Profitability becoming key to early-stage funding

Profitability becoming key to early-stage funding
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First Published: Mon, Feb 15 2010. 10 00 PM IST

New attraction: IDG Ventures’ T.C. Meenakshisundaram. Investors have even approached revenue-generating firms with offers of cash. Hemant Mishra / Mint
New attraction: IDG Ventures’ T.C. Meenakshisundaram. Investors have even approached revenue-generating firms with offers of cash. Hemant Mishra / Mint
Updated: Mon, Feb 15 2010. 10 00 PM IST
Bangalore: Bangalore-based iCreate Software Pvt Ltd, a business intelligence company focused on banking products, recently raised Rs15 crore from venture capital (VC) investor IDG Ventures India. The start-up deal was unusual in many ways. First, the three-year-old start-up raised Rs15 crore in its first tranche, four times the typical amount for an early-stage company. Second, iCreate is a profit-making entity looking at generating revenue of around Rs250 crore in five years, rare for a start-up. Third, the firm already has four customers—all based overseas—and is now looking at signing up clients in India.
New attraction: IDG Ventures’ T.C. Meenakshisundaram. Investors have even approached revenue-generating firms with offers of cash. Hemant Mishra / Mint
“As investors, we understand that start-ups need $15-20 million (Rs69.75-93 crore) to fuel their growth over three-five years,” says T.C. Meenakshisundaram, managing director and founder, IDG Ventures, on the possibility of funding the company again. “We have reserves in place for them.”
Start-ups and profit are usually out of sync because of the fledgling business of these companies, but profitability is a genuine attraction in today’s market among funds still grappling with a lingering liquidity crunch and difficult questions posed by limited partners—their key investors.
IDG Ventures and other early-stage investors, only a few of which are active now, are engaged in what could lead to a redefinition of early-stage funding. They are becoming inclined to back profit-making start-ups to cut investment risk.
Early-stage funding, by definition, refers to investment of about $1 million or less in companies that have a prototype, but not yet a product to approach the market with, and that are yet to earn revenue. The term “early stage” is, however, often used loosely and many times, investors refer to a deal of $2 million as an early-stage investment.
Three deals—not involving IDG Ventures—where cash-generating start-ups are being backed by early-stage investors are lined up. “These three deals are in consumer services, IT/ITeS (information technology/IT-enabled services) and healthcare sectors. The investors are in New Delhi, Bangalore and Mumbai, and the investment range is $2-4 million,” says a person close to the deals, requesting anonymity.
The No. 1 criterion for VCs is how fast a company can break even or generate cash, says Indus Khaitan, general partner, Morpheus Venture Partners, which mentors start-ups. Revenue generation, which cuts the risks involved in funding a firm, is used as a validation of the investment.
“If the revenue generation plan is not there, perhaps the entrepreneurs haven’t thought their plan thoroughly,” Khaitan says. Although investments are always risky, early-stage fundings are the riskiest because the business models of such companies are yet to be proven. According to investor estimates, only about 10% of start-ups manage to survive.
Also, from a fund’s point of view of diversifying risk, it makes more sense to invest $2-4 million in one profit-making start-up than invest $1 million in four different start-ups that have no validation of their offering.
In fact, risk-averse VCs are so eager to back profit-making start-ups that companies such as Reach Process Outsourcing Pvt Ltd, a tax preparation services firm, Naabo Solutions Pvt Ltd, which offers IT solutions for the healthcare industry, and online community-based T-shirt designing company Scopial Fashions Pvt Ltd—which have been mentored by Morpheus Venture Partners, and are generating revenue of at least Rs50 crore annually—have been approached by VCs asking if they need cash.
“It is very soothing for investors to invest in revenue-generating firms. They are a huge attraction,” says Khaitan.
Fund managers gain confidence if a customer is paying for an offering. It indicates that the firm has got its product, value and price model right, says Sarath Naru, managing partner, VenturEast Fund Advisors, an early-stage VC fund. “It’s imperative for an investor to ensure that the first few customers and the initial revenue are genuine and not driven by family or friends.”
ICreate, meanwhile, intends to use the money it raised to build a global sales platform, increasing marketing efforts, and continuing investment in product development to capitalize on a business opportunity in banking intelligence, estimated at $20 billion globally.
“Currently, banks use multiple sources for business intelligence and analytics products. We can offer them all in one package. We are now in talks with Indian banks,” says Vivek Subramanyam, chief executive, iCreate.
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First Published: Mon, Feb 15 2010. 10 00 PM IST