Miami, US: They make their fortune on the basis of their investment bets. Hunting for fledgling, bright firms with discerning and scalable futures, venture capitalists (VCs) cultivate them with mentoring and capital, with hopes that at least one among their portfolio firms will repeat the success story of Google Inc.
The global downturn and liquidity crunch has, however, clouded the optimism of US venture capital firms with a degree of caution. Venture capital investment from the US halved in the March quarter, declining to a five-year low of $1.87 billion (Rs8,826 crore today), according to data compiled by research firm Dow Jones VentureSource.
VCs in the US, the hub of venture activity, say the business is no more just about returns, it’s about sustainability now. Mint spoke with US-based VCs on what factors have become more crucial for them, while deciding on whether to invest in a firm. Here are some factors that US-based venture capital firms listed as of utmost significance. Some of these firms recently participated in a mentorship event organized by the Endeavor Global, a non-profit organization that aims to foster entrepreneurship in emerging markets:
Articulate vision: (from left) Matrix Partners’ Nicholas F. Beim (photo: Deepti Chaudhary / Mint), International Data Group’s Patrick J. McGovern and Norwest Venture Partners’ Promod Haque. Venture capitalists in the US say the business is no more just about returns, but is also about sustainability. Hemant Mishra / Mint
What an entrepreneur owns, background of promoters as well as those working in the management team, and clarity about whose money is being utilized are being questioned more closely today than ever before. The scrutiny of a promoter’s background has become so strong that at the latest Endeavor selection panel, a few experts, who had earlier given a green signal to a company on the basis of its business model, tried to backtrack after they realized that the promoter was based out of the US, while his business is in Colombia. Also, the process and parameters by which a firm measures its success needs to be crystal clear, said an executive at Brownstone Global Advisors Llc., who did not want to be named.
Capital efficiency is extremely important now as exit multiples are down and capital has to last for longer than earlier. Companies needing lesser capital not only from the Series A level, or first round of funding, but also in follow-up rounds, naturally, become more attractive. This favours Internet companies: they are seen as extremely capital efficient; they don’t need enormous investments; and some of them have generated huge revenues, said Nicholas F. Beim, general partner at Matrix Partners, citing an example.
It’s no longer about making projections about the next two years, or when will a firm break even. The question is, can a company do well not only in good times, but in bad times as well? Does it have the willingness and the means to change its strategy if things go haywire? Also, investors say as they are investing in a recession-hit market, they need to be sure of the company’s products or services and if they have genuine takers. “For any business, the bar is up now,” said Beim. He feels that companies which are into reselling extra inventory or facilitating job seekers may do well in this market.
Investors say one of the prominent reasons for most start-ups failing, even after having a great product, is the high cost of acquiring customers. The cost of acquiring a customer has to be seen in relevance of the value of the to-be-acquired customer to the company and the consequential return on investment of the acquisition, they say. This factor gains extreme importance in the current market as most big enterprises are trying to put a tab on what they buy, unless it is absolutely essential.
“We look for businesses that can grow quickly, with little marketing spend. (For instance),truly viral opportunities where the product spreads itself,” said Ravi Belani, associate at Draper Fisher Jurvetson.
The current crisis is forcing the investors to think twice. The hunt is not only for the right management team, but for people who would be flexible to alter or modify their business models and plans, to accommodate economic changes, said Pablo Salazar, consultant at McKinsey and Co., a management consulting firm. “We are looking for people who can execute both in good as well as bad times. Do they have the ability to sell a product in new conditions.”
Norwest Venture Partners’ managing partner Promod Haque said entrepreneurs must also exhibit the true passion and vision to build a company, and know how to clearly articulate their vision to investors, customers and other key stakeholders.
“Entrepreneurs also must know their limitations and be willing to be accountable to a board of directors,” Salazar added.
Also, cost effectiveness, starting from the management, is a must in this hour. The days of demonstrating worthiness through fancy offices and private jets are gone. “We want to see entrepreneurs who understand the need of this time. Today, we want to see people at lofts. Basic lifestyle will give a positive impression that its their intent to be economical and not be risky,” said Patrick J. McGovern, founder and chairman of International Data Group, which backs IDG Ventures.
Prospects of an outcome
Investors say during the boom time, their bet used to be on the company’s business idea. Now their questions are: Will it have an outcome at all? Will it be an M&A (mergers and acquisitions) target, or will it go public?
“We are now trying to imagine specific outcomes and time frames,” said John Hamm, general partner at VSP Capital, a San Francisco-based venture capital firm. Moreover, it’s no more about a company having aspirations such as going international in a short span. The promoters need to provide definite business plans, customer lists, revenue generation and utilization of capital plans to demonstrate their own seriousness.
Sooner a company can get profitable, higher are the chances of it getting funded, investors say. They say if someone comes and says it will take his firm two years to reach profitability, the question asked is: What if the market conditions worsen? Also, investments are a lot less casual now, unlike earlier when a lot of “cute” ideas were backed, said Hamm. Seeking strong value proposition, investors say, they gauge if there is a genuine market demand for the product and if it is really missed in the market.
If you are looking for a huge investment, chances are you will face an uphill task. Investors say they are not looking for project-like, long gestation plans, and that funding smaller needs such as $10 million would be easier. “Investors in this market would not invest $60-90 million. If a deal fails, you just go down,” said Matrix Partners’ Beim.
This list has been compiled after talking to Brownstone Global Advisors Llc.; Nicholas F. Beim, general partner at Matrix Partners; Pablo Salazar, consultant, McKinsey and Co.; John Hamm, general partner, VSP Capital; Norwest Venture Partners’ managing partner Promod Haque; Ravi Belani, associate, Draper Fisher Jurvetson; and Patrick J. McGovern, founder and chairman, International Data Group, which backs IDG Ventures.
Deepti Chaudhary was a guest of the Endeavor Group in Miami, US.