How VCs Work – Part 1 In the past few posts we’ve looked at various startup situations from an entrepreneur’s perspective. In this and the next few posts, we’ll take a look at how the people on the other side of the table, namely the venture capitalists work. It is important to get a perspective of how the other side thinks and works if you want to build a mutually beneficial relationship. It is important to recognize that the entrepreneur and the VC are on the same team and have a congruence of goals – namely the building of a successful company. All the negotiation happens before investment. As in all partnerships, if the relationship between the VC and the entrepreneur is viewed with suspicion and in an antagonistic manner, the VC-entrepreneur tussles in the board-room will kill the company. Having said that, let us know take a peek behind the curtains at how VC firms operate. In this post, let us get an understanding of the overall VC situation. VC firms collect money from investors and then invest the money in a number of carefully selected fast growing businesses. In the US, VC firms typically are partnership companies. In India, VC firms follow a structure more in common 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 clamouring for an US style structure for a while now, but that’s another story). That is, there is a VC fund into which various investors invest and there’s an Investment Management company (commonly referred to as an Asset Management Company or AMC) which manages the investments of the fund. In the US, the typical investors in VC firms are the pension funds, university endowments, insurance companies, corporations, wealthy individuals etc. In India, typical investors are wealthy individuals, developmental & financial institutions and some corporations. Laws do not permit pension money or insurance money to be invested. Universities in India have no real funds or endowments even if they were allowed to invest! It is therefore quite hard to raise funds in India for venture capital purposes. The tax treatments of Indian VC firms also act as disincentives. Which is why a large number of VC funds operating in India are really off-shore funds – based in places like Mauritius – with overseas investors thereby ensuring operating flexibility, tax benefits and speed. Contrast this with the VC activities in a small country like Singapore: A small country like Singapore, for example, invests huge sums of money (from a corpus in excess of $100 billion) all over the world in various VC activities. These investments which are government controlled are made keeping in mind the economic development of Singapore, strategic reasons (e.g. new technology, entry into new markets) etc. Singapore is also the source of capital for many of Silicon Valley’s marquee VC firms. There’s a lesson for India somewhere!
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