A new phenomenon is taking shape in the venture capital space in which venture investors targeting seed stage or pre-series A funding, avoid investing in spaces or themes in which larger funds like SoftBank, Tiger Global or Tencent have invested, due to the competitive advantage these firms bring with them.
In a Facebook live interaction with Mint under its programme ‘Ask the VC’, Karthik Reddy and Sanjay Nath of early stage fund Blume Ventures talk about trends in seed investing, the progression to a larger fund and the dynamics playing out with larger funds. Edited excerpts:
From the first fund, Blume allocated capital to over 70 start-ups. What was your strategy?
Karthik: It was more of a risk management strategy. We invested when those ventures were very young and we didn’t really know who will fund them after us. That is when we realized that capital is a very important determinant of success in this market.
It is very difficult to survive without capital, especially when you are giving them very little capital. Raising capital to the tune of $3-5 million in the seed stage is three to four times tougher than raising capital in the later stage.
Even though we lost money, we didn’t lose much. There was a trick in place. We doubled or tripled our funding in the winners but when we lost money, we ensured we don’t lose much in dollar terms by spreading the risk.
This is the formula in place around the world because while playing in the pre-series A, you cannot cherry-pick as to which companies will perform the best. The trick is, you have to spread risks by diversifying across sectors and across founders. At Blume, we ensure that we don’t lose a lot of money for our investors by making the mistake of investing too much in one start-up.
How high can the loss ratio be?
Karthik: Loss ratio can be as high as 45-50% in terms of the number of firms but since we do not deploy much of our capital until we identify winners, our loss ratio in dollar terms can be as low as 20%.
I think that’s the key in early venture capital investing. Having said that, if we look at our second fund, our fund size is almost three times, but our portfolio size is only 35-40% compared to our first fund.
It’s a conscious strategy because we have learnt a lot from our first fund. We have reduced our portfolio size to back our winners and as a result, we maintain healthy reserves to back our winners at a later stage.
What are your aspirations from the third fund in terms of size?
Sanjay: In the second fund, we went to $60 million from $20 million in our first fund. We want to be called the best institution to provide pre-series A and Series A funding and want to raise close to $100 million for our third fund. We don’t want to be a classic Series A fund, but want entrepreneurs to come to us for initial capital after the family rounds, and before they go to other institutional players.
Does this need of backing your portfolio companies come up because there are not enough venture funds willing to sign larger cheques?
Karthik: The value chain always matters and I think we are still inadequately placed as a long-term VC in the capital markets’ value chain. We barely have series C or series B funding, we still have this fly-in and fly-out funding rounds. The big funds like Sequoia and Matrix can take big bets on their own portfolio firms, but outside their portfolio they won’t cut big cheques directly in series B or series C.
If you were to reverse-pitch to start-ups, what would those be?
Sanjay: The reason we started Blume is that foreign investors are not investing in ambitious ideas. One of our frustrations comes when foreign investors say we love what you do but we are not interested in investing in India.
If you look at what Elon Musk is doing with Tesla, we tried to test that with Reva in India. Though we are far away from firms like Tesla, if you look at what TeamIndus is doing in Spacex—I think we can aspire to be there and someday catch up with them.
Karthik: We have looked back and we have realized that a lot is to be done in areas like energy savings, battery technology and storage technology. I think we have left them to the west but there is lot we can do in this space locally.
You talk about investing in deep-tech companies, essentially chasing non-linear growth. But one doesn’t see that linear growth translating into non-linear returns at least in India…
Karthik: Surprisingly, it is not easy to sell stakes; even selling secondary stakes is not easy. It happens at a much later stage when there is so much demand for the stocks that they are letting you take and exit. Either the company has to sell on its own or there has to be so much demand, like in the case of Flipkart or Ola that funds like Softbank and Tiger Global want to screen out initial investors. I think that’s when we get an exit.
The important question to ask here is, why would an LP (limited partner) give me money when I deliver same returns as Series A players.
What is the return profile that you have delivered to your LPs?
Karthik: We are still tracking. So far, it is two times but the goal is to deliver four times. We still have a lot of good companies like Instamojo, Zopper and Exotell from our first fund that is yet to break out and when it does, we will hopefully meet our goal.
Venture investing is going through an interesting phase as competitors become strange bedfellows with investors placing their bets on multiple companies. How do you factor this in your investment decision?
Karthik: Thankfully, this is not a phenomenon from seed stage to Series C funding market. Everyone in this stage is very conscious as they cannot play competitive here, because it is very difficult to manage conflict between the founders.
We will usually not fund any in the space where Softbank or Tiger Global has already invested, unless it is fundamentally unique. Again, in a thinly funded market like India, if you are confident that you will be bought by the same company funded by Softbank or Tiger Global, then there is nothing to bother. How often do you see three levels of capital competing at each level, like in the case of Ola? That is very rare.
In transportation, we have left a lot of start-ups centred around the themes of bike riding and bike-sharing. We would look and say it’s a great theme, but is it going where we want it to go? In most cases, we really didn’t see it going our way because of the competitive advantage that existing big players have.