Vinit Nijhawan: Serial Entrepreneur, Venture Capitalist

A Walk on the Dark Side

I have been part of the entrepreneurial ecosystem for over 25 years, mostly as an entrepreneur but also as a VC and angel investor. I firmly believe that the symbiotic relationship of entrepreneurs and smart capital is the key to economic development around the world.

I have spent the past six years either running VC backed startup companies or as an investor at Key Venture Partners. Here are some of my observations from my time on the Dark Side:

• If one rates what it takes to be a successful VC partner, sourcing deals is usually the number one task. Therefore it is surprising how many VCs are slow to respond to phone calls and emails from entrepreneurs, even when referrals come from trusted sources.
• The VC business requires long term thinking but very few VC partners are willing to invest in relationships with entrepreneurs that may not bear fruit for years. I believe that those VCs that develop long term relatioships, tend to outperform those that don't.
• Being a VC is learning how to drink from a fire hose. In the two years I was a VC I sourced 220 deals and invested in one company. That doesn't count all the other deals that we discussed in partners' meetings. One has to develop judgement on a deal very quickly even if it means that you may decline what turns out to be a good deal.
• My philosophy in dealing with entrepreneurs was that I always gave something back to them for the time they spent with me. Even if I declined to invest I would give them a VC or customer lead, or some advice about their business. In my view, this created the foundation for a longer term relationship. Many VCs have lost sight that they are service providers to entrepreneurs not the other way round.
• As experienced entrepreneurs know, not all VC partners add value to their portfolio companies. Some can even add friction to the governance process and can be distracting for management. Usually this results from differences in opinion about exit timing but also sometimes from ego issues.
• I thought hard about how we as a firm might add value to our portfolio companies. One area that a CEO is responsible for but always seems to get relegated to lower priority, because day-to-day operations take precedence, is exit planning. At Key Ventures we developed an exit template for all our portfolio companies that included: investment banks with relevant focus, analysts, potential acquirers (and we built a relationship with their VP Business Development), public company valuations, etc.
• It is known that serial entrepreneurs matched with serial VC partners generally leads to successful companies. The problem, in my opinion, is a shortage of serially successful VC partners in the US and especially in Massachusetts. I have joined Boston University's Institute for Technology Entrepreneurship and Commercialization and will endeavor to address this shortage by researching what makes the good ones so effective and then teach these best practices to aspiring VCs.
• The symbiotic relationship between entrepreneurs and VCs is recognized as the best way to develop an economy. It has been over 60 years since General Doriot and others founded American Research & Development Corp. (in June 1946), the first organised venture capital firm. In 2006 venture-backed companies' revenue made up 17.6% of the GDP and 9.1% of private sector employment in the US according to the NVCA. Similarily China and India have accelerated their economic growth rates as a result of unleashed entrepreneurial energy in the past 20 years. The rest of the world is now adopting this model.
• I believe this model needs some tweaking in the US as it gets applied to new innovative industries such as life sciences, energy and nanomaterials.

Predictions for 2008

Here are my predictions for 2008:

1. Buzz--The buzz topic of 2007 will continue to be energy and cleantech. We will see a huge growth in VC investments in such companies.
2. Exits--We will see a dramatic increase in cross-border M&A with many Indian and Chinese companies acquiring US and European companies.
3. National--We will experience a recession.
4. International--The Flat World concept (Friedman) will be replaced with the lumpy world (Ghemawat). Companies will have to deal with a global skills shortage in very local ways.
5. Mobile--Apple's greatest innovation in the iPhone is its browsing capability as a result the mobile internet will finally take off.

Here is how I fared with my 2007 predictions:

1. Buzz--The buzz topic of 2007 will be energy and cleantech. We will see a huge growth in VC investments in such companies. I was right on. CleanTech investments by US venture capital firms reached $2.6 billion from 168 deals in the first three quarters of 2007, according to data from Thomson Financial and the National Venture Capital Association. The year to date 2007 dollar volume represents a 46% increase over full year 2006 dollar volume.
2. Exits--After a six year hiatus Nasdaq IPOs are back and we will see a significant increase in Nasdaq technology company IPOs. Again I was correct. In the US there were 224 IPOs, raising $50bn. Additionally, Europe had a record year with a total of 651 IPOs, raising $90bn.
3. National--We will see a slowdown in growth and may even experience a recession. I was partially correct, the sub-prime crisis did cause a dramatic drop in the housing market but while the overall economic growth slowed, there was no recession.
4. International--There will be significant growth in US VC firms investing in India, especially in Infrastructure related growth opportunities. I was dead on. India is expected to place $13.5bn in VC/PE investments in 2007, up from $7.5bn in 2006. There are 366 PE firms operating in India with another 66 raising funds.
5. Mobile--The Apple iPhone will have disappointing sales. I was totally wrong, the Apple iPhone lived up to its expectations and is selling briskly.

Telecom’s new Epicenter: India, China

The acquisition of BCGI (Nasdaq) by Megasoft (Bombay Stock Exchange) for $65M continues the trend of Indian telecom software companies acquiring European and North American companies. Driving the trend is the growth of telecom, particularly wireless telecom services in emerging markets, particularly China and India. China now has 400M+ subscribers and India 150M+. Indian telecom technology companies are benefiting as suppliers to Indian wireless service providers. India is a highly competitive wireless market with five equal players generating profits at subscriber monthly revenue of $8/month (as compared to $50/month in the US). Suppliers to wireless carriers have to provide their products and services at a third of the price they would garner in the US or Europe. As a result these suppliers are very competitive globally. Additionally the capital markets in India, both venture and public markets are frothy so Indian telecom companies can readily raise cheap capital for acquisitions. Indian telecom companies can reduce the operating costs of any US or European acquisition and thereby make money losing companies such as BCGI immediately profitable. Also the Indian rupee has been appreciating against the US dollar so acquisitions are becoming cheaper for India companies. BCGI is yet another story of a Boston company that was not able to diversify its product and customer base in boom times and as a result was not able to survive setbacks in tougher times. BCGI provides outsourced prepaid billing services to US wireless companies and their largest customer Verizon decided to bring prepaid billing in house. Additionally, BCGI lost a patent case and the resulting payouts crippled them financially. I predict we will see many more acquisitions of Boston area technology companies by Indian and Chinese companies (especially if China strenghthens their currency). Sadly this continues the trend of local companies selling out, first to Silicon Valley and now to Bangalore and Beijing.

Predictions for 2007

A little into the year but here are my predictions for 2007:

1. Buzz--The buzz topic of 2007 will be energy and cleantech. We will see a huge growth in VC investments in such companies.
2. Exits--After a six year hiatus Nasdaq IPOs are back and we will see a significant increase in Nasdaq technology company IPOs.
3. National--We will see a slowdown in growth and may even experience a recession.
4. International--There will be significant growth in US VC firms investing in India, especially in Infrastructure related growth opportunities.
5. Mobile--The Apple iPhone will have disappointing sales.

BTW, here is my scorecard on my 2006 predictions:

1. Buzz--Like Web 2.0 was the buzz topic of 2005, the buzz topic of 2006 will be video over the internet. We will see an explosion of amateur video content creation with distribution to PCs . I was dead on: Google acquired YouTube for billions, and internet video companies raised hundreds of millions from VCs.
2. Exits--We will see many US technology companies looking to exit on the London Stock Exchange's AIM exchange which has a lower hurdle than Nasdaq but is increasingly providing liquidity. I was partially right, there were a few AIM listings but not as many as I thought there would be.
3. National--After being eclipsed by silicon valley in 2005 Massachusetts will be back: companies to watch are Airvana, Netezza, Starent, Virtusa, Airwide, Confluent Surgical. I was dead on: Airvana, Netezza, Starent and Virtusa all filed for Nasdaq IPOs. Confluent Surgical was acquired for $245M by Tyco. The CEOs of all these companies will be on a panel at www.tieconeast.com on June 16th. Airwide added over 15 new wireless operator customers.
4. International--Indian IT companies will acquire US and European IT companies. I was dead on: 60% of total M&A or $8.4B was outbound M&A, though pharma was in the lead and accounted for $2.2B. IT M&A was second.
5. Mobile--Music downloads to cellphones (songs not ringtones) will become a billion dollar market. Wireless broadband for "last-mile" internet access by companies will expand dramatically. I was partially right, Clearwire had a billion dollar IPO. Music downloads grew more slowly than wireless "last mile".

Wireless Spectrum: a scarce commodity?

Wireless spectrum is a public commodity that has increasingly become very valuable for national governments: as a source of public finance and for public policy. In the US the FCC is in the midst of auctioning 3G spectrum and the bids have reached over $13B. While this may seem like a lot of money, wireless operators in Europe paid almost $100B a few years back for 3G spectrum. In the current auction the highest price paid per megahertz per head of population (MHz-POP) was in Washington DC at $1.59. In contrast UK and German operators paid $4.22 and $3.86 MHz-POP respectively. T-Mobile USA was the biggest bidder paying over $4B. US spectrum is also less restrictive than European spectrum--operators can deploy any technology they want whereas European operators had to deploy W-CDMA technology which at the time was too immature.

In India the regulators do not sell spectrum but provide it on a revenue-share basis to operators. As a result operators do not need as much capital to provide services but do get hurt in their Opex. Since India is a hyper-competitive market with 12 operators resulting in the lowest voice tarrifs in the world, increased Opex is meaningful. Nonetheless the top operator in India Bharati Airtel is profitable at ARPU of $6. This compares to ARPUs of $45 in the US. Bharati's operations are very innovative and I predict that operators around the world will move in their direction. Bharati has outsourced most of its major activities: radio infrastructure to Nokia and Ericsson, business support services (BSS) to IBM. The radio infrastructure deal is particularly clever: it is revenue share based on $/erlang. In other words, Bharati has incented Nokia and Ericsson to efficiently utilize their spectrum, thus passing on the revenue share arrangement from the regulator.

I am less familiar with how China regulates its spectrum. Since its main operator China Mobile is majority government owned it is likely that they get "subsidized" spectrum. China has held out offering 3G spectrum to encourage a home grown standard SD-CDMA to evolve. The government hopes to use it's huge domestic market as leverage for its equipment and handset vendors to get a head start for global exports. This strategy backfired for broadband wireless with WiMax defeating a home grown standard.

Private equity in India

I am back after taking a couple months to run a very successful conference Innovating in a Flat World: www.tieconeast.com with over 1,400 people attending.

Stanford University and TiE have recently published a study on private equity in India http://aparc.stanford.edu/publications/accessing_earlystage_risk_capital_in_india/. Some of the highlights of the study:

• There is a dearth of seed and early stage investment capital in India with just 6.9% of capital going to that stage, as compared to 12.5% in China and 29% in the US.
• The authors recommend the Indian government allocate capital in conjunction with venture firms to early stage companies, modeled on Israel's Yozma program
• SEBI, the Indian regulatory authority, allow foreign accredited investors

An interesting observation from the study was that India gets more private equity than China, almost double in 2005. It appears China's industrial growth has been funded more by debt than equity financing. This is borne out anecdotally by the number of new private equity funds that are targetting India. The latest news is that Matrix Partners is setting up a fund in India. Likewise the average deal size in India is about $15M versus $4.5M in China. The number of deals in China are now greater than India. It seems that China uses equity financing at early stages and debt at later stages. India uses sweat equity and customer financing at early stages and equity financing at later stages. This also evident from trends in commercial loans--Chinese banks lend 130% of their deposits while Indian banks lend only 61%.

Indian VCs are reluctant to invest in early stages given the inexperience of entrepreneurs. Indian banks, dominated by state-owned banks are too conservative. Clearly there is a need for the government to reform banks and to encourage early stage investing like the US government did with the SBIC program.

Mobile Phone Revolution

I just returned from Barcelona after attending the GSM annual mobile phone conference (along with 50,000 other people, up from 35,000 last year). Having created two wireless companies and having been involved with the early days of wireless communications I have a historical view of this now red hot space. Some observations:

• Mirroring the industrial rise of China and India, mobile phone penetration in these countries has exploded, with 375M subscribers (in 8 years) and 80M subscribers in India (in 4 years).
• Now this type of growth has spread to MEA (Middle-east and Africa) with huge mobile phone infrastructure build-out in sub-Saharan countries such as Nigeria.
• Next countries that will join the high growth list are Indonesia and Vietnam
• In developed countries in North America and Europe 3G infrastructure has finally been deployed, five years after wireless operators paid large amounts in spectrum auctions. What is needed now are innovative applications and services to utilize this infrastructure and provide an ROI for this insfrastructure investment.
• I think the service to watch out for in 2006 is music downloads to phones. All major 3G operators are experimenting with this service. Sprint launched their service at the Super Bowl and claim over a million downloads so far.

With close to 2 billion mobile phone users worldwide and with the advent of fast processing and large memory, mobile phones are destined to become mobile internet terminals. I would argue though that most users will continue to use their mobile phones for voice and simple text messages. Growth of other value-added services will not match the projected hype. I believe music will be an exception, especially if Apple launches a wireless iPod this year.

China vs India

MIT Sloan School of Business professor Yasheng Huang's editorial in the Financial Times "What China could learn from India's slow and quiet rise" got a firestorm of discussion going with a few friends. His thesis is that China's economic growth is being driven by capital investment both domestic and foreign whereas India's is driven by domestic demand so the use of capital is far more efficient. Additionally, China's political structure is inherently unstable whereas India's turbulent democracy is stable-- "15 years, six governments, five prime ministers, one direction" is the slogan from a recently formed organization www.ibef.org trumpeting the Indian brand. My random thoughts on China versus India:

• The trade between them has grown rapidly in the past two years as a result of thawing of political relations but also Adam Smith at work. A few examples of this: (1) we had the Chairman of Infosys Narayan Moorthy speak at www.tie-boston.org and he described the growth of their China office to address IT outsourcing opportunities in East Asia: Japan, China, Korea, etc.; (2) a friend from Delhi who designs and manufactures industrial speakers found it was more reliable and cheaper to manufacture in China than India inspite of his low volumes; (3) one of www.keyvp.com portfolio companies supports a Chinese plastics manufacturer that is moving it's entire plant from Shenzhen to Chennai as the Indian market is less competitive than the Chinese market
• India's urban infrastructure is atrocious and definitely has an impact on growth. When I was in Beijing a couple of years ago 10 year old buildings were being torn down to be replaced by building as or more modern than those in Boston. India's infrastructure in circa 1970s. This is a failure of governance in India.
• Many of the professionals I met in Beijing had one leg outside the country, almost as if they felt the current political/business situation could dissapear overnight. I met many people with a spouse and children in Australia or Canada. Clearly the Chinese political situation has to change to encompass broader dialog of the future.
• Economic well being is important but so are social cohesiveness and spiritual happiness. I find India has an abundance of the latter two but China appears to be more like Japan. Once economic well being is achieved people thirst for more. Japan is facing that transition and so will China.
• So both countries' future depends on reform of their respective governments. China's government needs to evolve to plurarism and India's towards greater efficiency and free markets.

More about Exits

I summarized exit metrics for startup companies in my last posting. This is obviously a very industrial VC outlook. In the Web 2.0 world metrics are all over the map. Some companies like Flikr who had very little revenue exited at huge multiples in 2005. Is this Dotcom 2.0? I don't think so. I have been advising a Web 2.0 company www.fotki.com that is a media sharing community. The difference in Web 2.0 is these startups revenue-generating business models. The opportunity arises from the rapid change in user behavior for consumption of entertainment and commerce. The web is commanding more of everyone's time, from boomers to rebounders. As a result there is a relentless movement of advertising dollars from TV and print to the web. Similarly more and more physical goods are moving to digital goods (eg music and video) and there are emerging new business models to the purchase of physical goods (check out Catharine Arnston's startup www.hotelluxury.com).

Likewise, the purchase of Skype by eBay at an implausible price, or is it? I have been using Skype for 3 years to communicate with employees around the world. They have created a "sticky" user base of over 50 million users in just 3 years with about 5 million people using it at any given moment. eBay users can now complete their buy-sell transactions with a p-p Skype voice call but that hardly justfies the acquisition price. The missing ingredient in my opinion is the value of Skype's brand. As a global telecommunications company, their brand rivals other global companies such as MCI, Reliance and perhaps even Vodafone. Skype's brand is certainly more valuable than Oracle or Sun. Brand value and sane business models are the underpinnings of Web 2.0 exit valuations.

Financial vs Strategic M&A exits

Buyouts Magazine recently released 2005 figures for U.S. based buyout deals and funds raised:

• 845 leveraged buyouts of U.S. companies (or which included at least one U.S. sponsor) worth $197.8B. This compares with $137.4B in 2004 and $95B in 2003.
• $173.5 billion raised. This compares with just $42 billion in 2004 and $24 billion in 2003. Around 354 buyout/mezz firms raised funds.

Buyout firms have emerged as a credible alternative to strategic company exits and even to IPOs for startup companies. In my discussions with investment bankers and buyout firms the following exit metrics emerged for these different options:

	Nasdaq IPO	Strategic M&A	Financial M&A
LTM Revenue	$50M	$20M	$20M
Ebitda History	2 Quarters	None	Breakeven
Organization	Public CFO	Strong R&D	Will be restructured
Market	High growth	Doesn't matter	Fragmented