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Seed Stage Investing Gets Super Bullish, But What About Exits?

13 April, 2011

Are early-stage investors, both in India and the USA, caught up in a bubble of their own creation?

Seed funds and early-stage investing in India seem to have come of age in a big way. Apart from the number of seed funds that are being raised or already raised, a number of Y-Combinator variants (incubator/mentorship models) are being set up across the country. Being in the middle of all these as an i-bank, it's incredible to see angels competing fiercely for deals, unlike even a year ago when start-ups desperately chased a handful of angels or seed funds for money. This is indeed a very exciting time for entrepreneurship in India and I believe that the support system for starting up and raising capital is only going to get better over the coming years.

It is important to draw a parallel to the early-stage ecosystem in the USA, simply because there is a certain degree of overlap in participants and the Indian early-stage investor community tends to reflect Silicon Valley models and 'market sentiment'. The USA is witnessing something equally fascinating in its early-stage funding scenario. The angel investor/incubator/mentorship model has been around for many years in many variants and forms the bedrock of the Silicon Valley start-up machine. What is different now is the ease with which a startup can raise angel money and the easy terms on which they are doing so.

The recent launch of a fund called the Start Fund is a great example of this. The Start Fund commits a blanket $150K of convertible debt to every start-up coming out of the Y-Combinator program, with valuation pegged to the next round of angel or seed funding. No diligence, no seed stage valuation expectations just a simple, collateral-free loan that gets converted to equity whenever the start-up raises a follow on round! I don't think it can get any better for start-up entrepreneurs, whether they are in India or the USA.

This obviously leads to the predictable question: Are early-stage investors, both in India and the USA, caught up in a bubble (or should I say 'cloud') of their own creation or is the optimism justified? In a recent April Fool spoof article on Techcrunch, Dan McLure, who is part of a Silicon Valley startup fund called 500 Startups is quoted as saying, "We are at a unique point in history, where any two people can create a new startup and have a nearly certain chance of at least modest success. Even if the product fails completely, Google and Facebook will compete to acquire the team and investors will at least get their money back."

Facetious as it is, I actually think there may be an element of truth to this. I proceeded to dig out some numbers on the acquisitions made by Google and other tech/internet firms (Source: Wikipedia and company websites), and the numbers tell their own story:

No matter how much of a bubble early-stage investing may be in the US, there are hundreds of tech companies that have a strong DNA of making acquisitions as part of their core growth strategy. This creates a safety net that buffers the hyper aggressive leaps of faith seed and early-stage investors are making in the US. In fact according to the 2010 Angel Market Analysis Report by the Center for Venture Research at the University of New Hampshire. 66% of angel exits happen through M&A

Company Number of acquisitions

Facebook 10

Yahoo! 62

Microsoft 128

Cisco 185

Google 94

While the euphoria around angel and early-stage investing in India is fantastic, I cannot think of a single tech, media or internet entity here that will make multiple acquisitions every year. IPO's will only give exits to a handful of funded start-ups; a robust acquisitive universe is critical for the sustainability of early-stage investing in India. Along with developing the ecosystem to create and grow start-ups, investors and entrepreneurs have to focus on creating the exit ecosystem as well. Hopefully, this will emerge over the next 4 to 5 years, in time to provide exits for the current wave of early-stage investments.


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