A Different VC Model

Having made a number of investments in very young technology companies in India over the years I came to the somewhat obvious conclusion that it is relatively easy for startups  here to become ‘ramen profitable‘, but relatively difficult for them to exit. Making equity based investments in this scenario is problematic for the obvious reason that without an exit, investors don’t get paid. The alternatives I have heard people talk about to address this are dividends & convertible debt. Dividends are difficult to extract as the entrepreneurs would always prefer to reinvest revenue to fuel further growth. Debt is risky as it can lead to a scenario in which founders lose control of their company.

My dad was a software entrepreneur. When I was a kid he was always at work on the computer on the dining room table writing software to help scientists design experiments.  After borrowing as much as he could from his father, he talked to a number of investors around us in Silicon Valley, but ended up taking money from John Wiley & Sons. At that point book publishers saw software as something that got sold in the back of books and they already had a model for providing risk capital to authors. In exchange for an advance of $50,000 and a promise of ongoing royalty payments, my dad signed over the rights to the product he was developing. The package sold reasonably for several years, and after 4 years John Wiley gave my dad another advance so that he could create version 2 of the software.

John Wiley & Sons made money on the venture. My dad made money. Everyone was happy. It is unlikely my dad would have been funded under the traditional VC model. Is experiment design a billion $ business ? Is an IPO possible, aquisition likely ? No.

I believe there are far more tech business opportunities that look like my dad’s business than Facebook. These businesses are largely ignored in Silicon Valley where the cost of living is high and the opportunity cost of not going big makes people shut down marginally profitable businesses.

In India, I feel we should embrace this type of business. Rather than bemoan the lack of an Indian Facebook or Google, we should strive to create thousands of small profitable online businesses that earn their promoters above market salaries and their investors above market returns.

The financing vehicle we use to do this will look more like the publishing industry and less like Venture Capital. Earlier this month I saw this article by Om Malik, Why Apps Need a Different Kind of VC Funding about Vision+ which appears to be a Finish VC making these types of investments in young companies. I think this will work well here.

5 Responses to “A Different VC Model”

  1. krish says:

    …One of the primary reason for lack of investor interest in the startup space (besides the much touted, pet peeves like shallow idea, lack of execution capabilities, leaky revenue model etc.) has been the market downturn over the last 5 years… It has thrown up sufficient opportunities in the far more surer, established and listed universe that has driven many VCs morphing themselves as PEs and flocking over to finance gold loan companies… You can’t blame them for swapping their domain-expertise mantra in favor of opportunistic betting because some day soon the investors in their funds will be asking them questions or worse, stop cutting checks…

    I’ve been an avid watcher of startup space and I already notice prospective founders of Indian startups have stopped dreaming about college-dropout-making-it-big theme loaned from the silicon valley and are eagerly taking up that lucrative campus placement as it comes their way, and are saving for a few years, rounding up like-thinking-mates, pooling their own capital to show some results as and when they venture out on their own… I am sure serious investors likely will sit back and take notice of this bunch sooner…

    Happy Realization…!!!!

  2. Vijay says:

    I think the issue is one of predictability. Models differ based on how we know the future growth of the company would be. we know that the lifetime of an App is rather limited and hence it makes sense to fund them on Project mode like the movies, on the other hand lets say someone is building a company in the enterprise space – siphoning money out of sales – even if it is less than 10% each year will hit the company’s future in the long run. it can potentially be R&D money that the company could have reutilized to strengthen itself.

    There is never going to be one model that works for everyone. As Investors it becomes our perogative to work with entrepreneurs, understand what they are capable of, and where they want to go, and see if it aligns with what we see in our head. There have been some cases where i’ve seen investments done on revenue share – knowing that the entrepreneur was not keen on growing it to scale, or possibly had limitations. But you also have to wonder the cost of capital in such ventures – the cost of capital in India can be a bit prohibitive to do such deals (as high as 17% compared to the 2-3% in the US)

    If an entrepreneur can pay a debt – thats what i am going to call it, if it means paying off something equivalent to 15-20% (in alok’s draft) thats a very stable company. Truth is, how many companies do you know who can assuredly make that kind of money consistently?

  3. TheFeeSoul says:

    FreeMan,

    Power to people like you.

    Equity plus income will not work any way.

  4. Alok Mittal says:

    Freeman – interesting approach. I had earlier posted a model, which is an equity plus income-contingent-loan, which seems to get to similar effect. Here is the link – http://www.venturewoods.org/index.php/2009/12/15/angel-funding-framework-structure/

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