Startup Compass by Ujwal Kalra

Author:Ujwal Kalra
Language: eng
Format: epub
Tags: null
Publisher: HarperCollins
Published: 2022-01-15T00:00:00+00:00

‘We look at thousands of businesses every year, but 95–98 per cent of them don’t pass through to the next level because of the market factor,’ Anand says. ‘It’s not so much the team, it’s not the product, not anything else.’

The reason the market that a startup is trying to serve is so important is because of the way VC funds are structured. A VC firm would typically raise money from the likes of sovereign funds, pension funds, and high net-worth individuals to set up a fund. A typical fund will have a ten-year life cycle; VCs will look to generate returns within that period. Typically, a VC firm will look to invest in companies over the first three to four years, and will then work with the investee companies towards an exit in the subsequent five to seven years.

The VC firm will be required to return a multiple of the principal amount to investors in its fund. Typically, for a hypothetical fund size of $100 million, the firm will be expected to return $200–300 million, or more. The firm’s returns would accrue from investing in and exiting from startups at a higher valuation. The return from an investment will be a function of the value of an investee company at the point of exit and their share in the company. Suppose it were to invest the entire sum of $100 million in its fund into a single company and held a 20 per cent share at the time of exit, to achieve a return of $300 million, the investee will need to be valued at $1,500 million. For a single company to be so valuable, the market in which the company must be operating must be even larger; after all, except in the unlikely case of a perfect monopoly, the value of a single company could only represent a certain share of the value of the entire market.

However, this is an extreme example. Typically, the entire amount in a fund will not be invested in a single company, and will instead be distributed across multiple investments to distribute risk. A VC firm might make ten to twenty investments from a single fund. Not all of these investments might offer a desirable return; some might even not allow the recovery of the invested capital. Therefore, a small number of investee companies must yield a large multiple on the initial investment for the overall fund to achieve its desired return. VC firms, therefore, constantly look for opportunities in which a startup could become a major player in a large market.

According to Anand, the minimum size of the market that a VC firm looks for depends on the nature of the firm, its industry focus, and their understanding of how a market might evolve. A small angel fund of US$10 million may not have a very large market size requirement. However, larger funds in India might perforce look for very large markets.

Anand says that as investors, VC firms look for companies that will create impact at a very large scale.

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