Archive for October, 2007

80s all over again?

Merrill Lynch has a fascinating analysis on the various striking similarities between this financial cycle (mostly in the US) and the one in the late 1980s. Have a look at the article – just the charts should be enough to provide a lot of food for thought.

  • The late 1980s was a cycle characterized by a synchronized global expansion, but in the context of a fatigued US economy and strength back then in Europe and Asia.
  • A cycle fuelled by tax cuts and highly accommodative monetary policies early on, “new paradigm” views on the equity market bull run, and a massive housing boom that morphed into a bubble and credit excesses that turned into a crunch.
  • As was the case this time around, the Fed moved in the latter stages of the cycle to hike rates aggressively and invert the yield curve. As is the case today, practically every reason was cited for why the yield curve didn’t matter any more (nice call).
  • Back then, the Asian stock market that caught everyone’s attention was Japan – today it is China.
  • We also experienced a wave of LBO-financed merger and acquisition activity that certainly also took hold through most of 2005 and 2006.
  • Of course, we also had a faltering dollar in the late 1980s and rising commodity and gold prices igniting concerns over the inflation landscape – concerns that we can now say were overdone.

Peer to Peer Lending – India feasibility?

At Canaan US, we have invested in a peer to peer lending company – Lending Club. The company launched itself on Facebook and in last three months, it has facilitated $1 million in loans. The value proposition is for people taking unsecured personal loans of smaller amounts (~ $5000) and also for lenders getting higher returns on their surplus money in the bank (obviously at a higher risk – question is if risk fits into lenders risk appetite)

Business Model:Money is made by brining down the cost and eliminating bank from the chain


I thought to share my viewpoint on the key enablers of this business in US and would like to know your feedback on the India opportunity

• Scope of brining down cost of providing loan using technology – In US, the spread for a bank giving unsecured personal loan is around 10%. This spread consists of cost of providing loan (assessing and tracking) and Bank’s profit margin. The numbers are similar in India. Depositors get somewhere around 4-5.5% on saving accounts and personal loan interest rates are in the range of 15-24% depending on the profile of borrower. So the spread is north of 10%

• Ability to assess the risk profile of borrowers using technology

Firstly, using Credit Reports – Unlike US, this had not been possible in India because lack of data sharing between various banks. However; with CIBIL this has changed. RBI has made mandatory for all banks to report defaulters. Recently, I took an education loan for my brother from State Bank of Bikaner and Jaipur and to my surprise they checked my loan history from CIBIL database. With time, we all will have a credit report which can be used to assess the risk profile of individuals based on past history

Secondly, using social information about an individual’s community, associations etc – LendingClub has started with borrowers from different communities e.g. Harvard Alumni, Army Communities. In India, this is something not new. MFIs have very well tried this concept (of community based lending) through Self-Help-Groups and able to lend millions of dollars to rural people. The loan amount is as small as 4000 rupees. I think this can be extended to urban, young, educated class as well. Imagine my Facebook Lending Club application (with all my professional and social nodes) shows me as a defaulter – I think I would not like that for a small amount.

We still need to do some math on the market in India. I don’t have credible numbers as of now. However; unsecured personal loan market is growing at a rate of 30% (home loan is growing at 20%) and has been source of rich profits for some of the private banks. And personal loan market is still dominated by young, educated, urban people whom I think should have internet and mobile access.

Any views on why this business can work or fail in India – Challenges, Issues, Positives?

Great read: SaaSy security suits small businesses

Absolutely credible and intuitive assessment of the consolidated and de-productized information security market by David Cowan of Bessemer Venture Partners. David has hit the bullseye here, beautifully explaining the current and underlying bottlenecks ailing the business of information security. Personally, I feel this is a brilliant take on the future of the IT security industry. People have already shunned the idea of another killer security product and information security outsourcing (infrastructure management/MSS – whatever) is going nowhere.

Now, imagine the proven Indian offshoring model combined with SaaS! Companies like Wipro, which has a well-established security consulting services arm, has this whole market for the taking if they can streamline their messy operations. However, this is a tough bet for ground root entrepreneurs as it requires an elaborate operational setup and infrastructure.

Read here.

Sweat equity in new ventures

I recently read one article about compensation in early stage ventures. One of my friends is planning to invest in a startup where he is one the four partners of which two of them will be running the show while the other two will be just investors. The proposed equity structure is 25 percent each for the pure-investors in return for 35 percent investment (each) while the two guys who would run the show are putting in 15 percent of the money for a 25% stake (each). This means they are getting 10% extra as sweat equity. Interestingly, both of these folks would work for full salary in the new company (no salary cut).

Is this a good arrangement? In my view the managing promoters don’t deserve any sweat equity upfront as they are working for full salary. I would say that all four should have equity proportional to their percentage investment.

My friend wants to know what would be the best equity structure for this company with 2 working and 2 non-working promoters assuming that the working promoters take market compensation.

Consumer Push on Mobile

Mint published an article (contributed by WSJ) Why Microsoft, RIM Fight Is Entering the Consumer Market

“Already, Apple Inc.’s iPhone for consumers is forcing handset makers to rethink their own hardware designs. Meanwhile, Google Inc. is expected to jump into the mobile-phone market, hoping to court consumers by delivering software to handset makers and phone carriers to create offerings that could eventually be subsidized by online advertising. ”

Like to highlight couple of points:

• Increasing focus on consumers from enterprises (Morgan’s views earlier posted by Alok share the same thought)
• Demand of enabling platform/softwares like Web Services for search, digital maps for cellphones, voice based search, targetting ad
• Smartphones comprises only 10% of the total 1.2 billion handsets worldwide – increasing demand of technologies enabling basic phones into entertainment devices

Microsoft and Google have done some small acquisitions/partnerships in mobile technology arena. We are already seeing lot of action in Indian Mobile space. Indian mobile numbers are attractive for companies like Microsoft, Google, Yahoo and investments from these will push the frontier further. Any potential Google/Msft target 🙂


Compensation in early stage ventures

Folks, I am not sure if this has been discussed before. If so, can you pls direct me to the relevant posting?

I would like to know about the standard practices to decide compensation for early stage employees. Consider this example: I am planning to hire a person at the CxO level. My company is about 15-20 people. Of these say 4-5 ppl are the Sr Mgmt. The Sr Mgmt have equity stake and the remaining employees as low level guys hired at market salary. Now if I have to add another person at the CXO level, are there any thumb rules for compensation? Say mkt salary for this guy is over 20L. How can I estimate a fair salary/stock package? Pls let me know in both cases – 1. the company has a valuation 2. The company has never been valued.


Morgan Stanley on Technology

Morgan Stanley released this presentation on current state of technology and internet, and key trends that they see. Besides being a good overview, couple of things that I found interesting:

  • The globalization of technology markets
  • Consumers and not Enterprise is becoming key driver of technology adoption (not just the internet, but beyond that)
  • The shift from enterprise to consumers, not just on the internet, but in other pieces of technology as well, is something I found particularly interesting,

EVS Report on VC/PE in India

Just saw this report from Evalueserve on Indian PE/VC market. Compared to recent data that we see on a regular basis, this report has a nice perspective on the history of VC/PE and how it has evolved over last 10-15 years. Also touches on the broad themes for investment and growth in India. Interesting read.

It’s about the People, People

This is motivated by the Alok’s post on “Miniaturization of VC” that asked what technologies would enable VC’s to manage a large portfolio of companies to moderate exits. My contention is that for such companies no armchair quarterbacking will suffice, no matter how good the remote control is.

It is all about human capital – the team. When you build a company, to get reasonable odds of success, you need an outstanding team. The traditional model has been to get the core team together, go raise a pot money and then use that money to hire the rest of the team. This works for companies that are clearly going to go big or go bust – building an electric car for the masses, building a two way GPS system, building a 4G network, or even our very own Sanjay’s Eko project. But for companies that will require small investments and have moderate outcomes it is very hard to go down that path any more.

The reason is simple – Everyone wants to be a founder and no one wants to be an employee.

If all it takes to start something is an idea (everyone has one), a small amounts of money (maybe just go without a salaries for 6 months), and skills. Then the real barrier to entry is skills. Anyone that would make a good hire has skills. So they think – I have skills, I have an idea and I can go without a paycheck for a while and my uncle can put in a bit of money. Hey, I should do a company myself. It is much easier and more fun to nurture your child than someone else’s.

So a company that is going down the path of small investment, moderate exit will find it hard to build a team, even if they have the money they need to pay their employees a decent salary. Hence the abundance of founders and absence of employees.

Now switching to the investor side.

I have a lot of VC friends who have gobs of talent and energy but as an industry the VC’s have one broad core competency. Their ability to get institutions (pension funds etc) to trust them with 100’s of millions to invest. A small set of VC firms (less than 10) have a repeatable process of discovering and nurturing big hits. None have the human capital required to make many small investments and take them to many moderate exits and they most likely will not change their stripes.

The reason is simple – Their model is a hits centric model and it is very comfortable. Today a majority of VC’s are making most of their money from fees and not from the 20% carry (their share of the proceeds the fund gets from successful exits) and they are still living a good life.

For a VC firm to exist it must have the ability to raise gobs of money and they do. They then pay themselves a fee of 2% annually. So if you raise 200M fund (which in the US is not a big fund) then they get 4MM annually as a fee from which they pay themselves salaries. If they can keep the number of partners low then they can pay themselves great salaries and they do. Hence there is little lifestyle risk if they fail to execute, they still get a decent salary.

For VC’s to accommodate many small investments that result in many moderate exits they will have to lower the size of their funds by 10X or increase their number of partners. Consequently they will reduce their salaries substantially and increase their dependence on the “Carry” for their lifestyle. This is not going to happen unless there are no places to deploy large sums of money.

It is much better for a VC to find new places to deploy large chunks of money and continue to enjoy a good risk free lifestyle than find a way to change their stripes and deploy across a large number of moderate exits and put their lifestyles at risk. The best VC’s will find these opportunities and some but not many will be in web 2.0.

We created Tandem Entrepreneurs to address this class of company. Tandem has efficent deployment of human capital at its core. We are often confused with small funds. But these fund are often just VC’s with one partner or organized angels. Neither deal with the human capital issue. The best model for these funds seems to be to make many small bets. In some sense create an index fund of startups. It is a reasonable idea and one that has brought success to Ron Conway in the past.

We try and make it clear than Tandem is not a VC or an angel fund, but are a team with money from a powerful network of individual investors.

Since we invest human capital, this makes the number of deals we can do small , else we will be spread too thin. The areas we can invest are also narrow (based on where we can successfully add sweat and bring an unfair advantage of some sort – an edge). But when we do invest we serve as the extended team and address the human capital (team) problem as well as the financial capital issue. We make it possible to keep the number of people sharing the pie small, making it possible for the founders to make their million(s) with a moderate exit of 10-20MM and in a short period of time. The door to a big exit always stays open.

I think it is a great time for entrepreneurs to start companies but entrepreneurs need to think carefully about how they are going to build their team. A startup could succeed with an incomplete or subpar team, but they would have to be extremely lucky. Startups also need to be realistic about their exit value. I can make almost anything look big on paper but the inconvenient truth is that 85% of exits are less the 50MM.

Technology has been a big enabler for creating this environment. Amazon’s EC, Open Sources software, Social network api’s, Hosting services like Engine Yard all lead to startups not needing much in the way to enabling infrastructure and if it isn’t there today it will there soon. At Tandem we have made 3 investments in the last 3 months and not one of them has a machine to its name outside the founders’ laptops and their budgets for software spend is next to nothing.

Here is data showing a nice paycheck inspite of dismal returns

VC Compensation

VC Compensation: Rising

Somewhat Questionable

Private Equity Returns : Somewhat Questionable

Though-Provoking Radio programs

We have radio stations like NPR (National Public Radio) in the USA that produces and distributes thought-provoking programs related to current affairs. It engages in meaningful debates on all current topics. I always found that station to be most used by folks driving to work (Average of 40 minutes of drive time for any commuter). It provides intellectually-stimulating discussions for the civilized world.

I have been wondering why we do not have such channels in the cities of India. Is there a cost barrier to this? Are there any infrastructural limitations? I can see a burgeoning mid-class market for such a program. A typical car-owner in the country today spends a lot of time in traffic. This will be such a meaningful use of the time. While music and other chirpy FM talk-shows provide some entertainment, I think a channel like NPR will go along way in serving the market needs of the current advanced Indian.

I would certainly like to hear your thoughts on this. I am sure there would be some hurdles (if not, we should have had this type of channel on the air long ago)