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Is Micro-Funding a New Trend to Come?

A lot of folks seem to be very curious as to what I am working on, since my stepping back from Proto.in. Well, quite a bit actually and on some rather serious stuff. Serious as cash, infact. One of the major concerns that has been on my mind is the scarcity of capital in this market.

I am absolutely with the camp that believes that if there are quality companies, then capital will find its way. But we also know as part of most of our risk mitigation strategies, making a leap into a market with no safety net or partners makes it a really serious gamble – even for some of the most well-versed entrepreneur to tread in. I strongly believe that unless we enable some capital to flow, we are not going to see much of a difference in the number of quality startups that spring up, and inevitably the number of startups that get funded/get recognized, and the number that make an exit. This cycle, as you know is recursive.

So What have I been obcessing about? I’m focusin on three aspects and I think all three aspects are crucial.

  1. The mechanisms for loans from banks to become accessible for startups/SMEs
  2. An effort to bring together the Angel Investment Community, educate them and help them engage in an effective manner
  3. An effort to fix the “broken VC Model”

The First and Second are fairly straightforward and I promise to come back to you with some better news soon. But this is primarily about the third one.

I think the third one warrants a closer look for a simple reason. People have been claiming as long as for the better part of the decade that the VC model is broken and there seems to be no heed to that warning. Whats worse is that given that India couldnt be farther away from whats happening in the Silicon Valley in terms of similarities, the model is a force-fit one (There are some better models in Israel, Singapore etc). If you’d understand how a VC firm works, its primarily a specialized bank which runs on a management fee and bonus paid with the return on the investment. The overheads of running such a team is so high, that the only viable way for most firms to operate is to increase the fund size, which sets the ball rolling on them getting into a soup not able to invest in early stage no more, and the next thing you know they are either full-fledged in growth stage, or are in growth stage and are disillusioned about being an early stage investment firm. Suddenly working for a VC firm or being one doesnt seem so glamorous, does it? :)

What we need in India is essentially a firm which is capable of dispensing funds as low as 50 Lakhs to a crore (I am consciously keeping figures in INR to make it a point that we arent in dollar land and the rules and requirements are different here) – which can operate at lower costs, and can also manage a sizeable portfolio.

  • Problem #1: Cost of Manpower.

Manpower seems to be the highest cost in a VC firm. if you want to make your investment sizes smaller and invest in a reasonable size of companies, the issue usually is the fact that you are put in a loop of having to hire more resources, which pushes the envelope further to want to raise a bigger round to cover the increase in operational cost.

Solution: The right leads to manage the firm, the right risk management frameworks and rating mechanisms, and with a process management team, will make this work. More on this later on.

  • Problem #2: Monitoring.

Every investment is usually tied with a board member, mostly to ensure that the investment is safe. A fund investing in 100 companies, becomes a nightmare for most of the partners to manage the number of boards they are in, and even the number of companies that they can constructively help build.

Solution: If this space has to become active, those who have had experience building a company or two cannot afford to stay in the sidelines. There is a need to build a portal which will enlist potential Advisors  who can be engaged on a token fee +minority equity model should solve this problem.

  • Problem #3: Investment cycles:

Most companies in India simply take longer time to mature. 5 year cycles are bit of pressure on the firm and the companies to perform. You are lucky if you get the fund raised towards the earlier part of the cycle. The latter, the worse it gets.

Solution: Becomes easier if the funds are raised within India.

Building Indian companies needs the experience of Indian entrepreneurs who have built companies here in India to take calls. Fortunately there are a handful of such VCs in India and they clearly stand out.

Solution: Get hands on with a company or two. The rest will work itself out.

  • Problem #5: Hand in the Cookie Jar.

The VC industry isnt spared by the issue that most of the banks in the US are being accused of – the management teams making payments before the returns come home. Most of the compensations are primarily out of the management fee, in addition to the career interest generated from the returns on investment.

Solution: If the overheads have to go down, obviously the baseline salaries have to go down and the pendulum has to shift towards creating value and taking a pie out of that.

Is Micro-Finance Leading the way?

As I am understanding these issues better, there is a starking constrast to the operations of banks that becomes more vivid. Banks traditionally have the same problem. They cant issue small ticket loans because monitoring and recovery becomes an issue and logistics of the loan management are a night mare. Hence the the reason banks lend to Microfinance companies to handle this arduous task. Now most microfinance agencies have insights into the “individual equity” of a loaner to know the risk involved with lending with that individual and mitigate risks accordingly. We need a similar system like that.

Microfunds might very well be the trend to come. Why? There are 32 million SMEs in the country and the traditional way of investing is not going to work. They do not require huge quantities of money, and most of all there is a requirement for capital for expansion.

So How does this process scale? I came across a risk profiling tool built by an insurance company a few weeks ago, that allows field agents in rural areas to calculate the risk factors of an individual and household based on various parameters that they can understand from the individual. The tool is well built to the point that it can be used by an agent who doesnt have to qualified more than a 10th pass, and even better they are rolling out their next set of tools to enable these 10th pass graduates to manage the wealth of people in rural India.

Same criteria, same issues, but they’ve found a solution to it and are making money. That’s possibly a step that the funding models in India will have to take a look at and learn from. Its taken for granted that everything in India is grand – from railway stations to public toilets we have an issue of models having to scale up and dying by the lack of it. Funds are not going to be an exception to that rule. The right processes, definitely will play a crucial factor.

Ofcourse this is my understanding. Am counting on the wisdom of the audience here to continue this discussion – Whatever it takes to improve on things that already exist, but dont quite satisfy.

Update: On a Related note, Do Check Udhay’s Post on Angel Soft.

  • Renu

    We’re looking for all available options to raise about $8k in small business funding in order to fuel the growth of our Apparel business. We would like to use the funds that are raised for the purposes below:
    - Developing an e-commerce website for reaching out to international buyers
    - Buy some exciting and premium stocks from wholesalers which will be liked by international buyers
    - Operating/Growth Capital (Payroll, Sales & Marketing, etc)

    Any solutions to suggest..?

  • http://www.vijayanand.name Vijay

    Iqbal, Unfortunately what you are talking about is not a solution. And I didnt say folks needed microfinance, but lets face it, most of the companies in India dont have large financial requirements – atleast in the initial stages, and there are very few funds who are capable of meeting that need – and some of the concerns and troubles faced even by well-meaning funds are what i was listing.

    There is no cure against changing people’s attitudes, and grandiose vision. I consciously stayed away from that, because its usually nothing more than moaning and groaning about what all is wrong and leads nowhere.

    We cant compare. We dont have the credit history and enterprising backdrop (atleast from an institutionalized point of view) as London or Silicon Valley and the comparison is not one that is valid, in my opinion.

    But thanks for the two cents.

  • http://www.iqbalgandham.com Iqbal Gandham

    Hi Vijay

    I would disagree with this. I do not believe companies need micro finance, it is NOT the amount of money that is the problem, but the risk averse nature, follow the pack mentality of the people managing the funds. I have spent the last 6months in London, seeing what the startup scene here is like, and it has changed completely in the last few years. There is a vibe, people want to take risk.

    That is what needs to change, people need vision. The amount of times I have heard the line “Internet penetration in India is not as high” is amazing, question I usually have is “What was it, when Ebay started in the US”. US speculates to accumulate, India, waits and watches.

    You actually require MORE money in India to do the same startup Why?, because you have less experienced people doing the same thing, lack of mentors prepared to help out, less companies willing to help, more wanting to hinder and “steal” ideas and try to do it themselves.

    Hiring talent in India is no longer much cheaper than in US, or UK, GTM is probably harder since the channels are not always clearly defined, the general working attitude is different, this leads to an overall increase in time in getting the same idea to market, hence more money is needed NOT less. Couple this together with more risk averse money managers, than just people sitting on a pot of money, and you may get India to move.

    Don’t reduce the money, increase it.

    Iqbal

  • http://www.twistfuture.com Virat Singh Khutal

    Vijay:
    Thanks for your feedback.

    Now we are touching balance between this two. Innovator and Entrepreneur. This balance is highly required for future companies.

  • http://www.vijayanand.name Vijay Anand

    @ Venu: The Micro-fund in a lot of ways will become the conduit between a seed capital round and a full-blown VC round. So all the exit points that apply for a Angel would apply here.

    Technically a VC firm itself could put aside some of their raised capital to do this, in which case, as the company grows, the next round could come out of the larger fund – I am seeing some firms attempting this.

    I was talking to some folks in the valley and it seems MicroFunds (smaller VC Funds) are becoming quite popular and popping up all over the place there. So perhaps it will arrive sooner than we imagine it to.

  • http://www.vijayanand.name Vijay

    Anand: Whoa! While we are not perfectly happy with the ability of institutional funds to be engaged in India, I doubt this is the doing of any individual VC of VC firm and there is simply no conspiracy here. We are all simply victims of borrowed models. There is funding happening, so I would say Yes there are real VCs around in India. I also know that most of the companies seeking funding are nowhere close to raising funds, so the blame lies on both sides.

    As for Microfunds, I believe MVP is raising a fund already. So You’ll see quite a few of them pop-up even before this year is out.

    Rajagopal: You totally missed the moral of the story here. Stop copying. Start Adopting and Adapting. There are already enough folks who have been doing that process here in India – IAccelerator, Morpheus etc.

    Virat: You are confusing two very different things here. A company working on the next generation of fuel cells is an Innovator. A company which has figured out how to monetize that is an Entrepreneur. Is there funding to do basic research to come up with “Innovative” things? Absolutely. Dont ask a VC for such funds, but there are several government entities and organizations which are disbursing money for those things. But ofcourse research is always associated with an entity/Academia, so be ready to get into that framework as well. Its important to understand that differentiation.

    Its been 30 years and the 3 AA Cell Torchlight is still one of the best selling portable lighting equipments in India. Several players have tried all sorts of madness but that Eveready torch still works like a charm. Low maintenance, hardware, and adoption. Thats the stark difference between Innovation and Entrepreneurship.

  • http://www.twistfuture.com Virat Khutal

    How many companies in India r making Nuclear power plant or space shuttles. It is controlled industry by government. I am talking about new and innovative companies. Do you think new and innovative companies need huge funding. Secondly scaling requires money but before scaling you require valid model, which is workable and profit fetching. Micro-finance can help in finding valid model. Once you have valid model then Series A B C D financing can take place.

  • Venu

    Vijay,

    A good post. I have been thinking on the same lines for some time.

    However I was curious to know as to what is the next level for such micro funding org’s, how do they monetize their investments ?, when do they get their exits ?, what is the IRR for such small funds ?, what is the benefit for the guys (LP’s) who invest in such small funds ?, does the promise of dividends alone suffice to the investors into such funds ? so on & so forth…

    Since the source for such micro funds is not unlimited they need to have an incentive to keep investing in such micro funds.

    The model for scaling the micro funds is absolutely important for things to start happening there.

  • http://www.vijayanand.name Vijay

    @Old Hand: LOL :)

  • Old Hand

    Spoons are simple to companies should be simple? LOL what kind of logic is that? Should nuclear power plants and space shuttles be simple too? Should everything be simple?

  • Sum

    .. that should read “level slightly higher than we currently are at”.

  • Sum

    This is more topical than ever as we need to put all stakeholders into the same room. While I am aware of great work being done – how do we pick up speed and have cohesive strategies. We need greater accountability for how resources and time are being spent – then we can start thinking at perhaps a level slightly higher than what we want to.

  • http://www.vijayanand.name Vijay

    Sum, I’d have to disagree with you respectfully.

    First of all I think you just connect two very different worlds apart. Financial inclusion, especially on the context of rural has very different challenges. Delivery (physical), Access are the two main concerns, and there are some fantastic work happening there via the organization that I work for (www.rtbi.in), IFMR Trust, etc

    Secondly, I dont know which era you are in, but you have to wake up. The Govt can enable loans and policies regarding that, why would they want to get into operational level detail. That bit of yours made no sense – perhaps I misread, but if specialized “funding” bodies cant sort this out, dont expect the govt to do it for you – simply not their priority at this moment.

  • Sum

    It appears as if we have people operating with different levels of resources but all grappling with a number of problems that are really at a grassroots level. Financial Inclusion, e-Governance projects have been in the pipeline a while – but looking at the decision making process and the painful slowness of it all IMHO, the entrepreneur ecosystem would be benefited by definite models where govt can be engaged ( not the other way around ) and the public-private partnerships have greater accountability in terms of time and resources.

  • First-time entrepreneur

    Check out CRV’s Quickstart program (http://www.crv.com/quickstart). There are other VCs in the Valley who do seed stage (in the form of convertible notes) but don’t have structured programs like CRV’s.

    Here’s a summary:
    CRV makes $250K seed stage investments in the form of convertible-notes, which convert to equity at Series A and CRV also has a right co-invest in Series A. To compensate for the risk, the conversion takes place at a discount rate (25% in their case).

    The whole purpose of the seed stage capital is to take an idea to a product stage and see if gets some early traction.

    VCs,
    What stops from you bringing such products to the Indian venture community ?

  • http://www.sastwingees.org rajagopal sukumar

    Interesting. Maybe we should copy the Y Combinator model in India?

  • http://muglikar.multiply.com Anand Muglikar

    I absolutely agree with you Vijay…

    But are there really good and in-the-real-sense-of-the-term VCs in India? Are there Micro-financing Firms? If not, when and how will these spring up?

  • http://www.twistfuture.com Virat Khutal

    Vijay you are right.
    I am new or may be i do’nt want to understand all this.

    I enjoy cold analysis of “what could or would be done by entrepreneur and VC to make more profit”

    I hope one day i understand all this discussion.

    Virat

  • http://www.vijayanand.name Vijay Anand

    Virat,

    You should still take the time to understand what those clauses mean and why either parties prefer to have/not to have them. Its good to know these things if raising institutional funding is a consideration at all.

  • http://www.twistfuture.com Virat Khutal

    I think you are correct.

    It is always basic and simple rules workable rather then complex rules. I have gone through term sheet posted by Alok. It was so complex that my mind was spinning.

    In simplicity you feel control over situation and resources but in complex environment you search for security rather then risking everything. If i sign tht term sheet with anyone then for next 6 month i would be thinking about those clauses in my head.

    Spoon is very basic design of man. It is simple, useful and 2000+ years of engineering applied to it. Same thing is companies. They should be simple…..risk and reward equation. This parabola and equation elevation destroy the real reason.

    Virat