Why Is The Indian Venture Capital Investing a Non-Starter ?
By Ansh Pyura Verma
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The perspective of history is limited to one’s individual Hubble radius. It gets built from experiences communicated by one’s friends, families, and acquaintances. To go beyond that one must become a voracious reader and uncover, to a fair estimate, what could have happened several hundred years ago, try to unearth the length and the breadth of information for society, economy, and behavior at different times in history, find first-hand information through authentic scriptures or books passed through generations, do direct surveys in specific communities, visit places to dig hard, and ask tough questions while perennially attempting to unearth popular misconceptions, which have, almost always, been associated with tales of history.
The process of discovering great businesses in the venture world is a facsimile of the above-narrated exploration.
Many Indian venture capital professionals, particularly those working at foreign funds operating in India, do not only map advertisement history for making investments but also do the exact opposite of what needs to be done: do a little soul searching, focus on incremental solutions without seeing beyond what meets the eye, have a natural penchant for the next ‘Uber of India’, find those ‘Uber ideasa’ in graduates from IITs, IIMs, and Harvards of the world, build their investment teams from the same ‘Uber graduates’, and work within such like-minded and homogeneously opaque networks. Rightly and disastrously so, the Indian venture capital fund managers are, thus, miles away from ground realities.
With few sprinkled exceptions, the rotten attributes highlighted above define and explain, in more ways than one, the Indian venture capital world and its poor performance.
The performance problem for the venture capital asset class has been global. According to the Kauffman Foundation’s analysis of their 20-year history of venture investing in nearly 100 VC funds, it has been empirically proved that since 1997 less cash has been returned to investors than has been invested in VC. Among several reasons for poor performance, the most significant one is the misalignment that occurs when a VC fund charges a fixed 2%, or thereabouts, on committed capital/the corpus of the fund as the management fee to find, invest, build, and exit a winning company. The 2% fee, perhaps, would have made some sense had the raised money gotten back to limited partners (LPs) of Indian VC funds. But, for over a decade that has not happened.
In the case of India, this ‘incentive misalignment’ problem intensifies a million times.
Today, an above-average Joe, educated at an elite college in India and working in one of the Indian metropolitan cities, on average, makes around $25,000 pa. This adds up to $750,000 in 25 years of his professional career, which is a fair estimate of the average tenure of an individual’s working life. Even after adding some spread/bonus/increments/promotions, etc. to a star career, we will not be able to go beyond $2 million of total earned money over a superstar’s life. (For the sake of simplicity and to avoid embarrassment, we have not considered people working in tier 2/3 cities of India or in hinterlands — their abysmally poor numbers would make a mockery of this comparative analysis).
Now, compare this lifetime earnings of an elite Indian Joe with the average compensation that a ‘usual’ partner at a large Indian VC fund enjoys: a conservative estimate of $500,000 pa, or thereabouts, means lifetime earnings of approximately $5 million in 10 years, and $10 million in 20 years. These figures assume that there are little overlaps of different funds within the fund, that fund size is stable/constant, and that the contribution of profit-sharing is zero.
Furthermore, we have assumed that no ‘under-the-table’, ‘fair and transparent’ deals such as hiring ones espouse at 5x the salary, giving away business contracts to one’s relatives on quid-pro-quo understanding etc. have taken place. In any case and by all standards, making $10 million over one’s life in a developing country such as India is a big deal.
Basis purely comparative emolument numbers, one can fathom the extent to which the Indian venture capital industry is rigged and the grotesque nature of income inequity we face as a society, skewing the game completely for a resource-constrained country such as India.
Be that as it may, it is not difficult to comprehend why an Indian VC fund manager would not take it easy, and not be genuinely concerned about the performance of his/her portfolios. The fact is that without any contribution from the successes of his/her portfolios, an Indian fund manager could easily eject himself/herself into a cozier lifestyle via just the management fee, a lifestyle that would be better, by miles, than many average Joes in India.
This results in VCs having worse levels of incentives to work hard to make their portfolios successful. The problem of misalignment of fee versus profit-sharing incentives for VCs, in general, has been well-researched by the Kauffman Foundation.
Indian fund managers would argue on an incomplete and contentious logic that the venture industry is in the business of losing money and that they would eventually return money to their LPs. The problem, though, is that, so far, those returns have been elusive even as the Indian venture capital industry has moved well past a cycle.
Additionally, the PPMs/investment thesis of many Indian venture capital funds demo India’s billion-plus population, selling the country as a super large market that could result in handsome returns for the LPs. In reality, these funds have focused only on the top 10–15 Indian cities aka the urban population. India’s aggregate per capita income (nominal) stands around $1500 with more than 500 million small farmers, who reside far away from cities, where Indian VCs operate in. The urban Indian market roughly equals one-fifth of the dream that many of these funds continually peddle their LPs. It is not difficult to understand why such a double standard would exist.
(a) Despite India’s lower GDP, gross income inequity, and perplexing nature of the market’s heterogeneity, selling one large market thesis supports the rationale of raising bigger funds resulting in a larger pie of management fees for fund managers.
(b) To go beyond a handful of Indian cities, the fund managers would require special skills, real India know-how (not necessarily Ivy League degrees), different business models and focus areas, and passion to bring impact by catalyzing the growth of far-flung hinterlands and connecting such heartlands with mainstream India, all of which would require a lot of work.
The Indian fund managers have not made their prize money in the past via operating successful businesses, through inheritance, or otherwise. Most don’t seem to have a missionary cause of building and creating new companies, making it tough to change their mindset of living off management fees. Contrast this with examples of venture capital investors in the US: Marc Andreessen and Ben Horowitz of Andreessen Horowitz, Vinod Khosla of Khosla Ventures, Peter Thiel of Founders Fund, etc: in addition to having made their prize monies, these guys are passionate about building great companies and creating brighter future for our world.
In the Indian context, it is tough to find VCs who have a purpose beyond looking to mint money. One of the ways to align interests is by structuring fees and profit-sharing in a ratio that is not equal to the usual 2 to 20: VCs, typically, are paid a 2% management fee on committed capital and have a 20% profit-sharing structure. The fee could be brought down to 1% while the profit-sharing could be increased. This, though, would mean that operations of the fund would require to be cost-effective and lean, which is possible in the new world order.
Global LPs must understand that investing in brand-name VCs is not what would work in India. Even from the perspective of getting better/positive returns, LPs should get themselves distributed among different kinds of VC investment vehicles in India including the home-grown, quality Indian VC funds, and impact funds, which might emerge winners in the new world order. More importantly, LPs should participate in India’s growth story based on a different structure of fee and profit sharing.
While VC funds, globally, are not required to keep a transparent system of inducting people in their teams including the process of selection of Partners, for reasons related to propriety and transparency, the Indian venture capital industry needs mechanisms to evolve into a more transparent system.
The current opaque method of running the fund on whims and fancies/diktats of a few gibberish senior professionals within the fund is another reason why Indian funds have not returned money to their LPs and will, most probably, continue the losing streak.
It is counter-intuitive but simple to understand that if a VC fund aggregates a bunch of mediocre, ‘like-minded’, sycophants in its team, it will not produce great venture results. Most great companies are discovered by way of extreme disagreements within a fund than by finding a common intersection of nods. The irony, though, is that these issues could be known to a few senior/older people in the Indian VC industry. But, for obvious reasons, they would not like the change to come by. The more-than-opaque functioning of Indian VCs also lends itself to the problem of hiding of real portfolio situations, and issues around valuations and the status of the fund, in general.
Indian VCs lack creativity, which is the fundamental block for building differentiated, sustainable, and enduring companies. When one doesn’t know why, how, and to whom Snapchat appeals, how could one identify such companies and invest in them? Most Indian VC professionals don’t have multi-disciplinary or diverse experiences. Additionally, they appear to have spent considerable time thinking about their experiences to be able to appreciate unique companies, uncommon business models, and weird but bright entrepreneurs. As discussed earlier, they would seem to be in it for leading a cushioned life, have linear mindsets that result in linear companies, and react to situations rather than being prepared. Worst of all, they do not seem to be working hard enough.
India might be one of the only few countries in the world where sub-standard, mediocre people/VC teams making no-return investments for years were/are called stalwart(s) of investing.
A derivative of the quality problem within teams in Indian venture funds is that boards of invested ventures get mediocre board members nominated by the VC fund it receive money. Such boards are inept, and weak and continually make wrong decisions at the wrong times, burning millions of dollars only to push the company to pivot in random directions before eventually shutting down. How many late-stage Indian technology ventures were invested in, put on cash-burn rockets, and, later, shut down speaks volumes about the quality and intent of venture capital professionals sitting on the boards of those companies.
A pointed case as an example to highlight board ineptitude in India could be drawn from the fact that few founders of late-stage ventures in India have been able to cash out multi-million dollars even before any of those companies could prove to be sustainable and profitable. It seems that the board members, particularly VCs, are/were severely conflicted on moral grounds to not allow their portfolio founders to make some good money so early in the cycle. After all, they made theirs via management fees without bothering much about profit-share, i.e., waiting for portfolios to eventually succeed.
There is perhaps little rationale or other good reasons to allow entrepreneurs of late-stage ventures in India to cash out multi-million dollars in secondary deals and to make a hero out of them when their companies, in reality, could be worth zero at the time. Few older generations of Indian VCs have bred bungalow-buying entrepreneurs who, despite running loss-making entities, look to form lobbies to influence the startup ecosystem in India.
One can see more than required bonhomie among Indian VC investors mirroring each other’s winning thesis, allowing investments in each other’s portfolios with seemingly clear quid-pro-quo mechanisms, manipulating the public with confused signals about their portfolios, going out of the way to invest in boutique media companies to be able to influence ecosystem through them, etc.
It would appear that the master strategy of top-tier VC funds in India is to copy the master strategies of other top-tier VC funds.
Such insecure, self-fulfilling, and downward-ratcheting approaches emanate from the fact that very few in the industry have convictions about the kind of companies they would like to invest in/build.
If these were not enough, the so-called heroes of the Indian startup ecosystem, entrepreneurs and investors alike, recently began singing protectionist songs to the Indian government. For entrepreneurs and investors who killed every other smaller Indian startup basis truck loading funds from anywhere and everywhere, it came as an abject piece of irony that they would like the government of India to save them from ‘the unlimited treasure’ of funds accessible to foreign technology ventures operating in India. The Indian heroes didn’t seem to understand that in the world of technology and innovation, it is inconsequential whether one is an Indian, a Polish, or a Puerto Rican company — all one needs to do is to build the best product and an amazing company to lead the pack. The clamor for differential treatment based on nationality is an extremely vulnerable argument to make. Unfortunately, Indian startups, in general, don’t fall, as yet, in the creator’s category. Understandably so, India’s startup narrative, so far, has not been hinged on missionary and creative entrepreneurs, who have a purpose beyond making bucks.
The Indian venture ecosystem won’t develop unless the focal point becomes doer-entrepreneurs who are independent thinkers and who have a worldview of their own.
For that to happen, India needs high-quality entrepreneurs who can stand without the ‘able’ support of VCs. Unlike what happened recently, when a few imprudent entrepreneurs and their investors tried hijacking the Indian ecosystem with propagandist ideas such as the formation of lobby groups, India needs to find missionary entrepreneurs who believe in building unique products. The Indian startup ecosystem should make a conscious effort to shift away from such technology entrepreneurs and investors who have the lobbying mindset of the 90s. All narratives, online and offline, should hinge on India’s real problems, ways to solve them, global use cases of Indian innovations, technology hegemony of India through differentiated products, the conceptualization of clear mission statements, finding missionary Indian entrepreneurs who have a passion to make positive change, building profitable and sustainable companies, and bringing clarity about the larger purpose of creating ventures.
Unfortunately, the new crop of Indian VC funds (the ones that have been publically announced), homegrown or otherwise, doesn’t seem to be improvising on the existing model, which has not yielded results. Perhaps there are many 50-year-old stalwarts of investing that the entrants are looking to emulate.
But doing so would be too bad for India.
~Ansh PYURA Verma
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This article first appeared on the author’s website, and then on VCCircle.
PS: Post the publication of this article in 2018 in one of the major online platforms in India, a bunch of frauds from the Indian venture capital industry went after my life, and my career, and surprisingly, my family members too, aided and supported by a few local politician friends in their network. Most of these fraud VCs work in the Bangalore office of a global fund headquartered in SF.
