VC bigwigs breaking away to start anew face steep climb as they struggle to raise funds

“LPs (limited partners) are very satisfied at this moment with the delivery of returns that are taking place in the public markets," said Sanjay Nayar, former CEO of KKR India, who retired to start his own early-stage fund, Sorin Investments, which closed its maiden fund in May. “If the stock markets give 25% returns and private about 15%, they wouldn't see much scope here given that it's illiquid and highly risky. Therefore, they are also hedging and allocating to private markets, but at a slower pace."

Venture capital funds are managed by general partners or GPs, while limited partners or LPs invest in them.

However, Anup Jain, former managing partner of Orios Venture Partners, said a correction in the public markets is imminent. Jain, along with Rajiv Suri, quit Orios at the same time last year and is in the process of raising the first fund for their new VC firm.

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“I would expect a sell-off at some point of time based on the US election results," Jain said. “While the pool of domestic retail money is definitely there, it is currently making the most of the stock market rally."

Funds such as Sorin have been able to raise capital in a quicker time frame as the bulk of the commitments came from domestic pools of capital including the Nayar and Banga family offices. Many have, however, struggled or are taking longer to close as they navigate the intensely competitive fundraising arena.

Apart from slower allocations to the private markets, many LPs have a policy of not backing first-time fund managers. Over the years, LPs have chosen to consolidate their funds and invest large sums in fewer managers.

Niche opportunities

Prominent members who have departed VC firms to launch their own funds include Nexus’ Sameer Brij Verma, Peak XV’s Piyush Gupta, Lightspeed’s Vaibhav Agrawal, and Premji Invest's Atul Gupta, according to recent media reports. These fund managers did not respond toMint's request for comments till press time.

According to experts, fund managers leave to take advantage of niche opportunities that emerge from the proliferation of startups. Other reasons include internal conflicts and fairness issues in their previous firms and corporate governance lapses in portfolio companies that could hurt their track record.

 

This is not the first time that partners have left to branch out on their own. About two decades ago, cross-border funds such as Helion, Nexus, Accel, Sequoia India (now Peak XV Partners), Matrix Partners and Lightspeed came into existence when the country’s venture capital landscape was an unexplored frontier. This was also when domestic funds Kae Capital, Orios Ventures and Blume Ventures took shape.

Over the next decade, fund managers from Helion broke away to start on their own with Stellaris Ventures and Fireside Ventures. In the past two years, fund managers have left firms such as Nexus, Peak XV, Lightspeed, Matrix and Orios.

Such departures came largely as the number of startups looking for funding grew exponentially. As the market matured, many new general partners (GPs) created niche opportunities by devising sector- or stage-specific funds, Alok Goyal, founding partner of Stellaris Venture Partners explained.

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Goyal was among the early investors to leave VC firm Helion and start Stellaris. He added that the deal pipeline of funds has almost tripled over a span of five years.

However, such opportunities are rarely the sole trigger for investors to leave the security of their established firms to chart out on their own. Often, exits have occurred due to internal conflicts.

“In every VC firm, it's well known that there are usually one or two rainmakers. If a founding partner, who is the majority owner of both profit share and carry, isn’t one of these key players… it calls for a fairness-driven reset on the commercials between the partners going forward," Jain said.

Rainmakers are people who bring in clients, money, or prestige to a firm because of their contacts and associations. Typically, VC firms keep up to 20% of the profit from fund exits, while the remaining amount is returned to limited partners. Additionally, fund managers receive a 2% annual management fee from the committed fund corpus.

Detrimental effect

"On top of this, when there is an attempt to undermine even existing agreements and work on multiple other businesses alongside, it speaks to a mismatch on fundamental values," he said, adding that such behaviour is often the cause of exits or fallouts of rainmakers from "promoter-mindset" firms.

These challenges are aggravated when there are corporate governance lapses in portfolio companies that may have a detrimental effect on the track record of the investor and the firm. It also complicates the process of raising an additional round of funding.

In the past two years, there have been corporate governance issues with Indian startups such as Byju’s, GoMechanic, Trell, BharatPe, Zilingo and Mojocare, leading to significant backlash for their investors.

The track record of a firm is a closely watched parameter and determines the tenacity and the decision-making abilities of an investor. It includes metrics such as the internal rate of return, distributions to paid-in capital (a measure of investment performance), multiple on invested capital (the value or performance of an investment relative to its initial cost), and the loss ratio, which reflects the number of companies funded by an investor that have shut down or failed to secure additional funding.

With track records carrying so much weight, investors tied to prominent VC firms or big-ticket deals are in the perfect position to strike out on their own, sparking a wave of others following suit. But this could be the point when the wheels often start to come off.

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There have been instances when fund managers find themselves in a knot because their former employers prohibit them from using their past track record. In 2019, Everstone Capital took legal action against a former employee for attempting to leverage their track record even before launching their first fund.

Such metrics are keenly observed by LPs who have become picky in a market that is already small and dominated by a small pool of about 100 high net worth individuals or investors. This is based on the premise that fund managers have had abysmal exits with very little gains for LPs. To be sure, LPs favour experienced managers who have left prominent VC firms or dealt with high-profile deals.

“Typically, LPs are also privy to the people in different funds who are performing exceptionally and are willing to back such managers," said Ankur Mittal, co-founder of Inflection Point Ventures.

Track record

However, the real troubles begin when fund managers must prove their track record all over again.

“VC funds' (support) provide tremendous opportunities for senior management to identify, fund and continue to work with new startups and founders... However, fund management is a different beast. Amid fundraising, deal sourcing, investments, post-deal support, investor relations, and working on exit, the learning curve can be steep," Mittal said.

After raising the first round, proving one’s track record in venture investing could include short-term metrics like the number of up rounds, investors said. Up rounds are levels of financing when a company’s worth increases from its previous valuation.

“The only real measure of success is cash in, cash out. That’s why we focus on metrics like DPI and TVPI (total value to paid-in capital). Until cash is fully delivered to LPs, nothing is proven," added Goyal. While successive fundraising rounds are a challenge, many firms ultimately falter because of internal conflicts among team members.

“Teams do not separate just because of performance; it could just be that the team members have different visions for the fund. Like founders in a startup, GPs might decide to part ways to realise their vision and continue separately, and this cycle continues," Goyal said.