Bengaluru/New Delhi: Venture capital (VC) firms are scrambling to sell stakes in old portfolio companies to specialist funds and seeking fund extensions, as they seek to prove that their bets on Indian start-ups will pay off after more than a decade of investing.
Funds are usually set up as 10-year legal entities, with clauses that allow for extensions of one or two years.
Since most VC firms in India including Nexus Venture Partners, Kalaari Capital (in its previous avatar NEA-IndoUS Ventures), Matrix Partners and IDG Ventures India started out in 2006 and 2007, their first funds were supposed to end in 2016-2017.
Mint had reported in November 2016 that VCs have been forced to extend these funds because of a lack of exits.
The two-year extensions will end over the next 15 months, six investors said. All of them spoke on the condition of anonymity because they aren’t allowed to talk publicly on the matter.
VCs have been unable to get exits from all of the portfolio companies of their first funds. Consequently, they are exploring four options, the investors cited above said. The first is selling leftover portfolio companies in a bunch to specialist secondary funds; second, seeking another one-year extension to their funds; third, exploring discussions with new investors or limited partners (LPs) who wish to take over the funds, and finally, returning shares in leftover companies to the LPs.
LPs are large investment firms such as pension funds, endowment funds and family offices of wealthy individuals that invest in VCs.
TR Capital, NewQuest Capital Partners, Newbury Partners, HarbourVest Partners and other secondary funds have held discussions to buy VC portfolios, the investors cited above said. Though no deal has been finalised yet, Nexus, Kalaari, Matrix and IDG have all expressed interest in pursuing deals, they said.
Venture funds are expected to generate returns of anywhere between 3-5 times of their fund sizes. For the first funds out of India, returns will be far lower, the people cited above said.
VCs are struggling to generate attractive returns on these funds partly because the dollar has appreciated significantly since the funds were raised. Additionally, many bets made by VCs in that period turned sour, prompting them to change their investment strategies.
The upcoming closure of the first funds raised by VCs in India is important as it will give LPs a concrete indicator of how start-up investments may work out in India. The returns on these funds could potentially affect the fund-raising efforts of VCs over the next two years.
But the investors cited above said that LPs have known for years that returns on the first funds will be low given that the India start-up scene had just started then and it was unclear what shape it would take. With internet consumption becoming mainstream because of cheap smartphones and data connections, many LPs are still bullish on India, they added.
“Obviously, the conversations around what to do with the first funds started many years ago; so the LPs are prepared for this. That’s why you’ve been seeing so many exits (via secondary share transactions) in the last two years. It’s true that many funds will struggle to give good returns in the first funds but LPs have acknowledged that India is going to take longer in terms of getting returns than US or China and they are prepared to keep investing,” said a partner at one of the VC funds cited above.
For now, selling shares to new investors looks like the quickest way for VCs to get exits from their old portfolio companies since public listings and buyouts have been tough to come by.
In the past 18 months, some VCs including Accel Partners, SAIF Partners, Saama Capital, IDG and others received millions of dollars by selling part or all of their shares in companies including Snapdeal, Flipkart and Paytm. Secondary share transactions, in which an investor buys shares from other investors without putting any money directly into the company, have become the most lucrative exit option for VCs in India.
Apart from share sales in individual companies, there have been a few block share sales as well.
In 2016, India’s largest VC firm Sequoia Capital sold a bunch of its portfolio companies in such a secondary transaction. In earlier years, two VC firms Draper Fisher Jurvetson and Canaan Partners sold their portfolios to NewQuest and JP Morgan, respectively, after deciding to exit India as their bets didn’t work out.
While there’s a willingness to do more such block deals, the selling VCs and potential buyers find it difficult to agree on the mix of portfolio companies—typically comprising a few investments that still look attractive and others that are likely to give below-par returns—and the valuation of the portfolio.livemint