What Sequoia's exclusionary act says about India's startup ecosystem

Many experts believe that a relatively nascent LP ecosystem and a general expectation that VC funds be closed-end in nature prompted the country's omission

A few weeks back, venture capital firm Sequoia announced that it was restructuring its fund structure in a number of ways, the most important being that the 10-year fund cycle would be abandoned. The Sequoia Fund will be able to invest in and hold public stocks indefinitely, bypassing a basic constraint of venture capital which is limited time horizons. 

What stood out in this announcement was that its India arm would not be a part of this restructuring--this was only for Sequoia’s funds in the US and Europe. According to Crunchbase data, Sequoia was the most active startup investor in India in the September quarter with 41 deals. 

Till date, Sequoia India has participated in 541 rounds of investments in 198 companies and has made 93 exits, according to data from Pitchbook. The VC firm’s India arm, which began investing 14 years ago and also bets on Southeast Asian startups, raised $1.35 billion through two funds in 2020. It counts unicorns like Zomato, Freshworks, Byju’s, Unacademy, Rebel Foods, Oyo among portfolio companies.

The question then is why was India excluded from Sequoia’s ‘crucible’ moment as the venture capital firm describes it? Several founders and investors believe there are two major reasons.

Sequoia declined to comment on the matter.

Firstly, most Indian LPs (limited partners) such as high net worth individuals and family offices who put money in VC funds, and who caught on to the startup as an important asset class only in the last decade, have yet been part of only one full cycle of 7-11 years and are still recovering their money. 

Siddarth Pai, managing partner of VC firm 3one4 Capital which manages a corpus of $250 million, said “The US has already gone through many fund cycles, which has built confidence amongst institutional LPs like pension, insurance funds, and endowments to be interested in such a perpetual play like Sequoia’s new fund structure as they are looking for long term yields.”

“The Indian startup ecosystem is still nascent and is yet to develop long term patient capital. There are policy changes happening which encourage provident funds, life insurance companies to invest in startups, but the appetite needs to develop,” he added.

However, for patient capital to stay invested for the long term, startups as an asset class need to prove that they are stable long term businesses. This might be the second reason why India has not found a place in Sequoia’s restructuring.

“The fact that such a construct is even feasible is a strong testimony to the brand value of Sequoia and the trust built over decades with the LPs. Zomato and Freshworks have been massive listings from Sequoia’s India portfolio and more are in play right now. However, you need several such companies to be listed to be able to have the coffers that make such large, liquid perpetual fund structures possible,” said Vinod Murali, managing partner of venture debt firm Alteria Capital.

“I think the Indian startup market needs to generate a lot more liquidity predictably before an open-ended fund can be a sustainable option. LPs may require liquidity at some point even from a long-term fund, which is why you need to have multiple good listed investments that can provide the cash flows required,” he added.

Most venture capital funds around the world follow a cycle of 7-12 years which includes deployment of money in companies, working closely with them to monitor growth and eventually finding an exit route -- via selling stakes to other PE/VC funds, taking the company public, getting the company acquired, or selling the portfolio wholesale (the worst-case scenario, equivalent to a fire sale.)

But many founders believe that such a fund will be very beneficial for Indian startup ecosystem. K Vaitheeswaran, founder and CEO of AGAIN Drinks, said: " What happens currently because of the shorter time frame is that start-up founders and investors do not share the same agenda. One is trying to build a business, while the other is looking for avenues to exit."

"In my two decades of experience, it has been a fairly common occurrence that I have seen founders not making the best decisions for the business as VCs were pushing for an exit", he added. Vaitheeswaran is known as the pioneer of e-commerce in India as his company, Fabmart, was the first such venture in the country.

Also, sector watchers believe that Sebi-accredited funds that do investments in unlisted companies are generally expected to be closed-end. Venture capital is a relatively newer regime in India and closed-ended funds at least give investors some indication on when their money is likely to be returned. It puts that much pressure on the fund manager also to deliver a performance within an agreed period.

But this close-endedness may also hurt returns for LPs if the end of a venture fund’s life cycle coincides with a bear market. “Take the Franklin example as an analogy. It was an open ended fund and had ended up with a lot of sticky paper. If it had been closed-ended, the fund would have had to compulsorily do a fire sale. The winding up did allow the manager to stop redemptions in absence of liquidity. Essentially, bad periods in the market can force fund managers to make short-term decisions,” said Suraj Malik, a senior management consultant who has advised family offices in the past.

This is one of the major reasons why traditional VC funds are expected to make changes to their investing style as start-ups become a popular asset class for money managers of all hues. In this context, media reports have surfaced in the Silicon Valley indicating that VC firms there might even list themselves to compete with hedge funds and private equity players on Wall Street.

One approach to startup investing in India has been taken by Infoedge, the parent company of job search portal Naukri.com, which went public in 2006. Since then, Infoedge has been an early investor in startups like Zomato and Policybazaar. Sanjeev Bikhchandani, founder and executive vice chairman of InfoEdge said: “We have been funding startups from our balance sheet for the past two decades. In India, it takes longer for a new tech company to establish itself and we have determined that a 12+2 year horizon is a good strategy for our investments.”

“Founders are bound to make some sub-optimal decisions if VCs keep pushing them for an exit,” he added. Interestingly, Infoedge last year set up a traditional VC fund with a target corpus of around $100 million, half of which was to be raised by external LPs. This fund has already disbursed money to startups like DotPe, Qyuki, Fanclash and Truemeds.

A founder whose two startups have cumulatively attracted VC funding of above $300 million said, "Naspers is another good example of a technology investor which places bets for the long term. VCs tend to force a merger or an acquisition after a company has been in the portfolio for 7-8 years."