portfolio ends up in the ‘duds’ category, 50-60 per cent are somewhere in the middle and 15-25 per cent are at the high end. And the 25 per cent at the bottom usually suck up 50 per cent or more of the VC’s bandwidth. So, think about it.

Roughly, half of the partners’ time often goes into reviving the dying and turning a zero into a 1x, rather than focusing on the rock stars or those in the ‘amorphous middle’ who can potentially be pushed from a 1x to 5x-10x or more. So, logically it doesn’t make sense to be spending the time and energy on the challenged companies. But in practice, whether it’s driven by ‘this is my baby’ emotion or ‘I don’t want to a have a complete write-off in my portfolio’ or ‘I think, with the right team, right astrological signs, vaastu compliance and a small miracle, we can turn this into a homerun,’ the time and bandwidth sink continues. If we take the 200-250 company number (and assume rightly that the number will continue to rise), then the 25 per cent rule would suggest that around 50-70 companies in the current group will simply not make it, and some have already hit that end.

In the USA, the above is a given, well-understood and there are fairly straightforward processes in place to make sure that in the risky business of start-ups and venture investing, companies which are not going to make it, have a relatively straightforward end of life, liquidation, winding down, etc. In India, that particular process of winding down a company is nothing short of a nightmare. With close to 30 known (and several unknown) steps, and a timeline from 18-36 months, shutting a company down in India might actually be harder than making a company successful. I often share this with our current portfolio CEOs and indicate to them that if nothing else, the Indian wind-down process itself should be a significant deterrent to make sure that they do everything possible to avoid that situation.

There are a few of our VC brethren who have gone through the painful process and, for obvious reasons, have not publicised it. Virtually, everyone in the early-stage VC business is bound to go through the above (there may be an exception or two who are lucky, brilliant and actually an incarnation, or pretending to be one, of the Almighty Himself, who may avoid it). But the agony of dealing with the bottom 25 per cent far overshadows (in real and emotional terms), the delight of the rock stars.

As a result, with the critical mass of investee companies, India is now ready for a new kind of investment bank with a very different mindset – one that focuses not on the top 25 per cent of a VC’s portfolio and tries to get them tens of millions of dollars at ridiculous valuations, but one that focuses on the bottom 25 per cent and actually diminishes or eliminates the agony for which firms and partners will be willing to pay happily.

Essentially, the set of bankers should put together a crack team with lawyers and accountants to come with a strong overall proposal to VCs and say basically, “Give us your non-performers and we will figure out whether they should be turned around, sold or shut down. And we will take care of any or all of the options, for a fee, of course.”

The struggle that VCs often have is similar to what entrepreneurs face, especially in India. There seems to be a stigma associated with failure, which will evolve over time. VCs have to realise (and it took me a long time) that we are in the business of portfolio management, with a mandate to minimise emotional attachment to and maximise returns from our investments. And the sooner we realise that a company is simply not going to perform and will struggle and, as such, should either be packaged and sold or shut down, the better off we will be and quite honestly, the entrepreneur and the team will be.

As a rule of thumb, every company should do a brutally honest gut check around five-six months from ‘cash out’ and decide whether there is a high probability of cash from external investors, cash from existing investors or positive cash flow from operations. If none of those are possibilities, it’s better to embark on an M&A route at that time, rather than waiting till the end and hoping for a miracle. And the above new investment bank may be just the entity to call at that six-month mark.

 


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Jolly's Volley: The Case For A New Investment Bank

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