A quick question—how long is ‘long long ago’? If the answer is ‘two to three years’, chances are this reply will be deemed ridiculous. But if one was to add that the reference is to ‘two to three Internet years’, the answer would suddenly not seem so preposterous.

OUTSOURCING IS HOT: View Group chief Gopal Jain believes that outsourcing in the services area will be the hot mover for India. Outsourcing is a $600-bn segment, growing at 10% in the US. India is now validated as a delivery center

It does seem like a long long time since the ‘got an idea, get a million’ days. The sky rocketing NASDAQ, a dotcom with niggly revenues of Rs 1.5 crore being valued at a jaw dropping Rs 499 crore, loss making companies being valued at 100 times over their brick and mortar brethren…those really were the days. Now, there is no more talk about valuation, it is just a question of survival. Given the changed scenario and venture capitalists’ (VCs) huge lists of loss making projects, are VCs really interested in India? It was expected that India would see a downtrend in VC investments after the dotcom experience. However, the good news for Indian entrepreneurs is that VCs are still flush with money and India seems pretty high on their investment agenda.

Says ICF Ventures MD Vijay Angadi, "Of the total investments of $ 3.5bn, India garnered $841m, Australia was a close second and China came in third with $601m. Countries like Thailand and Malaysia received less than 5% to 7% of the investments that India did." Others like Infinity Ventures promoter Saurabh Srivastava talk of a billion dollars coming into India. "Given the potential the country offers to the VC community, it is difficult to wish away India," he says.

India still has the basic components to tempt VCs to part with their money. The cliched ‘low cost high quality’ Indian work force is still an attractive proposition for international companies to outsource to India. The ‘Made in India’ brand is no longer looked down with suspicion. Another important factor has been the positive image of Indian IT professionals in the Silicon Valley. With the large number of Indians in the valley and many in the successful entrepreneurial mode, global VCs are more comfortable betting on Indian companies. Though the amount invested in India is insignificant compared to global angel investment figures, it is growing rapidly. According to Nasscom, the angel investment in high-tech firms in India has jumped up from $20 million in 1996 to touch over a $1 billion by 2001 and about an estimated $10 billion by 2008. Today, India is already home to over 200 venture firms including key multinational players like Draper International, Kliener Perkins and Walden. These firms have sizable investment in India and walking away from the same is not easy.

However, the bad news for wannabe entrepreneurs is that VCs have become a lot wiser and are asking a lot of questions before parting with the money.

Spending in spurts
Caution is the name of the game today. Very few VCs have actually been able to show profits on their investments after the first round of funding. The majority is still licking its wounds after the dotcom massacre. According to Gaurav Dalmia, co-founder, Infinity Ventures, "Playing the ‘bubble game’ was certainly was a question of timing. And in India, without any exit routes, it’s highly unlikely that VCs could have succeeded in playing the bubble game." Forget profits, VCs have even lost their principal investments. Today they have no choice but to be cautious. This is also reflected in the nature of funding. While early stage funding was the flavor of the season two years ago, not many VCs are placing their bets on it today primarily because of the high-risk involved. Investment is now directed at mid and later stage funding. Agrees Srivastava, "The kind of investment made two years ago is certainly dead." The dot-com hype saw many investment bankers (without any clue of the business dynamics involved), turning into VCs overnight. Says Dalmia, "In hindsight, we have all realized that we had all been pumping millions of dollars in a bubble which was bound to burst."

As was the case with the IT industry across the globe, India too had joined the valuation bandwagon. It was not uncommon for a $100 million company to be valued at five times its revenues. And given the ‘assumed’ huge potential for Indian companies, promoters were upbeat about their company transforming an idea into a $100 million in just three to four years. Take the case of Netacross. Today, after three to four acquisitions, the company is below the $15-million mark and still remotely distant from the touted $100-million mark. VCs too had adhered to the great fools’ theory. Having put in their money in ‘promising’ ventures, they were waiting to find a bigger fool who would buy from them at a much higher valuation. In fact, many are still waiting. Then came along the caution mantra and VCs started reducing the risk factor by picking up companies at the mid or pre IPO stage. In picking up close to 5% stake in NIIT, a company, which is already listed on the stock markets, Chrysalis Capital went a step further in ‘playing safe’.

Says Pravin Gandhi, director, Infinity Ventures, "The focus is still on funding start-ups because that is the essence of VC funding. But now, funding has been advanced to a slightly later stage. Rather than funding pure ideas, money is now released only after there is some grip on the revenues, a semblance of management maturity and IPR." Few even question whether VCs as they are known across the globe, actually exist in India. Says Dipti Chopra, MD, Hansuattan Finance, "VC funding has given way to private equity." Srivastava agrees but points out that investment bankers are doling out what they know best – private equity. "But not everybody is into it," he stresses. VCs are still sticking to their agenda of early stage funding. Adds Angadi, "We have been focussing on first round funding and a large chunk of our business comes from this segment."

It is ITES that’s hottest
Once again, the good news for the entrepreneur using IT at the core of his business is that VCs are not averse to investing in the country despite the multitude of infrastructure and regulation problems. Unlike large markets like the US, VCs in India are yet to segmentize their investments in specific niche areas. But today, about 70% of the VC money is flowing into the technology area. The situation is similar in the US with the technology sector gaining a giant slice of the VC investment pie.

The VC Checklist Here’s what VCs look for in new companies before parting with cash: The Team: This is the most crucial factor in getting VCs to invest in new companies. Forget the great idea, think the great team. The kind of experience the company’s core founders have, how well their skills are suited to grow the business, their understanding of technology and business trends and more importantly, their ability to implement them in a cost efficient manner, are critical issues. Scalable business model: Finding the right niche is fundamental to success. VCs are on the lookout for companies doing extremely well in few well-defined niche segments. However, companies need to chalk out a clear growth path for themselves within the niche and make sure they have the ability and infrastructure to take on market forces. Positioning: As a majority of players are focussed on the segment of ‘improving efficiency’, rather than cutting edge technologies, it is imperative for the VC to have a good idea about how the company is positioned to take on the competition.  Quicker Growth: Gone are the days of dreamy eyed projections. VCs want a realistic picture but expect companies to ramp up quickly. Given that the ‘Made in India’ brand is no longer an issue, VCs are expecting companies to grow much quicker, slowdown or otherwise.grow much quicker, slowdown or no slowdown.

So which aspect of technology is hot? Since cutting edge technology development along the lines of that carried out in the US and Israel is still not done in most Indian companies, most VCs are keenly looking at companies focused on using IT to ‘increase efficiency’. This segment is important as a huge market is available in the US to leverage on India’s low cost English speaking work force. Says Gopal Jain, managing director, View Group, "The focus is on global outsourcing in the services area with the delivery happening from India. Outsourcing is a $600-billion sector growing at above 10% in the US and India has been validated as a delivery center. So expect improved action in the IT-enabled services segment."

IT-enabled services are definitely in. Services like eCRM and call centers will certainly attract VC attention, especially if you have good global clients. Companies like Daksh.com and customerasset.com have received good investor response. However, finding the right niche is imperative. For example, while medical transcription is low on the VC funding checklist, if a company moves up the value chain by dabbling in medical coding, the probability of getting VC funding increases manifold. Agrees Dalmia, "Medical coding, customer interaction and tech support are reasonably attractive niches in the ITES segment."

Another sector gaining VC attention is software, especially high end software that could result in the creation of intellectual property rights (IPRs). Companies working on wireless, convergence and telecommunication technology are hot areas for VCs. Comments Angadi, "We are keen on investing in companies that generate intellectual property in areas like security, storage, communications and broadband." Agrees Rattan Joneja, CEO, Marigold Capital Management, "Our strategy is to encourage deals in the IP area. We have invested about Rs 10 crore in IP-related start-ups in the high-risk, high-return on investment area."

Only the top product companies need apply!
Where does that leave companies focussed on products or those dealing primarily in the domestic market? In the US and Europe, a large chunk of funding is funneled for product development. Will the same happen in India and will we finally see exciting products from Indian companies? Says Dalmia, "In case of product companies, if you are not # 1 or # 2, you run a high risk of being wiped out. This is not the case with a services company." Also, given that the resources consumed by a product company are many times higher than a services company, VCs seem reluctant to place their bets on Indian product companies. Secondly, most VCs don’t understand the dynamics of the international market from the products’ standpoint. This is in stark contrast with the services market where VCs have been active for many years now. The other important aspect of product development is the absence of a robust domestic market. Srivastava explains that in the absence of a sizable domestic market, products have to be created for the international market. And this is where Indian companies are at a disadvantage. Product development is a totally different ball game. Companies need to anticipate what the market wants 18-20 months later and build the product accordingly. But how do you make a product if you don’t have a clue about the international market dynamics?

VC Survival Kit Fewer, bigger deals Unlike the gold old days where the Indian brandname could loosen purse-strings, there is only one reason why a global VC would agree to dole out money today—returns. If India can provide the returns, funds will come in, or else, there will always be other markets. In such times, VCs have to strike fewer, possibly bigger, deals rather than dishing out loose change to all and sundry. Nurture existing investments Time to show that you are more than a mere avaricious VC. Offer whatever help is possible to your portfolio members in order to help them survive the current troubled times. If possible synergies exist, this is the time to force them to merge or be acquired to have larger and more sustainable operations. Reassess portfolio VCs are already reassessing their investments and trimming them down. While this may entail some write-offs, it is still better than releasing additional funds just to keep the company afloat. Adhere to tough performance measures or exit from the venture as soon as possible. This works better than trying to feed the white elephant and hoping that it will turn into a nimble horse. Cash reserves at new highs Time to hoard cash. The money reserves will determine the survivors and give the flexibility to pick up good investments later.

Another interesting feature is the VC preference to invest in ventures in southern and western India. Since VCs need to track their investments on a regular basis and interact with company officials, they prefer geographical proximity. Says Joneja, "We believe in working closely with clients and restrict the number of deals we do, lest we lose the bandwidth to nurture these companies." Since a majority of the Indian VCs are based out of Mumbai and Bangalore, they are keener to invest in companies located in the southern and the western belt. Another reason is that a major chunk of the IT related activity takes place within these two regions. As a result, companies located in the northern and eastern regions find it difficult to get access to VCs.

So, where does that leave wannabe entrepreneurs in the 20-30 year age group bubbling with ideas? Well, the idea could be brilliant, but the going will still be tough. VCs today consider the execution of the idea more important than the idea itself. So it’s imperative to first have a team in place. Even an industry veteran like Suresh Rajpal, in his avatar as CEO of Mumbai-based Trigyn Technologies, found it tough to get VC funding when he spun off eVector as an independent company. "While VCs were ready to invest in the company, it took about five to six months for the actual funding to come in, primarily because we had not formalized the team and the CEO for the new company," recalls Rajpal.

What are VCs really looking for?
VCs are still flush with funds but dreamy-eyed millionaire wannabes will have a hard time convincing them to part with cash. VCs are comfortable with entrepreneurs with hands on experience in the international market. Says Jain, "Successful entrepreneurship in the technology area has come in only from one of the following sets of people- IT professionals with global exposure, ex-MNC employees, and NRIs." International exposure helps in ramping up business and this is a key VC requirement. New companies do not have the luxury of following Infosys’ low cost model of working onsite and gradually bringing more and more work offshore. As Dalmia says, "I keep telling companies in my portfolio to grow quickly." VCs admit that even in the current scenario, they are ready to dole out big money, but only for the right candidate. Agrees Joneja, "We are willing to guide them in developing business models, help expand operations in specific geographies, control and monitor budgets, evaluate strategies and recommend areas for future investment, growth and acquisition."

Angel founders are an important source of capital and have contributed greatly to the success of companies like Intel and Microsoft. However, India has only seen a wee bit of the global money coming in. After burning their fingers in the dotcom inferno, VCs are moving to India’s traditional IT strengths and are keen as ever to invest in software and IT enabled services. The problems are many but the market is maturing. The VC experience so far, has not been positive. Comments Gandhi, "Projects are taking longer to mature and the growth of the Net has been disappointing. Exits have been few and far between."

A few VCs have shut shop and moved out of India. Indocean Chase for instance, has relocated to Singapore. Another company—eVentures, has closed down as well. But there is still a glimmer of hope. The caution displayed by VCs today will force large-scale consolidation, mergers and acquisitions and the creation of IP in areas like wireless, communication and security. Until that happens and India moves into high end product and technology development, VCs will continue to pour money into Indian information technology’s traditional bastion—software and services.

Yograj Varma in New Delhi With inputs from Sarita Rani in Bangalore and EaswarDas Satyan in Mumbai

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