Venture capital (VC) firms in India are showing a tendency to avoid risk and invest in more established companies or those who are already backed by VC firms. Even if it means lower returns, VC firms seem to prefer to preserve their capital for now.

B versus A: Nexus India Capital co-founder Suvir Sujan says there are only a handful of VCs doing early-stage investments in India. Abhijit Bhatlekar / Mint

According to data compiled by VCCEdge, the financial research unit of VCCircle, series B, or second round of funding, is turning a favoured investment stage while series A is shrinking in importance.

Usually, VC firms prefer to be the first institutional investor in a start-up. Though risky, funds enter at a lower valuation in the first round, and hope to multiply the value of their investments when the company goes for subsequent rounds of funding or an exit. So, ideally, VC firms’ sweet spot has been the first round of investment, or series A funding. But, if the trend in investment stages in the last two-three years is any indication, this seems to be changing.

In January-September, there were 17 series B deals with a disclosed value of at least $130 million (Rs611 crore today). In the same period last year, there were 13 deals valued at $93 million, and in the first nine months of 2007, there were eight series B deals valued at $52 million.

For the 12 months of 2008, there were 19 series B deals with a disclosed value of $184 million, which shot up from 14 deals in 2007 with a disclosed value of $99 million.

VC firms’ affinity for series B is much clearer when one looks at the number of series A deals during these years. There have been only 25 series A deals in the first nine months of this year with a disclosed value of $19 million (13 deals did not disclose the value of their investments). Compare this with 45 series A deals valued at $103 million in January-September 2008, which rose from 25 deals valued at $98 million in the same period in 2007.

For the 12 months of 2008, there were 66 series A deals of a disclosed value of $184 million (around 30-odd deals did not disclose the value of their investments) and 44 series A transactions in 2007 with roughly half of them declaring $155 million in transaction value.

Ashish Gupta, co-founder and managing director of Helion Venture Partners, reasoned: “When markets take a beating, everyone becomes cautious and you look for stuff that is slightly older."

The appetite for risk is much less when the VC firms are under pressure to show not just returns, but also the real state of their portfolio.

“The downturn has made venture capital firms realize that companies will take time and (a lot of) capital to scale in India. Companies require a lot of heavy-lifting at the early stages. But venture capital firms have a limited bandwidth to do this," said Mohanjit Jolly, executive director (India) at Draper Fisher Jurvetson (DFJ), a Silicon Valley-based early-stage VC fund.

Moreover, limited partners, who invest in VC firms, are pushing for a near-time exit horizon. “Even though venture capital firms are not doing exclusively late-stage investments, they are balancing out their portfolio with Bs and Cs (the third round) along with As," Jolly added.

In fact, a fallout of this strategy has been that most VC funds have earmarked a part of their fund for growth capital investments (a minority investment in relatively mature companies looking for capital to expand or restructure operations) or even launch a separate fund for this. Sequoia Capital India pioneered this concept in India when it launched its first $400 million growth fund in 2006. Last year, it came up with another growth fund of $725 million.

Sequoia now straddles early- stage, late-stage, private equity and even pre-IPO (initial public offering) and private investments in public equity, deals in India. It recently made two times its investment of, or 2x returns as it is called in the VC industry, from a $25-30 million investment in Nasdaq-listed Cognizant Technology Solutions Corp. within eight months.

Norwest Venture Partners last year hired former Goldman Sachs investor Sohil Chand to spearhead late-stage investments. It recently picked up a 2.11% stake in the National Stock Exchange for Rs250 crore and bought less than 5% stake from the open market in mobile value-added services firm OnMobile Global Ltd.

Accel Partners India—which till now has been consistent in its strategy of doing seed/early stage deals in the country—recently brought Neeraj Bharadwaj from Apax Partners India as its managing director to lead its growth equity investing initiative in India

“There are only a handful of venture capital firms doing early-stage investing in India," said Suvir Sujan, co-founder of Nexus India Capital Advisors Pvt. Ltd.

But more and more VC firms will do a mix of early-, mid- or late-stage investing. “Most firms will at least balance their portfolios and look at series Bs and Cs in parts if not exclusively late stage," said Jolly of DFJ. “Ours is a balanced portfolio approach, we will do early-stage with mid-stage, going forward."