2012: Internet and Mobile VC investments

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VC investments in Indian E-Commerce

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Negotiating “timebomb” termsheets – By Deepak Srinath

(This piece was first published in VC Circle on Jan 17, 2012)

Fred Wilson of Union Square Ventures, the best VC blogger in my opinion, recently referred to a blog post on negotiating job offers (http://t.co/2MNZUIKZ) and said “replace the words “job offer” with “term sheet” in @spolsky’s post and the advice is still spot on”. What Fred is referring to here is the “exploding termsheet”, a commonly followed practice in which a VC issues a termsheet with a really short validity period – sometimes less than 24 hours. VC’s use this tactic to lock in deals and prevent entrepreneurs from shopping around for other offers. The intent may also be to prevent entrepreneurs from fully understanding implications of certain clauses not giving them enough time to negotiate. While this tactic invariably pisses off entrepreneurs, they succumb to it many a time because they do not want to risk losing out on the offer.

I actually believe this tactic can be detrimental to VC’s who want to invest in the best entrepreneurs. Let me illustrate with an anecdote – One of our clients was in advanced discussions with three funds for their first round of funding, lets call them funds A, B and C. Fund A was the first to move to termsheet stage and sent us a draft copy of their standard termsheet without any numbers and specifics. We received this at around 3 pm in the afternoon and we were told by the fund that if were fine with the broad terms, they would send us a copy with the numbers filled in by 6pm or 7 pm the same evening. However, the termsheet would expire by midnight on the same day and if were interested we needed to sign and send it across before that. We requested for a couple of days time to properly review the termsheet and negotiate terms. The fund declined and said that they did not like to have their termsheet floating around after they made an offer. We had to sign the same day or the offer would fall off. The entrepreneur politely declined the offer and walked away from the deal. To the entrepreneur, this was a clear indication of how his relationship with the fund would pan out and he did not want investors on his board who would hold a gun to his head and force decisions on him.

A few days after this, Fund B made an offer and sent us their termsheet, with all numbers filled in. Over the next couple of days, we negotiated various terms and arrived at a consensus on most of them. By this time, Fund C was also very close to making an offer and we naturally wanted to compare offers and make an informed decision. We decided to be completely transparent with Fund B and told them that we were expecting another offer and requested for a few days to make a decision. Fund B’s response to this was that they wanted the entrepreneur to make a decision based on what was best for him and did not believe in forcing him into a decision. They were happy to wait for us, but requested that we do not leave this hanging indefinitely.  We promised to give them our decision within two weeks. The offer we received from Fund C in a few days was marginally better than the offer from Fund B. However, the entrepreneur was so impressed with the way Fund B handled the negotiations that he was convinced they were the right people to be on his board and help him build a great company. We accepted the offer from Fund B with hardly any renegotiation and closed the deal within a month.

Looking at this from a fund’s perspective, I understand why VC’s try and push the “exploding termsheet”. However, I think they stand a much better chance of winning the deal by making the entrepreneur comfortable enough to be open and transparent with them. Most entrepreneurs don’t just decide on the basis on valuation or a few other terms. As long as the terms are fair, it is the comfort level with the funds partners that usually sways the decision. I agree that a termsheet cannot be open indefinitely, but the timelines need to be reasonable and fair to both sides.

My final piece of advice to entrepreneurs – Funds are not going to go back on an offer if you take an extra week or two to decide. Once a fund decides to make an offer, they want the deal as badly as you do. So do not succumb to pressure tactics and sign a termsheet unless you’re fully convinced about it. Being open and transparent works best (as with most situations in life). At the same time, be fair to the fund and respect their time too. The VC community is a small closely knit group and if you try and play one fund against they other, you’ll do your reputation more harm than good.


IPO valuations and the role of bankers – By Aravind G.R

The Business Insider’s Henry Blodget asks ‘how would you feel if your real estate broker sold your house one day for $1 million to someone (a friend of his, presumably) who turned around and sold it the next day for $2 million.’ You’d be pissed, right, and feel betrayed? Of course you would.

To put it simply, LinkedIn execs sold their shares to ‘some people’ at $45 on Wednesday night, while these people sold it $100 on Thursday morning. Obviously, finger(s) was pointed at the Ibankers who simply “screwed their client out of $130 mn” and charged them $25-30mn to do it.

Before we hang the Ibankers in the middle of the street (while a massive protest at wallstreet continues), lets listen to some of their most probable excuses/arguments and try to debunk them:

1. Mr Banker: How in the world can you expect us to know that the stock price would double to 90+? When we priced at 45, we were told by the same pundits that it was unreal and that we had ‘lost it’

My Take: Agreed, it is very difficult to ‘value’ internet & tech companies, especially lightspeeders like LinkedIn. If you remember, a few years ago Google had no idea about their correct value either, but they pioneered a best practice of ‘Dutch Auction’ to clearly put the ball in investors court and ask them-‘tell me how much you want to buy us at’.

So, Mr Banker’s job would have been easier if he’d trusted his institutional investor buddies to come up with the ‘value’ rather than taking a shot at it in the dark.

2. Mr Banker: No two people value a high growth technology company the same way. Our valuation was close to $45. Live with it.

My Take: We Ibankers are hired to solve this exact problem; we are supposed to get the valuation close to what the market is willing to pay. I understand that underpricing has an inherent advantage and has become sort of an ‘expectation’ from IPO investors. The process of Dutch auction addresses this problem as well.  The fact that you are setting a price band is keeping you in control of pricing rather than the buyer who is bidding against thousands of other bidders for the same share. Price discovery is being stifled a bit, isn’t it?

We boutiques face the same problem, we don’t know if our client should be valued at 10X or 30X of something. But, in the name of god, I wish we had 10 VC funds bidding for the current round. We have done so much better to get closer to a ‘fair’ valuation with just 3-4 VC’s jostling for the same opportunity. Lets face it, we all know how much of termsheet shopping gets done and what a couple of termsheets on the table means to a fund which is looking at the opportunity for the first time.


3. Mr Banker: These pundits will be on my case if the price comes down after listing. I’m being ‘just’ to everyone!

My Take: There are enough instances where Ibankers have been accused of screwing the ‘unsuspecting investors’ by selling them a crappy stock at a ridiculous valuation. Can Mr Banker really help this? In India, he is ‘paid’ to ‘maintain’ the price for a few weeks/months after listing. But it is not Mr Banker’s job to see that the stock price is always above the IPO price.  Well, buyers beware, right?

4. Mr Banker: Aha, I’m way more intelligent than you think. I’m doing this to ‘bait’ investors (future ones as well) into believing that the stock is ‘hot’. Investors will not support a stock if it did not ‘pop’ on the listing day; I’m attracting a lot more bids in the IPO because of this and investors will continue to be drawn to stock after Meanwhile this also helps

My Take: Please, diligent investors understand that magical ‘pop’ on listing is not a sudden spike in valuation, but rather a bouncing spring that you had suppressed. The only folks who’d be fooled by this ‘act’ are the media and may be some retail investors. This baiting game will eventually make sure someone bites your hand off, Mr Banker

Killing me softly with your Due Diligence – By Deepak Srinath

(This post was originally published on the VC Circle blog on October 14, 2011)

Why does it take so long for a venture deal to close after a term sheet is signed? This is a question entrepreneurs often ask in despair. This interminable state of Due Diligence (DD) kills entrepreneurs and I can’t think of too many reasons an investor would want to drag the process (other than issues with availability of funds).

For those of you who may not be familiar with the Venture Capital investment process, after a termsheet is signed an audit firm and a legal firm are usually appointed to do a financial and legal due diligence on the firm. Sometimes there is a business diligence or a technology diligence added to this, but more often than not the fund does this on their own. Based on the findings of the DD, there may be a renegotiation of the terms (unlikely in early stage firms) and the lawyers then draft the definitive agreements which usually comprise the Share Subscription and Share Holders agreements along with a bunch of other letters, board resolutions, etc.

Every time we sign a termsheet for one our clients, I make it a point to ask the fund how long they expect the Due Diligence (DD) and agreements drafting to take. The standard reply is that if all goes well the deal will close within a couple of months. Every single time, this has proved to be untrue; our experience has been anywhere from 3 to 6 months. Sometimes there are genuine reasons for this, but usually it is a combination of ignorance, incompetence, apathy and ego clashes that cause this wasteful delay.

A few observations on some of these delay factors:

1. Lack of preparedness of the company – It’s easy to pass on the buck to VC’s, auditor or lawyers for dragging the deal; entrepreneurs first need to make sure their own house is in order. Bad or non-existent accounting practices and lack of regulatory compliance are very often the cause to delay.  I’ve heard many entrepreneurs claim they are so busy building the business that they have no time for accounting or compliance issues. All it takes is engaging a good CA firm and keeping your eye on them. If the entrepreneur is using an investment banker, make sure they provide a basic DD checklist in advance and get things in order.

2. Engagement model with audit and legal firms – Audit and legal firms must be engaged on terms that do not give them an incentive for taking forever. The fee for the assignment should preferably be fixed and not hourly billing. Moreover, there must be a show cause and penalty for delays beyond agreed timelines.

3. The fund partner is not driving the process- Sometimes, the senior partner in the VC fund does the deal and leaves it to the junior associates to handle the DD. The juniors are not able to drive the process and exercise control over the firms doing the DD. Partners should stay involved or delegate authority to their juniors and communicate it to the firms doing the DD. This way a fund can influence the DD process and make it move faster.

4. Data checklist relevancy: More often than not DD firms use a standard requisition list of documents irrespective of the target’s sector. Even though it gets clarified during the course of the DD, it always adds a couple of week’s worth of back and forth and mostly redundant work. The fund should make sure that instead of a standard template, a relevant data checklist is sent out.

5. Audit and law firms using inexperienced resources – The DD is not just about gathering data; it requires some judgment calls on what is important and what is not. Inexperienced resources getting stuck on issues that are irrelevant or minor have caused much delay. The fund should make sure that the DD firms they appoint provide adequate supervision of junior resources.

6. Lawyers playing ego games – My lawyer friends won’t like this, but I’ve been in situations where the lawyers representing the fund and the entrepreneur start playing games of one-upmanship and endlessly debating technical terms that have very little impact on the terms of the deal. This is a really tricky situation because even if the fund and the entrepreneurs sense this happening, there is a perceived risk in asking their lawyers to let something pass and move it faster. Nevertheless, funds and entrepreneurs need to be aware of this and discuss it with their lawyers.

7. Simultaneous drafting of definitive agreements – It could be helpful (especially in early stage deals) if the lawyers are instructed to draft the definitive agreements in parallel to the DD. If changes are required based on the DD findings, they can always be incorporated. This can save a few days, instead of waiting for the DD to complete and then start drafting.

8. Lack of trust between the fund and the entrepreneur – In the deals I’ve worked on, when the level of trust has been high between the entrepreneur and the fund, deals have closed much faster. When the entrepreneur goes into a deal wary that he is going to get shafted, every single point is debated endlessly and deals take forever to close. Trust is something that gets built over time and through a lot of intangible actions. I can only urge entrepreneurs not to get into deals where they don’t trust the fund’s intentions completely.

Ideally, all venture deals should close in less than two months. Hopefully, this will become the norm rather than the exception as the VC space becomes more competitive and entrepreneurs more aware.



Viedea’s pick of must read posts for October

The Viedea team tracks a number of blogs about the startup and investing world. We thought it would be useful to share some of the best blog posts we’ve come across in the past month with our community. We will make this a regular feature henceforth.

1.Building a Company vs Building a Business:  Fred Wilson of Union Square Ventures on the distinction between building a business and building a company; something all entrepreneurs need to understand.


2. The Art of getting back pending dues from customers: Venky from efarm has posted this piece on pluggd.in. Every entrepreneur who’s done business in India has experienced the difficulties of recovering dues. Very relevant and topical post.


3. How to sell your company : Entrepreneurs need to know how to sell. Some are born salesmen, some have to learn along the way. Entrepreneurs are rarely successful if they do not learn how to sell. This Techcrunch post talks about how being a good salesman does not mean you’re a good negotiator. Important distinction and some good tips on sales.


4. Understanding how dilution affects founders: This is a must read for any entrepreneur aspiring to raise capital. Mark Suster’s blog has a great infographic representation of how founders get diluted over fundraising rounds and the impact of ESOP pools and participating liquidation preferences on their returns. Fred Wilson and Brad Feld have also written some great posts on dilution, but this one has an easy to understand graphic.


The perils of taking seed money from VC funds – By Deepak Srinath

I met three interesting startup’s last week. All of them were founded by entrepreneurs in their late twenties or early thirties, who had been part of product teams in other startup’s or global tech firms. The startup’s were pre-revenue or had just signed up a few customers. Typically, in the Indian VC context, these firms would be considered too early by ‘early stage’ VC funds to do a Series A. They would be asked to come back in 6 months time when they had signed up more customers and had discernible revenue traction. However, to my surprise, all of them claimed to have termsheets or were in serious conversations with VC funds – not seed stage focused funds, but regular VC funds.  What’s even more surprising was that the quantum of funding they were offering ranged from $200K to $500K, not the usual $2 million plus that these funds like to invest.

A few top tier VC funds have started making investments in the realm of angels/seed stage funds. When a VC fund makes a seed type investment, they are essentially purchasing a low cost option to participate in a full round if the startup shapes up well. Unlike an angel investor or a seed fund, a VC fund’s economics don’t work on a  $200 K investment; their economics work on making much larger investments in each of their portfolio firms. So how does this matter to a startup as long as they get the money, right? Maybe not, let me explain.

In most cases when a VC fund makes a seed investment, they contractually tie in an option to lead the next round, which is typically in the $2 to $5 mil range. If the fund exercises this option, the startup loses out on talking to other funds and discovering the best possible valuation and terms. If the fund does not to exercise the option, other funds will be very wary to investing in the startup. Their view will be that if the fund who did the seed round and has an inside view of the startup does not want invest, surely there must be something amiss.

A few VC funds who make seed investments mention that they do not tie in an option on the next round for precisely this reason. Nevertheless, with or without a specific option to invest, if the fund does not participate for whatever reason, other VC’s will wonder what’s going on.

On the other hand when a startup takes money from an angel or seed stage fund, there is no expectation that they will participate in a follow on round. Their model is based on investing a small amount really early and guiding the startup through to a stage where they are ready for a VC fund to come in.

For long we’ve bemoaned the lack of adequate seed stage funding in India. This is clearly changing now with the more angel investors and seed stage funds springing up everyday. From an entrepreneur’s perspective, funding at every stage is critical. However, if entrepreneurs have alternatives, they must think carefully before taking seed money from a VC fund.

Internet Commerce Valuations: Pay for strong fundamentals, not for hype – Deepak Srinath

(This blog was first published on the VC Circle blog on 29 July 2011)

There is a raging debate in the US tech and financial media about the ‘tech bubble’ we apparently are in the midst of. Every journalist, blogger, VC and academic is either painting doomsday scenarios or vehemently denying there is a bubble. Either way, we’re seeing unprecedented valuations for social media and social commerce startup’s, both from VC’s and public markets.

US tech valuations seem to have had their affect on the Indian startup scene too. A few days ago The Economic Times carried an article on Snapdeal’s next round of funding – ‘sources close to the deal’ are quoted as saying that the deals site is raising INR 200 cr at a valuation of INR 1000 cr. Rumors are doing the rounds that Flipkart is raising its next round at a billion dollar valuation. If these valuations are halfway close to the truth, we’re talking multiples of 10 to 15 times their annualized run rate or Gross Merchandize Value-GMV (i.e., their current monthly sales multiplied by twelve). Are investors justified in paying such valuations? What about margins and net income, have they become irrelevant?

This debate about VC’s over paying for e-commerce startup’s is particularly important in the Indian startup context. VC funds in India, barring a handful, are still going through their first or second investment cycles and very few of them have seen big exits yet. Most early stage funds have significant exposure to e-commerce and need to show good exits in order to raise future funds. It may not be an exaggeration to say that the early stage ecosystem will suffer if VC’s have overpriced these investments and don’t make good returns.

I actually don’t think these valuations are as crazy as they are made out to be.

E-Commerce companies take a long time to become profitable. Amazon took seven years to turn in its first profitable quarter. Even today Amazon’s net income is small compared to Google or other tech giants. The market values Amazon (P/E of 82) for the kind of profitability it will deliver in future. If you take a closer look at investments in the internet commerce space in India, it is only the category leaders who command such valuation premiums. E-commerce worldwide is all about becoming the no. 1 or no. 2 player in a category and dominating it. So investors are essentially taking bets of firms who have demonstrated early traction and paying in anticipation of what they hope these companies will grow into in two or three years.

However, investors must be wary of paying valuation premiums based on GMV alone. GMV spikes can be achieved by deep discounts or cashback schemes and these will ultimately prove unsustainable unless you build loyalty and repeat purchases. Critical success factors in the long term are low Customer Acquisition Costs and high Customer Lifetime Value (CLV). Profitability will ensue if these two metrics are under control. Investors should be very careful not to pay for hype. As long as premiums are being paid for real fundamentals, all of us will be fine in the long run.

Observations on how good VC’s work – By Deepak Srinath

Two recent incidents prompted me to write this. The first was a VC meeting that left me super impressed- the fund partner had read through all the material we had sent him, analyzed data, made reference calls and asked the most perceptive and intelligent questions. What’s more, the meeting started exactly on time and even though he rejected the deal we were thankful for the insightful feedback. A few days later I was in another pitch to a couple of partners from a fund and one of them fell asleep- I’m not talking about a drowsy eyed yawn, this was chin on neck full on oblivion!! Maybe our pitch was boring, but that’s still no excuse.

The VC pitch phase can be a very jittery time for most entrepreneurs. VC’s become mythical gods who have the power to decide their destiny. As an i-banker I’ve had the opportunity to participate in pitches made to a lot of VC’s over the years. Every VC (the individual and the fund) has their own unique style of handling the pitching process and I’ve seen good, bad and the ugly. Here are a few reasons why I respect the VC’s I do-

1. They always value the entrepreneurs time – Anyone who’s gone through a pitching process is familiar with the ‘we’re running late on our previous meeting’ routine, especially when a VC from out of town has lined up 10 pitches in one day. A line that I’ve heard often enough is “what can be more important to the entrepreneur than pitching to us”. Good VC’s know how to plan their meetings and respect an entrepreneurs time.

2. They do meetings only if they’re really interested – Sometimes VC’s do meetings even when they know they’re not going to invest, maybe to gather information about a sector.  It’s easy to see through when there is no real intent to invest and entrepreneurs end up feeling very resentful.

3. Stay alert during meetings – It’s hard to sit through pitch after pitch and be excited about each one. Good VC’s have the ability to stay tuned in to every pitch they hear.

4.They do their prep – It’s always a great interaction when the VC understands the domain and has gone through the IM or done some background research. Their questions are so much more relevant and entrepreneurs appreciate it.

5. They respond to emails – Entrepreneurs hate it when they pitch to a VC and never hear back from them. Not responding to emails or calls after a meeting is inexcusable. No matter how busy you are, a one line email with a “sorry not interested, or I need a couple of weeks to think about it” helps the entrepreneur move forward.

6. They give candid feedback – Entrepreneurs always appreciate candid, constructive feedback and good VC’s know the art of doing this. Sometimes VC’s reject deals just based on gut feel or think that honest feedback will be too discouraging to the entrepreneur. Whatever it is, getting the right feedback is important for the entrepreneurs’ growth.

7. They engage, don’t dominate – Perhaps the most important skill of a good VC is the ability to engage and build an equitable, trusting relationship with the entrepreneur. This comes to the fore especially during term sheet negotiations. Too often VC’s hold a gun to the entrepreneur’s head and put them in a take it or leave it situation (and vice versa one may argue). If the rationale behind asking for certain terms is explained to the entrepreneur, the entrepreneur is more likely to agree to them (assuming the terms are not blatantly unreasonable).

I suspect VC’s who practice these traits will end being more successful investors, as the best entrepreneurs will prefer to partner with them.


A perfect example of innovation from India – By Alap Bharadwaj

Recently, in a meeting with a VC from a tier 1 global fund, the conversation turned to India’s tech companies and the ideas that these companies are built on. The VC made an all encompassing statement to the effect that every single venture funded Indian tech startup recently has ‘absorbed’ its basic idea from a similar company in the US. The statement was loaded but one that could not, for the most part, be countered. It made me feel disappointed and put a serious question mark on the creativity of nouveau Indian entrepreneurs. I have blogged about this before, and to be perfectly honest – the apparent “apathy” tech entrepreneurs are showing towards actually building out a unique idea SUCKS. Has an Indian company come up in the recent past with an idea before its western counterpart? I am sure many have, but have they been able to drive scale using technology before the western equivalent? I am thrilled to report; the answer came to me on a recent trip to Hyderabad.

Travelling from my house to the Bangalore airport, and then to various meetings in Hyderabad and back was all enabled by one phenomenal Indian company – Meru Cabs. Meru, since 2007 has leveraged GPS to the maximum, efficiently allowing cabs to service customers closest to them, provide great service, reduce a ton of consumer frustration and make entrepreneurs of over 5000 drivers in India. I know what you’re thinking right now – so which western equivalent did they beat out to the implementation of this idea? That would be San Francisco based Uber – a company that has been getting rave reviews from the TechCrunch faithful for months now.

An analysis of the two companies will reveal differences in their business models. While Meru is more of a supply player (the company owns every single one of their 5000+ cabs) Uber is an intermediary that consolidates demand via a mobile app. The secret sauce of both companies is the same though – the ability to track, in real time, a cab’s location and then push relevant demand of transportation services to these cabs. Isn’t Uber better in terms of payment you ask? Uber allows users to pay using the credit card that is on file with the app, while Meru allows their customers to pay via a swipe of their credit card right in the cab as well.

The best part about Meru though is the “Indian-ness” of their model, in allowing so many cab drivers to make a better living by allowing them to offer a better service backed by robust technology. To say I’m impressed with Meru is an understatement, but I’d like to end by stressing that I am not in any way shape or form running down Uber. They are a fantastic American startup with a truly disruptive idea, backed by an amazing set of early investors in First Round, Lowercase Capital and a host of angels. I am just ecstatic, as an Indian, to have such a compelling business model be executed so well in India before it was done out of the Valley!

Do let me know the other Indian companies who, in your opinion, have implemented a disruptive idea before Silicon Valley has.

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