The elusive early-stage investor

The Indian venture capital and private equity industry has seen phenomenal growth over the last few years.  The industry has attracted the best capital from LPs across the US and Europe  along with some of the best investment managers.

The trend in the industry has been to create funds of at least a US$100m in size while most are much larger.  To successfully manage a US$100m fund, a team of 2-3 GPs can at best invest in 20 companies.  This implies that the average ticket size should be US$5m.  With most sectors in India experiencing double digit growths, there are several companies that can absorb 5m and get 2x-3x returns in 3-5 years.  From a fund manager’s perspective the best approach is go after revenue generating, growth companies that need at least US$5-10m in capital and have market and product risks all ironed out.

Now looking at the other side, a early stage entrepreneur is typically seeking US$100K-1m in capital to validate his product / service and get to revenue.  These entrepreneurs not only need the capital but also need the strong support of the investors to build the business.  Unfortunately most VCs in India will shy away from these opportunities as these companies would be a big drain on their time, have additional product / market risks and increase the risk in the portfolio.

Participation by angels in these transactions is also minimal as a US$100K risk is still large for one person to take in the Indian context.

Most early stage investors in the US have strong operating and entrepreneurial backgrounds.  They typically tend to not only invest with a financial mind set but most importantly their understand of the space and potential disruption a startup can bring in the market place.  They bring skills and experience that may be critical in creating that 10 or 100-bagger, rather than a 2-3x growth.

India needs more funds managed by operating and entrepreneurial partners that are smaller in size that can take advantage of these opportunities.  For example a US$25m fund can comfortably accommodate 1-2 partners and a small team at 2% fees.  The funds can invest between US$500K-3m to create a portfolio of  10-15 companies.  mostly importantly the entrepreneurial background of the managers can bring enormous value to the startups.  A typical early stage success can generate 5x-10x return and in a portfolio of 15 companies, if 3 companies generate 5x returns the fund is home with a 25% IRR.


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Filed under business, entrepreneurship, Venture Capital

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