Early stage technology investing – analysis

Interesting discussion here on issues around early stage technology investing in India. Many valid issues that have been discussed there. I particularly like the perspective around “distribution” being a killer app in India – but more on that sometime later.

Earlier this year, we analyzed the investments made by 11 early/growth funds in India (across 144 companies and 156 rounds of investment) to understand how those companies were doing – clearly a qualitative exercise with subjective judgment around what is headed north versus south.

That data led us to believe that the case for stage diversification is far stronger than sector diversification. The success rate on pre-revenue early stage investments (call them seed) seems very low, in the 15-25% zone. Once you get to some revenue, or some profitability (at time of investment) the success rate seems to climb above 50%. The 3x fall off between the seed stage versus post-revenue early stage investments doesn’t seem to get compensated by valuations available at those respective stages. This doesn’t say that we won’t do seed investments – just that there needs to be enough diversification, and the bar on seed stage investments needs to be really high.

Broadly speaking, IT investments (Internet, VAS, software) seemed to underperform BPO/KPO/consumer services etc. However, that was partially because the seed stage investments were biased towards IT than others. On a stage adjusted basis, IT seemed to generate as many successes as others, perhaps with a potential to actually outperform on exit value, due to often higher multiples commanded by those businesses.

Of course, the debate of how innovative these IT companies/investments really are is yet another dimension. Short of that, we are continuing to find the broader early stage technology investing landscape interesting.

9 Responses to “Early stage technology investing – analysis”

  1. Alok, if I have this right, what you’re saying is that the valuations are either too high at the seed stage, or too low at the early stage – or both?

    Also I imagine eventually success will have to be defined at exit – so it could take a few mindblowing exits to move the conclusion either way?

  2. Alok Mittal says:

    Deepak – you are right in theory – note the mention above – “The 3x fall off between the seed stage versus post-revenue early stage investments doesn’t seem to get compensated by valuations available at those respective stages”

  3. Question: If the average seed stage investment was 1/10th the post-revenue average round, and the number of seed investments was say 4x the latter, then wouldn’t the success of the system as a whole be more pronounced if you got in at the seed stage? Sorry for being abstruce – this is a classic trading problem, if you can make 10x your money by being right 20% of the time, then what you want to do is make the maximum number of bets possible. If you change the probability to higher, you can live with lower odds. One of the problems in India is we haven’t yet seen much of the big odds businesses yet (10x, 100x etc.)

    Of course, investing pre-revenue is probably beyond my comprehension at the Canaan level, and pre-profit would still raise an eyebrow. This is probably where the angel business should happen; smaller ticket sizes is probably uninteresting to the large fund.

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