This is a guest post by Ramneek Gupta of Battery Ventures, a Silicon Valley based top tier VC firm that is now active in the Indian space as well. I bumped into Ramneek recently and asked if he would be willing to share his perspective about VCs & startups, for the readers of this blog. He gracefully accepted, and the result is this rather (unexpectedly) candid writeup, about a question that bothers every startup entrepreneur – “To VC or Not to VC…”. Ramneek’s detailed bio is at the end of this post.

Every entrepreneur will face this pivotal question and needs to carefully evaluate raising PE/VC money as he/she thinks about scaling their ventures. The barriers to entry and capital requirement to start a new business have come down dramatically due to a number of innovations in hardware (eg: storage and processing power available as utilities in a pay as you go model) and software (eg: SAAS). As a result it does not take a whole lot for entrepreneurs to code a new idea and let it loose on the netizens to see what sticks. This has led to a tremendous spurt in formation and growth of new ventures that fall all along the feature/product/company continuum. Each of these opportunities can represent a good business provided the capital usage and the capitalization table (% ownership of the various stakeholders) has been carefully matched with the scope of the venture. Let us discuss this point in greater detail:

Feature/Product Ventures….
Feature/Product type ventures are generally limited in their ability to be standalone companies for various reasons: their monetization models may not be suited to support costs like G&A overhead, direct sales, marketing; they might be add-ons on an existing platform, etc.….especially in the Web 2.0 area, these types of ventures are well suited to being acquired by a larger company that already has the ability to monetize the feature across its existing traffic, can acquire and retain new users/traffic as a result of the product and can continue future development efforts. This does not mean that these “built to flip” businesses, as they are sometimes referred to, are less exciting intellectually or any less enriching financially for the entrepreneurs. As long as these types of businesses are built with little or no venture capital they can still translate into significant paydays for the entrepreneurs.

This might be an over simplification of the math but at a high level, a $15-30MM exit for a business that is majority owned by the founders (which often means that there is no venture or private equity involved) can result in just as significant a return for the entrepreneur as a $300M+ exit where the entrepreneur owns only a small piece of the company. Additionally, if we factor in the probability of success by using the number of acquisitions with considerations <$40MM as a proxy, the risk reward ratio becomes even more attractive. To give you some examples, there have been a number of ventures that were acquired very early in their lifecycle and tended to be products rather than companies including Flickr (acquired by Yahoo), Blogger (acquired by Google) and Bloglines (acquired by Ask.com). If one is to take a closer look at say Flickr one would find that the founders made the decision to join forces with Yahoo early on rather than go down the path of a Snapfish or Ofoto (not that they ever intended to) which would have required greater investment and consequently outside capital. Similarly, Blogger (a service that enables consumers to easily create web logs on the Internet) is a perfect example of a product that may not have supported a standalone company on its own but made perfect sense in being scaled under the Google umbrella. Large standalone company type ventures….
This is not to say that there is no home for venture capital (there better be otherwise I am going to have a serious existential crisis ). There are businesses that require tremendous upfront investments in technology, operations, distribution, fulfillment, sales, marketing, etc., before their business models can be tested and they can demonstrate the hockey stick exponential growth that we as VCs look for. These businesses are perfect candidates for VC/PE investment. Readers can take their pick out of any number of companies like eBay, Expedia, Amazon, Akamai, Google, Yahoo, etc., that would help illustrate this point.

Then there are the rest….
In between these two ends of the spectrum, are a host of businesses that do require some outside sources of capital and are well suited to angel investment and/or investments from smaller to mid-sized VC firms that have much smaller terminal value hurdles (not to be confused with return multiple hurdles). These are companies that have terminal values in the $100-$200M range that take anywhere from $10-$30M to build to cash flow break even.

A little about what drives your friendly neighborhood Venture Capitalist….
VCs represent a very specialized source of capital which is inherently high cost. Their investors which tend to be large pension funds, university and other endowments, sovereign funds, large family offices, etc., have a much higher return expectation from the asset class in line with the inherently higher risks involved. Additionally most funds are structured on 80/20 split of the profits (meaning that the VCs get to keep 20% of the profits only after they have returned the entire corpus of the fund). So most VCs are driven to make investments that would help them get to a point where they have returned their corpus and are able to share in the profits. This is where the fund size comes in. If we assume that out of a portfolio of 30 investments somewhere between 5-10 can have return multiples of 5-10 times the original capital invested, then a VC needs to be able to return his corpus from their 5-10 investments and also make profits on top of that so that he/she can get paid. For a $100M fund a return of $20M from a single investment would be considered a very good outcome as 5-6 of those would return the entire fund whereas for a firm with a fund size of $1B the same return hurlde would need to be $100M before it can be considered a good outcome.

As an entrepreneur one needs to make sure that they understand the return expectations and hurdles of their potential investors and should carefully match that with the potential of the opportunity before partnering in order to avoid disagreements and acrimony later on in the lifecycle of the venture.

In summary….
A solution based on a good idea that serves a real need in the target market will always have the potential of being a good outcome for all the stakeholders as long as the expectations are well matched with the opportunity. This is one of the key assessment exercises that entrepreneurs and VCs alike should go through in order to increase the probability of a good, successful and enriching outcome.

Author’s Bio:

Ramneek leads the India investment efforts at Battery Ventures. Battery is one of the top tier VC/PE firms in the US that has been around since 1983 and has over $3B under active management. Battery has backed a number of successful companies in the past including Nextel, MetroPCS, Akamai, Qtera, LIFFE, FORE Systems, Pixelworks, Omniture, SigmaTel, HNC Software etc.

In India Battery has invested so far in four companies namely:

– TechProcess – Electronic payment processor
– Tejas Networks – Leading-edge optical networking products
– Travelguru – Travel solutions for Indian domestic market
– HighMark – Next generation consumer credit bureau.

Battery focuses broadly on companies in the Technology (software, hardware, telecom, semiconductors, clean tech etc), Tech enabled services (BPO, KPO etc), Media (TV, Print, Radio, Internet, Mobile) and Financial Services space across all stages (early, mid, growth).

Ramneek will be moving to India in Q3 2008 to open Battery’s offices in India and continue to scale its investments and team in India.

Prior to Battery, Ramneek spent more than four years as a Principal at ITU Ventures. At ITU, he was responsible for investment activities in the communications and semiconductor sectors, and worked closely with Hier Design (acquired by Xilinx) and PowerSiCel (acquired by Advanced Power).

Earlier, Ramneek was a Design Engineer at TiVo Inc., where he worked on the design team for the Series 2 DVR. Before TiVo, he was with PMC Sierra and worked on system design as part of the carrier switching division. Ramneek holds a BS in Mechanical Engineering from the Indian Institute of Technology (IIT) Bombay, where he graduated at the top of his class, and an MS in Mechanical Engineering from Stanford University.