Why a shakeout in India’s venture capital industry is long overdue
It isn’t common for venture capitalists in India to worry about losing their jobs. Especially not on account of poor investment decisions. Lately, however, that’s changed. Ever since a top-rung fund manager at one of the country’s largest venture capital shops was shown the door—his investments, a gaggle of mostly consumer Internet bets, haven’t performed as well as the firm would have liked—the local brotherhood of venture capitalists has been on the edge.
Fears of a shakeout within the venture capital industry at this juncture aren’t unwarranted. It is soon going to be two years into a crippling downturn in the start-up market. The period has been fraught with hectic, sometimes desperate, consolidation across the spectrum of venture capital-backed start-ups. Investors have employed every trick in the book to keep their investment portfolios built over the last decade from going up in smoke. Some startups have been pushed to alter their business models, others have been steered into mergers with stronger rivals, some have been swallowed up in fire sales and yet, others have had to shut operations for lack of capital.
Those manoeuvers have helped control the damage—a consequence of unbridled investments chiefly in consumer Internet start-ups just prior to the downturn—for the short term. The consolidation, or ‘clean-up’ as many fund managers dub the exercise, has helped venture capitalists separate the bankable assets in their portfolios from the rest. Capital reserves have been reallocated to ensure that more good money isn’t thrown after bad.
Yet, the industry is still far from being out of the woods. After more than a decade of investing, venture capitalists in this market continue to wrestle with their biggest challenge—the lack of blockbuster exits to justify the billions of dollars that have been pumped into startups here. Investments that were tipped to be showcases for those elusive blockbuster exits are in disarray.
Nowhere is this more evident than in the ranks of the mighty technology unicorns, or start-ups valued privately at a billion dollars or more. Snapdeal, an e-commerce unicorn valued at $6.5 billion at its peak just over a year ago, is currently fighting to stay alive. A merger bid with larger rival Flipkart was called off last week due to reported differences over valuations. Flipkart had offered to buy Snapdeal in an all-stock deal that valued the latter at $850 million. The deal would have given Japan’s Softbank Group Corp., Snapdeal’s largest investor, a significant stake in Flipkart and a chance to salvage its estimated $900 million-plus investment in the company. Snapdeal has raised nearly $2 billion since its inception in 2010 from an assortment of investors. Apart from Softbank, venture capital firms Nexus Venture Partners and Kalaari Capital stand to sustain major losses from the Snapdeal implosion.
Over at Flipkart, the situation isn’t terribly stable either. The e-commerce company, which has raised nearly $5 billion since inception, has seen its valuation tumble from a peak of more than $15 billion to $11 billion.
Sure, the $1.4 billion it raised in April this year from marque global investors Tencent Holdings, Microsoft Corp. and eBay Inc. gives it enough fuel to play the market for the next 12-18 months. But, the external and internal factors it continues to battle make for an uncertain future. There’s Seattle-based e-commerce giant Amazon breathing down its neck with an inexhaustible capital war chest. Flipkart’s largest investor, New York-based hedge fund Tiger Global Management, is desperate for an exit—it has pumped in an estimated $1 billion into the company—and has slowed down on fresh investments. Tiger Global, in fact, is currently running the company.
In January, it deputed one of its managing directors, Kalyan Krishnamurthy, to the CEO’s job. It is widely believed that Krishnamurthy’s primary mandate is to find a buyer for at least part of Tiger Global’s stake. The failed Snapdeal acquisition would have met that objective and given Flipkart access to Softbank’s considerable capital resources. Mint reports that Softbank is now separately in talks to buy shares worth $1.5 billion in Flipkart. Apart from Tiger Global, venture capital firm Accel Partners is a significant shareholder in Flipkart.
Then there’s ride hailing unicorn Ola, which is having troubles of its own. Like its peers, it has seen its valuation take a beating, down to a reported $3 billion from close to $5 billion last year. Since last year, it has struggled to raise fresh capital and is locked in a bruising capital-intensive battle for market share with San Francisco-based Uber. To complicate matters, there has been talk lately of Softbank sniffing around for a stake in Uber. The Wall Street Journal reported last week that the Japanese conglomerate had initiated discussions to pick up a “multi-billion dollar” stake in Uber. If that happens, the situation at Ola could go from bad to worse very quickly. The company has raised close to $2 billion from multiple investors, including venture capital firm Matrix Partners India, since 2010.
Given the uncertain fates of even some of the biggest bets from the past decade, it isn’t difficult to understand why venture capitalists are nervous about their own fates. Limited partners—investors in venture capital funds—are nearing the end of their patience and need to see more than average returns. “India is gaining this reputation (among global limited partners) for being this black hole… money goes in and nothing comes out,” says one venture capitalist with a global venture capital firm in Mumbai. Limited partners, he says, have started to hold fund managers, especially those at the partner level, accountable for poor returns. “The chatter among fund managers these days is pretty candid… one told me the other day that he may not be around six months later…” shares another venture capitalist with a homegrown firm in Mumbai.
There are a couple of ways in which a shakeout in the venture capital industry will manifest itself. One, individual fund managers across the spectrum will be asked to go based on the performance of their portfolios. This is more likely at firms that operate here as the local arms of larger global firms, either investing from a global fund or from India-dedicated funds. Firms that fall in this category would include Sequoia Capital India, Lightspeed Venture Partners, Matrix Partners India, Norwest Venture Partners and Accel India. “For a lot of the global firms, a 4-5x return, which is what the average IRR (internal rate of return) has been so far, is simply not good enough,” says the venture capitalist at the global firm mentioned earlier. More heads, he says, are likely to roll as the downturn in the market gets deeper.
Two, entire teams of fund managers will disintegrate. This will happen both at the local arms of global firms and at homegrown venture capital firms. In the case of homegrown firms, teams that are unable to hold the confidence of their limited partners will find themselves out of business. This has already happened with Helion Venture Partners—following internal conflicts and a lacklustre portfolio performance, the firm was unable to raise a fourth fund. Three of the firm’s four founding general partners—Kanwaljit Singh, Sanjeev Aggarwal and Rahul Chandra—have gone their separate ways to raise independent funds. “I know of a couple of general partnerships that are on the verge of breaking up… the shakeout is just starting…,” says a fund manager at one of the country’s largest homegrown venture capital firms. Well known homegrown firms here include Nexus, Kalaari, IDG Ventures India and Inventus Capital Partners.
In all fairness, a shakeout in the venture capital industry is well overdue. The responsibility for the excesses of the past, that led the start-up ecosystem into the ongoing downturn, lies as much with such investors as with the start-ups they’ve backed. So far, only start-ups have been held accountable—founders have been eased out of their companies, employees have lost their jobs, and vendors haven’t been paid. It’s time to even the scales.
Snigdha Sengupta is a consulting writer with Mint. She contributes stories on venture capital and private equity.