There is a concept in the stock market known as "ten baggers". These are stocks in which an investment grows at least ten folds within a given span of time. The basic trick lies in spotting a ten bagger when it is a one bagger, or still in its embryonic stage and then analyzing and predicting its growth potential, and finally staying invested till that potential is realized. Easier said than done, isn't it?

But Venture funds, the modern day soothsayers, do just that …………and of course a lot more!

They provide funding and other specialized services to "An Entrepreneur" , "An Idea" and see it through the setting up stages, mother it and nurture it with additional rounds of funding and then after their baby can stand on its feet they gracefully make an exit. Of course venture funds provide assistance not only at the seed stage, but also at the growth, expansion or rehabilitation stage. The venture funds have been around in India for a long time, but it is only in the last couple of years that they have started lending their "ears" to the needy! A lot of this sudden activity in venture funds has to do with the government regulations which are actively encouraging venture funds into the country and are aiming for an annual $10 bn funding by year 2008.

Entrepreneurial acumen has been a hallmark of corporate India’s success stories. We have never lacked "to boldly go where no man has gone before" and now with the success of Indians in the net arena, things couldn’t be better.

One venture fund head is quoted to have said that he meets at least 1 budding entrepreneur every alternate day, but he chooses to fund only one in a hundred. This is a ratio justified if one takes into account the facts that world over venture funds have a success ratio of 1:10, and plus the quantum of exposure could range from a mere Rs. 50,000 to a phenomenal $10 mn. Also the returns do not see the light of day for atleast 3-5 years. So it pays to be cautious. But then how does one go around seducing these reluctant grooms.

Well the first step is very basic, research the groom! Do a thorough due diligence of the fund. Not all venture funds cater to all industries, so the budding "Bhatia" should ensure that he or she has done the background research on what is the area the fund specializes in or is it a general fund. Post that, it is always better to go recommended by some one. But if that can’t happen, then a straight approach will at least qualify you for the entry round.

Now from the groom's perspective. Most venture funds have a fairly set criteria of what they look at in a project. The three main deciding criteria can be termed as the three P’s - People, Project and possibilities.

The foremost thing is of course the "Entrepreneurial Team", this consists of the entrepreneur as well as professionals in the team. The best ideas have to be backed by a winning team. In the dotcom arena especially, the entrepreneur is really young and may have no track record. So he or his idea as a stand-alone may not be enough to attract funds. But his ability to put a dedicated team together would definitely be a big plus. VC's insist on a professional team coming in, including a CEO to operationalize the idea in the absence of a complete team. Because without the fundamentals of people - the entrepreneur and his team - even a great idea can be a disaster. The team itself should be confidence inspiring and be able to portray personal integrity, transparency as well as dedication and belief to the common cause. In case the venture fund is on the board with the entrepreneur then he would seek a personal chemistry with the entrepreneurs; so as to facilitate a working relationship.

The next most important aspect is of course the "dream/idea/concept" and its ability to be monetized resulting in growth in valuations and profit. In effect a business model. There are certain factors which enable an idea to be business model friendly. Scalability or rather how "Big" is the idea-i.e. the world is my oyster, in terms of national or global boundaries is critical in building valuations, revenues and profits. Ease of entry or entry procedures in that particular industry would also help indicating the competitive pressure and mortality resistance of an idea. The entry barriers could be in the form of technology, products, and now in terms of speed of entering and securing markets/customers. What does the idea really create-tangible as well as intangible is another important factor in the business model i.e.-Creation of Value, does the business model allow for creation of intellectual property, patents, methodologies, processes and Brands, which will add to increased valuations?

Increasingly the value of building brands is becoming critical to valuation of a company. In essence, the importance from a valuation perspective, of softer assets, are increasingly becoming critical for a VC fund. Because Venture funds derive their earnings not through revenues but by way of valuations, so they place a lot of importance on a company’s propensity to accumulate family wealth like the drive to build intellectual capital, building methodologies in IT enabled services and building brands.

Then comes the big V- Valuation. These would differ for a start up or an ongoing concern. And are usually drawn from parallels in the stock market, business projections and experience. Traditional models like Price-to-Earnings ratios or Discounted Cash-Flows etc are all used and new valuation formulas are tailor-made for industries where these traditional formulas don’t work. Expected returns is the base line and these have to be interpreted with a host of other factors like rupee depreciation, political instability - such issues tend to suppress valuations today. Presence of intellectual property, brands or predictability of future revenues and profits enhance valuations.

Depending on the valuation the fund then decides to participate in the venture. The representation of the fund can be as high as 50-70%, especially in a seed operation. Here the Indian entrepreneurs should shed their normal paranoia about controlling stake and allow the venture fund to participate fully.

The venture fund of course has to have an exit route available to it post its nurturing of the venture is over. This is normally in the form of a trade sale or an IPO. Here structuring for tax optimization while existing is essential as well as the time frame of the holding. For the investee company and the entrepreneur, life after exit is critical; in the event of an IPO, the VC and the entrepreneur are really creating an ongoing concern with fiduciary responsibility to a larger set of investors. VC funds will discuss exit options at the time of investment. Also Exits are never ever stand alone decisions, they must be discussed with the entrepreneur.

The entire process of starting a dialogue till the final stage when funding is disbursed can take upto 3-5 months. And as the risks are so high this time is well-spent on due diligence both by the Venture capitalist as well as the entrepreneur. After a relationship is about the future and is based on trust.

Aru Srivastava