How Vcs Work – Part 1

In the last few posts we have looked at various startup situations from the entrepreneur’s point of view. In this and the next few posts, we will take a look at how people on the other side of the table, ie venture capitalists, work. If you want to build a mutually beneficial relationship, it is important to get a perspective of how the other party thinks and works.

It is important to recognize that the entrepreneur and VC are on the same team and have a combination of goals – namely, building a successful company. All happens before investment. As in all partnerships, if the relationship between the VC and the entrepreneur is viewed with suspicion and in a hostile manner, VC-entrepreneur fights in the board-room will kill the company. Having said this, let’s know behind the scenes a look at how VC firms operate. In this post, we get an understanding of the chancellor position.

VC firms collect money from investors and then invest money in carefully selected fast-growing businesses. In the US, VC firms are typically partnership companies. In India, VC firms follow more of a structure with a mutual fund structure (due to legal and tax reasons, VC partnership companies are not viable in India.

The VC industry in India has been struggling for an American-style structure for some time, but that’s another story). Namely, there is a VC fund in which various investors invest and there is an investment management company (commonly called asset management company or AMC) that manages the fund’s investments.

In the US, VC firms are typical investor pension funds, university endowments, insurance companies, corporations, wealthy individuals, etc. In India, the typical investors are wealthy individuals, developmental and financial institutions and some corporations. The laws do not allow pension money or insurance money to invest.

Universities in India have no real money or endowment, even if they are allowed to invest! Therefore raising funds in India for venture capital purposes is quite difficult. The tax treatment of Indian VC firms also act as disruptive. This is why a large number of VC funds operating in India are actually off-shore funds – located in places like Mauritius – with foreign investors ensuring operational flexibility, tax benefits and speed.

Oppose this with VC activities in a small country like Singapore: A small country like Singapore, for example, invests more than $ 100 million worldwide (more than $ 100 billion from a fund) in VC activities. These investments, which are controlled by the government, are made keeping in mind Singapore’s economic development, strategic reasons (eg new technology, entry into new markets), etc. Singapore is also a source of capital for many marquee VC firms in Silicon Valley. There is a lesson for India somewhere too!

In India, traditional investors in VC firms have been ICICI, IDBI, SIDBI and similar development and financial institutions. These VC firms have had to deal with various operating constraints and have had difficulty dealing with high-risk investments due to the very nature of the structure within which they had to operate. Indian VC firms should be registered with SEBI (Securities and Exchange Board of India).

Over the years, India has seen the advent of several Silicon Valley-style independent private VC firms such as Draper (which led the movement in 1995), Walden, Chrysalis and Infinity Capital. Many more are in the pipeline and international-level chancellors will bring investment styles and standards with a deeper understanding of technology, finance and strategy. India is expected to attract $ 10B in VC funds by 2008. It attracted around $ 300m in 1999.

With this background on the status of VC, we will take a look at how a VC fund / firm operates in our next post.

This article was originally published in Venture Catlist, India’s first e-zine aimed at entrepreneurs, which was started by Sanjay Anandaram