Author Archive for Freeman

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.

Alternative Startup Financing Schemes

I’ve seen a number of posts lately discussing the ‘changing face of venture capital’. Paul Graham talks about the change in dynamics caused by the low capital requirements of technology startups. Fred Wilson discusses the need for a market for privately held common stock. There seems to be a general consensus about the growing role angels play in the startup ecosystem, and sadly there also seems to be a general consensus indicating that angels should basically write off their investments the moment they make them.

This last point rings true for me. Before coming to India I made a number of investments in tech companies. During my chapter in Los Angeles I also put money into a couple of independent films and a big event with uniformly poor results.

“family, friends, fools & freeman” – Joke by John Mullins at the Venture Capitalist development program at ISB.

While the returns on these investments were uniformly bad, the journey the ventures took was not. One tech company has seven figure annual revenues which support the two founders in adequate if not lavish lifestyles. The founders / promoters in each case saw money on the way. Little made it back to the investors.

In iAccelerator.org we’re fortunate to have a team as advanced as HashCube.com. They are profitable with a proven record of developing and deploying casual puzzle games for social networks and mobile devices. Recently MySpace opened up its platform to developers and HashCube has done well as an early provider of games for it. They see an opportunity to scale – more games, more platforms, more promotion, more revenues .. more investment required.

Even if HashCube can reliably replicate the success they’ve had with their initial games, the question of whether their success can translate into a meaningful exit for its equity investors remains uncertain. What if it is simply a profitable business heavily dependent on the founders? Far from being an aberration, this maybe the common case for technology companies. 37Signals.com promoter David H. Hansson argues that creating small (compared to Facebook) profitable companies which serve the needs of real customers is a far more reliable path to startup success, than the traditional Venture backed Big-Bang approach.

To address this scenario, I had the thought that HashCube could offer investors the right to invest in a pack of games taking a % of the revenue generated by those games until achieving a certain IRR. The goal being to produce an automated mechanism in which investors get paid as a normal part of the company operations rather than being dependent on an exit event. 

<p>Chetan Pungaliya spent some time here in Ahmedabad mentoring our companies, and had some interesting observations on this. He didn’t like the idea of selling the game pack as the founders needed the flexibility to apply both, the money and their time, where it would do the most good. This may be promoting the existing games rather than building new ones. For the same reason, he was resistant to carving revenues out for the investors early as he believed that HashCube could be ‘big’, and may need to reinvest all revenue back into the company to fully realize their potential. He suggested an alternative financing scheme as a compromise between the game pack based revenue share approach and the traditional equity model. His idea was to allow founders to reinvest all the revenue for the first few (say 3) years, but to cap founder compensation during this time. At the end of three years the rev share kicks in. This provides the founders with full flexibility to grow the business quickly during the initial period, and provides a clear path for investors to recoup their money if an exit isn’t apparent and the founders are taking the startup along a ‘lifestyle’ business route. Presumably, if the company raises a significant venture round angels at this stage would either be bought out, or would convert to shares on similar terms to those of the VC.

I’d be curious to hear from other potential angels about whether this kind of structure would make it more likely for them to invest in very early stage tech ventures.

iAccelerator – Supporting Early Stage Tech Ventures

Preparing to come to India I talked with a number of Silicon Valley VCs about the opportunities they saw here. Some were bullish, a partner at MDV told me he thought there was a 30% chance the next Google would come from here, but many were taking a ‘wait and see’ approach to investing.

In the four years I’ve been here I’ve seen VCs talk at a large number of startup events. Startup founders and VCs seem to like being in the same room together, but the VCs usually say ‘We are looking for profitable companies with proven management teams who need money to scale’. Founders tend to be young, energetic, first time entrepreneurs hungry to get started.

The net of this disconnect is the small amount of technology investing that happens. While complaints of a lack of innovation and leadership may be valid, they are excuses for inaction and represent a failure to identify and address the real power and potential of India.

The power and potential of India rests in it’s people and it’s youth specifically. 50% of India’s almost 1.2 billion people are under 25. The successes of Silicon Valley demonstrate that the digital economy is the domain of younger people who quickly adapt to and adopt new technologies. The ever decreasing costs of powerful computers, the advent of cloud computing and widespread free open source software frameworks has made the capital costs associated with starting a technology company cheaper than ever. At the same time, rapidly expanding mobile phone adoption and internet penetration has created a large addressable market for these companies that does not require massive spends in sales and marketing.

Large markets, low entry costs, all that is required is smart motivated people …. 600 million people under 25 … We should own this sector. To reach this potential though, the venture capital scene needs to service this part of the entrepreneurial sector by providing bootstrap capital, intensive guidance and connections catered to young first time entrepreneurs in India.

This is what we are doing with the iAccelerator a micro venture program I am conducting with the Center for Innovation Incubation and Entrepreneurship at IIMA We invest upto 5 Lakh INR in the companies we work with, and run them through a four month intensive startup bootcamp where they live and work in Ahmedabad. We help refine ideas, establish proper legal, financial, marketing and engineering processes, and connect teams with advisors, clients, partners and investors who can help take them further.

April 1 is the last day to apply for the summer program which runs from May 1 to September 1.