Ventureast has close to $300 million under management. Sarath Naru, founder of the company, has the lead role as the managing partner across its funds since its inception ten years ago.
He has invested directly or has overseen investments in over 50 deals in growth to early stage and in sectors ranging from technology, biotech and healthcare, and consumer goods to infrastructure services. His academic qualifications include a B. Tech. from IIT Madras and an MBA (finance) from University of Chicago.
Is it true that investors back services startups and not product companies?
Fund managers tend to invest in service-oriented businesses because there is lower risk and particularly in today’s environment where capital is less, they become even more risk averse. The other thing is that those bold ideas addressing big market needs in a smart way—we are not seeing those. “I can do this product or this service 10% smarter or more efficiently than the other guy,” that doesn’t move any needle for us. We need to see changes where you talk of a magnitude of 50%. Or is it a totally new need. That kind of thinking we don’t see. Where we do see it, it is totally unrealistic.
How important is the role of intermediaries in reaching investors?
If you look at our portfolio, I think less than 5% of companies have come through intermediaries. Intermediaries, I think, provide a great service, but tend to look at deals that are $10 million plus. Now may be they are saying, “I’ll see $5 to 10 million also.” I think intermediaries certainly provide value to entrepreneurs. They make them ready for meeting investors.
When an entrepreneur is approaching you, what should he write in the introductory e-mail?
It should talk of the business proposition, as to why they think it is special and what stage they are today. And the third point is who they are and why they are better suited to address this proposition.
What is your investment strategy?
A common theme of a venture capital investor is that they invest in multiple rounds and not one large chunk of money, which is what most PE investors would do. On an average, we would invest two to three rounds of investment in a company. That is a trademark of ours. So that is why we are calling it a venture style of investment. We would invest $5 million in the first round, invest in multiple rounds going up to $10 to 15 million. In a seed-stage fund, we would start in a different manner.
How has your investment strategy changed in the last six months?
From a sectoral viewpoint, we pretty much seem to be on the same track as before. We have a few broad investment themes. These themes run across our funds. One of the primary themes has been that we look at the needs of the Indian market. So that theme continues to resonate even more now.
The second theme is that of semi-urban and rural areas. We say that our focus is on the needs of the rural, the semi-urban markets and the needs of the SMEs, as opposed to the needs of urban areas and needs of large corporates. That has been the theme on the healthcare side too. Our last fund, while it was called the Biotech Fund, we backed the diagnostic chain, whose model was to move primarily from one hub to all the semi-rural, semi-urban and rural areas. From our sector perspective, healthcare, particularly the Life Fund sectors, seem to be very appropriate. Healthcare related, even agri-processing etc.
One of the things that has happened in the downturn, while the sectors didn’t change, we have certainly become less receptive to pre-revenue companies. There is no doubt about that. It makes sense to salvage existing value as opposed to trying to create a new one. That has certainly affected us in our thinking. We continue to be venture-style investors, but we would be extremely cautious on pre-revenue investments.
In our seed-stage fund, however, by definition we have a small program that is called the Blue Sky. It is going to be a very cautious approach, but we do have some allocation left there. That is one change in our approach.
Another thing has helped us in the market, why we can get not only pre-revenue, but pre-profit businesses is because valuations have dropped, cost of doing business has dropped, salaries have dropped, rents have dropped, cost of material has dropped. Promotors are more reluctant to take on too much investment now because their valuation is low. All this combined together, you can get huge amount of opportunities now. Earlier promoters were looking for $10 to 15 million checks, now they say they will take $5 million. It is healthy because they can prove the milestone and then look for more funds. We are quite happy to give them higher valuation in the next round. That helps both the promoters as well as us. That’s the beauty of venture-style investing.
What is the minimum ticket size of your investment?
As far as our regular funds are concerned, it is sub-$5 million. It is an 80/20 rule. At the end of the day, as fund managers, we are also opportunistic. First round will be sub-$5 million and going forward we can put in $10 to 15 million. In the case of seed-stage fund, the first round would be sub-0.5 and we would invest up to 1 million or 1.5 million.
Have you recapitalized your portfolio companies because of the slowdown?
We haven’t yet done any recapitalization because of the slowdown. There are a couple of ways to look at this. There are businesses that build intellectual property (IP) and there are businesses that are growth-oriented. We haven’t fortunately gone into a situation where there are growth-oriented businesses that overextended or had expected certain revenues and income from the expansion and now its not coming.
How many companies have you exited so far?
We have exited only from our first fund. We are into what I would call a third generation of funds. The first generation is invested and exited, which had 18 companies. We have two significant returns still left. We made multiples on the fund side itself on the return already. The second-generation fund is fully invested. We don’t draw money in one shot as a fund manager. We have four to five years to draw the money. Because of the way we approach our business, we do a multiple round of investments and not one round of investment in the first investment round itself, which is what most PE managers would do. PE fund managers would draw down their entire money in the first two years. We would take a full four to five years. So a fund that started in 2004, the weighted average age of my portfolio is still only two years as of March 2009. So the second-generation fund is fully invested and we are yet to divest anything.
Now we are investing from our third-generation fund — Ventureast Tenet Fund and the Proactive Fund. We are raising the third generation of the Life Fund.
What is your exit strategy? Is it mostly IPO?
We have multiple exit routes. Our first fund had two IPOs in the 18 companies. Roughly about 10 to 15% would end up going to IPO. In case of about a third of the companies, we would see a strategic investor buying. Another third of the companies would see another fund coming in. The rest get written off.
What kind of returns do you look at?
At least one-third of our investments have to go into companies that make double-digit multiples. How do you get to that stage? Let’s take, for example, what happens to venture capital in the US. Out of an average portfolio, the top 10% makes huge returns — 10x plus or even 20x, 30x, 40x. And they write off, I believe, about 50 to 60%. About 40% make decent returns. The 10% is what is known as the stars. In India we should be able to do at least 15 to 20%. This is because we are not going after such cutting-edge technologies. But at the same time, the market is huge.
The point is that we expect to put at least one-third of our money in companies that give us double-digit multiples on investments. The time-frame could be anywhere from three to seven years.
Typically, we found in the first fund, which had 18 companies, that the top three companies returned in excess of 10 multiples on their investments. Most of our investments also went into the top companies. In the better performing ones you tend to put in more money. You do that in stages.
How closely are you are involved with your investee companies?
By the definition of the style of investing, we don’t have a choice but to be invested closely. We do multiple rounds of investments, we monitor milestones, most of the times our returns are based on performance-based milestones or the valuation we give the company. With some companies we contact them every week. Then it varies.
If you talk to companies where we have exited, you will find that there is a very cordial relationship between us still, irrespective of whether we had a great exit or a poor one. And I think that is the hallmark of the kind of relationship and value addition we brought to the game.
How do you allay fears of entrepreneurs regarding the alleged interference of investors in day-to-day decision making?
The important thing to realize is it where we can add value and where we cannot add value. At the end of the day, we are not putting money in the company because my team and I are some really smart guys who know the business better than the entrepreneur. We have co-created business with the entrepreneurs. There are give-and-takes, but there are a few of them only. Typically, where we can add value is from the point of view of how you can structure and position the company for better value from the investor's perspective (where next round of investors are going to come in), how do you spend money so that the RoI on every rupee that is spent is visible for the next round of investments. The second thing we have done is, we are very active in cash flow management. We help our investee companies with working capital. We also have been able to build facilities into our own fund where we can draw down money to give loans. We have given loans from our own fund management companies as opposed to a fund.
The third thing we bring to the game is attract good talent. Unless we get involved it becomes difficult for small and medium-sized companies to attract great talent. They get to tap into our network where we are able to bring in senior management by virtue of our credentials.
What are some of the challenges that you face as an investor?
When it comes to IP-driven businesses, more so on the life sciences side, it gets very difficult to find co-investors in India. So we have had to always create these cross-border companies so that we can track US investors. Without a cross-border presence it becomes difficult to attract them. In case of innovative technologies, we haven’t found these ideas too convincing. They are only marginal improvements over existing technologies. Our style of investing is well suited to investing in those kind of companies, but we find few people who can take advantage of that.
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