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, as to what could have happened several hundred years ago, try to unearth the length and the breadth of information with respect to society, economy and behaviour 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 little soul searching, focus on incremental solutions without seeing beyond what meets the eye, have natural penchant for the next ‘Uber of India’, find those ‘Uber ideas’ 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 defines and explains, in more ways than one, the Indian venture capital world and its poor performance.
The performance problem for venture capital asset class has been global in nature. According to 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 an 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 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 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 earning of an elite Indian Joe with 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 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 performance of his/her portfolios. The fact is that without any contribution from 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 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, 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 double standard would exist.
(a) In spite of India’s lower GDP, gross income inequity, and perplexing nature of 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) In order to go beyond handful Indian cities, the fund managers would require special skills, real India know-how (not necessarily ivy league degrees), different business models and focus areas, passion to bring impact by catalysing 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 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 fee and profit-sharing in a ratio that is not equal to the usual 2 is 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 totally 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 with 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 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 few senior/older people in the Indian VC industry. But, for reasons that are obvious, 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 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 who Snapchat appeals to, how could one identify such companies and invest in them? Most Indian VC professionals don’t have multi-disciplinary or diverse experiences. Additionally, they won’t 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 than being prepared. Worst of all, they don’t 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 receives money from. Such boards are inept, weak and continually take wrong decisions at wrong times, burning millions of dollars only to push the company to pivot in random directions before eventually shutting down. The manner in which 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 in 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 make some good money so early in the cycle. After all, they made theirs via management fee 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 hero out of them when their companies, in reality, could be worth zero at the time. In fact, few older generation of Indian VCs have bred ‘bungalow-buying entrepreneurs’ who, in spite of running loss-making entities, look to form lobbies to influence 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 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 conviction around the kind of companies they would like to invest in/build.
If these were not enough, the so-called ‘heroes’ of Indian startup ecosystem, entrepreneurs and investors alike, recently began singing ‘protectionist song’ to the Indian government. For entrepreneurs and investors who killed every other smaller Indian startup basis truck loading of 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. In fact, the clamor for differential treatment basis 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 few imprudent entrepreneurs and their investors tried high jacking the Indian ecosystem with propagandist ideas such as the formation of lobby groups, India needs to find their missionary entrepreneurs who believe in building unique products. The Indian startup ecosystem should make conscious effort to shift away from such technology entrepreneurs and investors who have ‘lobbying mentality’ of the 90s. All narratives, online and offline, should hinge on India’s real problem, ways to solve them, global use cases of Indian innovations, technology hegemony of India through differentiated products, 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 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.
This article first appeared on the author's website.
Anshuman Verma is an entrepreneur-turned-investor-turned entrepreneur. He is creating The Invention Factory and M1L.
