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Investors insist on new clauses to protect money

Investors insist on new clauses to protect money
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First Published: Mon, May 17 2010. 09 09 PM IST

Restrictive steps: DFJ India’s Mohanjit Jolly says there will be a lot of cleaning up of portfolios by venture capital investors. Hemant Mishra/Mint
Restrictive steps: DFJ India’s Mohanjit Jolly says there will be a lot of cleaning up of portfolios by venture capital investors. Hemant Mishra/Mint
Updated: Mon, May 17 2010. 09 10 PM IST
Bangalore: It’s damage control time for venture capital (VC) investors in India.
Restrictive steps: DFJ India’s Mohanjit Jolly says there will be a lot of cleaning up of portfolios by venture capital investors. Hemant Mishra/Mint
After overpaying during 2006-07, when the business was at a peak, investors are seeing at least a fourth of their portfolio firms performing below expectation. And the slowdown of 2008-09 has dimmed exit possibilities for many of these firms.
“We will see a lot of cleaning up of portfolios—packing off or selling off of companies—because inside rounds (small additional funding) would be difficult,” says Mohanjit Jolly, managing director at VC firm Draper Fisher Jurvetson (DFJ) India.
Investors are now inserting additional clauses that would at least protect their capital. For instance, term sheets or contracts now come with covers protecting the initial investments.
Some of these steps have existed before, but are being enforced only now, adding to the hoops entrepreneurs have to jump through before reaching the coveted cheques. “I would not be surprised if this starts impacting deal closures,” says Ashish Gupta, managing director, Helion Venture Partners.
Below is a list of clauses investors are adding to protect their money:
Fixed returns
Some investors have started seeking fixed returns of 20-30% irrespective of how a portfolio company fares. They still stand to lose if the company becomes bankrupt because the investment is in equity.
Dividend provision
This clause, specific to the Indian market, ensures capital returns over a fixed time. In the US, start-up firms become successful or fade out in about five years, but in India they continue existing without doing either, reason investors.
Deferred valuation
Valuations in many VC deals in India are being arrived at based on a company’s performance a year after an investment.
In effect, a VC fund puts its money into a company for a certain stake but the holding could go higher or lower based on the firm’s functioning after a year.
Budget, exit oversight
Investors want to work with promoters in budget allocation and are seeking the right to enforce a strategic sale of the company or a buy-back of shares by the promoters after a stipulated period.
Milestone funding
VC funds are offering to extend funding against set milestones, including marketing and financial goals, over specific periods.
This gives the VC funds a greater say in the portfolio company and protects against large investments in a firm that’s not doing well.
Market linked
Early-stage investments could become difficult for companies that have offerings for markets that are yet to develop. Investors say market evolution can, at times, take longer than a company can stay afloat.
Debt-equity combo
For the small, additional capital needs of a portfolio firm, investors are insisting that the debt be converted into equity at a later date. While such internal rounds of funding are not unusual, the conversion clause is promoter-unfriendly. Entrepreneurs don’t usually look forward to an investor’s overall stake in their firm going up.
Liquidation rights
Under this, an investor gets the first right to get his money back, say, when a portfolio firm is acquired. In addition to the capital, the VC fund will get twice the worth of its stakeholding in the company.
Anti-dilution clause
Even VCs say this is one of the most restricting clauses for promoters. Under this, if a firm’s valuation goes down after a year, a VC’s stake in the firm would increase to keep its investment from diluting. There’s no change if the valuation rises.
Promoter vesting
This clause is meant to keep the entrepreneur team together at least for a specified period. If a promoter decides to leave a portfolio company before this, his or her stake is nullified.
This list has been compiled based on inputs from Gupta, Helion; Jolly, DFJ India; Bejul Somaia, managing director, Lightspeed Advisory Services India Pvt. Ltd; Sailesh Rao, partner, transaction advisory services, Ernst and Young India; Deepak Srinath, co-founder, Viedea Capital Advisors Pvt. Ltd; Rajesh Srivathsa, managing partner, Ojas Venture Partners; and Mukul Gulati, managing director, Zephyr Peacock Management India.
deepti.c@livemint.com
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First Published: Mon, May 17 2010. 09 09 PM IST
More Topics: Venture capital | Investors | Dividend | Budget | Debt |