Karthik Reddy, managing partner at early-stage investor Blume Ventures, talks about India’s fundraising environment, competition in seed-stage investing, and a worrying lack of exits. Edited excerpts of an interview:
As you approach your third fund’s final close, how have limited partners (LPs or investors in VC fund) conversations changed over the last 7-8 years?
Institutional LPs form the base of a long-term fund house and their ask has not changed over the last eight years—“Show us that the country’s growth curve or markets you are chasing are capable of building large outcomes", “show us how exits will happen" and “show us that you are building a team and culture that attracts best founders and builds the next layer of great venture spotters". As the fund sizes grow, this ask only grows to be commensurate with the size of exit outcomes—in our case, this means needing to be 4x larger exit values from what we achieved in Fund I, at the least.
With more than a dozen dedicated funds and new entrants like Sequoia’s Surge, does the seed stage have the capacity to absorb so much capital?
Seed stage has been competitive for 2-3 years now, even before Sequoia’s Surge. I don’t think that alone changes anything. There are far more than just a dozen seed funds. Maybe 3-4 dozen if you add all the sectoral funds, family offices, spin-offs from larger funds etc. And they will all make 6 out of 10 bets that don’t scale to full potential (these are misconstrued as failures most times, which is not the case) - this hasn’t changed across six decades of venture capital. The key is to make investments with great founders and great market opportunities and both those sets are growing every year. We think the entrepreneur pipeline has never been stronger and there are enough great investments to make, but later stage capital and/or strategic buyers need to have similar alignment of scale in the ecosystem.
Will we see Blume exit a few companies this year? Is the lack of exits also worrying for the VC industry?
We consistently have a few exits every year. We don’t force them as much as the market does. We are beginning to realize that the only way to predictably drive exits is to build IPO-worthy companies, back such founders and build on that trajectory - the best exits will follow. Lack of exits? Yes! A resounding yes! The industry should be alarmed at not planning better for how to build “exitable" companies or paths to exits. We are woefully inadequate (so far) on building IPO-worthy companies but I think there is a massive wave coming - I’m hoping to see 50 IPOs in tech of all sizes and shapes by 2025. Acquisitions continue, but not at the prices one expects since it’s a buyers’ market and it is in Indian markets’ DNA to squeeze the seller. To my surprise, it’s not one bit different across most of the startup industry since the large startups have yet to hit their own IPOs or massive positive cash flows, resulting in very conservative acquisition prices.
We haven’t seen any unicorns from Blume’s portfolio yet. Is that something you worry about? Do LPs ask about this?
There’s only one measure of Fund returns - IRR or Cash on Cash returns! Yes - As fund sizes grow, it’s imperative for a top decile fund to have “Unicorn" outcomes in the portfolio. So, LPs understand and want this but they’re also aware that we could deliver a great Fund I without arguably needing Unicorns. Fund II is all of 3.5 years old - so, it feels premature to demand Unicorns, but we think some of our companies including Grey Orange, Unacademy, Servify, Turtlemint, can get to the $500 million to $1 billion level if not surpass the Unicorn mark comfortably. We are much happier building sustainable, path to profitability businesses, even if a year or two slower, than chasing Unicorn speed and valuation artificially.
Blume has made fairly broad based bets across consumer, saas, B2B, internet, etc. What would be some specific focus areas going forward?
The broad areas still hold. The India opportunity is still consumer or SMB-led growth. SMB's include micro-entrepreneurs. The post Jio India is hungry for growth enabled by what a smartphone can deliver - the next 500 million folks on the Indian net will shape the country in many ways for the next decade - financial services, education to jobs, smarter cheaper healthcare, media, travel/commute, and revolutionizing agri (even ahead of manufacturing) will be the areas we will try and find bold founders challenging India's status quo. Our early Fund III investments - Jai Kisan, an undisclosed EV play, TartanSense and LeverageEdu - are indicative of what's to come in this 2/3rds of our portfolio. Software and deep tech plays that are leveraging Indian tech talent to build solutions for global markets are the other 1/3rd of our portfolio. Going to overseas markets means that very large market sizes open up for these entrepreneurs - we think we are going to see Indian founders deliver more and more large wins. Agara Labs and Ethereal Machines are our first Fund III investments in this thesis area.
We also hear you are raising a follow-on fund along with the third main fund. Will this trend continue?
The follow-on fund is designed only for large winners out of Funds I and II. We didn't have adequate reserves with our small fund sizes and it would've been a shame to let go companies at $50-100 million valuations when we think they're growing to grow 10-20x to exit from here. We hope to get better at rightsizing funds in the future than keep raising opportunity funds. The $80-100 million attempt at Fund III is a step in that direction with a much more concentrated portfolio - we can now play as deep as $5 million per company across rounds, as and when we see the potential. Other seed funds may mimic the opportunity when they feel they're missing a big winner but this is a tactical phase that smoothens into larger fund sizes over the long-term.
Do you see the market to be overvalued? How much of a concern is valuation, from B2B to B2C? Has it increased in the last year or so?
In B2C, we see overvaluations when market winners have been decided. Too much of the future prospect seems built into the justification of valuation, especially if there's a parallel large winner in the Chinese market. Lofty B2C valuations at seed seem to justify another type of confidence - a scaled founder or leadership member from a large startup / unicorn has disproportionately better odds at succeeding to build even larger - this is somewhat true too. Its tough to compete in those kind of spaces/companies for small funds. In B2B, we see some inflation when the company starts crossing /trending into $10 million+ ARR but that's justified since all the hard work is behind - the investor is betting that a much more profitable $100 million ARR outcome is possible. Quality founders / quality performance / traction are beginning to understandably attract premiums on valuation.
Do you see the seed stage getting more competitive as bigger funds including Sequoia double down on the space?
Seed stage has been competitive for 2-3 years now, even before Sequoia's Surge. I don't think that alone changes anything. I'm a believer that all the best founders will work with funds that significantly increase their odds of building a great company. So, as a pre-A fund, the key is to demonstrate this repeatedly, with stellar performance - no different from what the LP asks for. If one can do that, it doesn't matter what the "competition" is - everyone can collaborate anyhow as co-investors - the key is in the hands of the best founders, on who they choose to pick as partners.