April 06, 2008

Do QCs on the VCs - by Sanjay Anandaram

India is an attractive venture capital (VC) destination today and the future will only get better. Many more VC funds will come in and entrepreneurs, at least the good ones, will be badgered by VCs for “lets-get-to-know-each-other-better” meetings. This capital availability and increased VC activity is good for the entire entrepreneurial ecosystem.

But, in all this hype and hysteria about round and about VC and entrepreneurship, something has been missed. Namely, that in as much as due diligence is performed by VCs on entrepreneurs prior to making an investment, a reciprocal arrangement needs to be in place for VCs. Wheat needs to be separated from the chaff, the genuine from the pretenders.

Classic VCs are partners in business, not purely opportunistic money makers. They see themselves as company builders, not just as investors. They don’t take short term stock market oriented investment decisions. They help build successful businesses, not spend time on financial engineering. In the early days of the Indian VC industry (that’s less than 20 years old!), most of the VCs had a lender’s mindset where risk minimization (zero risk?) took precedence over risk management. They found it hard to understand the startup situation used as they were used to more stable and less risky companies. The situation today has undergone a sea-change with the entry of Silicon Valley style VC funds. Therefore entrepreneurs will do good to keep the following in mind:

a) Don’t adopt a servile attitude towards VCs (perhaps a social ill that puts someone with the ability to invest on a higher pedestal?) or for that matter, anyone! Learn to also ask questions. Among other things, probe the backgrounds of the VCs, examine their track record of investments, talk to fellow entrepreneurs who have raised money from these VCs, understand their investment focus and approach, and what can be expected from them. The real quality of the VC is known during the singular moments of crises in a startup: Do they want to cut their losses and run? Or, are they willing to help redefine the business? Can they bring in additional resources (management, financial, technical) to boost the company? Can they help make the deals? Can they open doors? Can they help hire people?

b) Get to know the person who’s going to represent the VC firm on your company’s board. Even if a top notch VC firm is investing in your company, it is useful to know which individual from that firm will be dealing with your company. At the end of the day, it is this individual who will play a key role. Is this person experienced? Can this person really help your company? What is this person’s experience with companies in your stage and sector? Is the person a straight-shooter who will give feedback or someone who engages in back-room wheeling and dealing? Can you trust the individual to take speedy action or is he someone who’s bureaucratic?

VCs spend a lot of time and effort understanding the market opportunity of the startup, the backgrounds of the founders, the business model, and the likely paths the company could take post-funding. Entrepreneurs should also do the same with the VCs. After all, the entrepreneur and the VC must see eye-to-eye and there must be absolute congruence on objectives and philosophies. For example, timelines can be an important consideration. Is the VC willing to wait to realise value from the investment or is the VC in a tearing hurry to exit? Notwithstanding the fact that the nature of the business calls for a minimum of 4 years to build a successful company? A mis-match in time-lines that can therefore lead to unwanted complications.

Choosing the right partner is therefore as important to the entrepreneur as choosing the right entrepreneur is to the VC. After all, when you don’t even buy a washing machine without talking to a few people, shouldn’t you at least talk to a few people to check if your VC will take you to the cleaners?

Remember VCs need QCs (quality checks) too!

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.