The biggest challenge for private equity and venture funds that are looking to invest in the Indian retail sector is finding business models that are logically scalable within a four-to-five years time frame and allow the investor a decent exit. Due to the nature of the most funds and how they are structured, a seven-to-eight year term is the maximum time a fund would be involved with an investee company and it is difficult to find an investor with a longer-term horizon.
On the other side, this can also prove to be a challenge for the investee company: some of them may feel unduly pressured to grow faster than the natural pace of their business and could make strategic and operational decisions that are destructive to the business. As consumer incomes move up and the environment becomes more conducive, the life cycle to building a retail business becomes shorter. For instance, 20 years ago it would have taken over 10 years for a business to cross Rs. 100 crore (INR 1 billion). Today, with the right mix, it would take much less time. However, building a business that is both large and profitable (hence sustainable) still takes a significant amount of time.
Venture equity is suitable for businesses that can grow and add value inorganically, either in intellectual property-driven businesses such as technology companies and brands that can provide higher margin returns on a given equity base, or by selling the business further to investors who think they can derive even more value from it in future.
Retailing, on the other hand, is inherently an organic growth business, and the most suitable sources of funding for organically grown business are internal accruals and debt. However, the rapid economic growth in the last 15-20 years has created an opportunity for large businesses to emerge inorganically. Good examples of this are the large corporate groups that have entered retailing.
Looking at them, one could be seduced into thinking that the environment and the business have changed significantly such that other professionally created businesses could be easily launched, venture-funded, and grown to exit. My take on this is that if you can create a fund whose life is 20 years or more rather than the typical 10 years, there is a better likelihood of making it work.
Of course, bank debt is not easy for an entrepreneur either – Indian banks have become more progressive, but the norms are still relatively stringent. Unless the space is bought, the retail business has few significant-value fixed assets, and bank loans are limited for businesses that cannot offer much collateral.
Each stage of the retailer’s growth needs a judicious mix between own capital, supplier credit, bank loans and external investors’ equity. The last one evolves from friends and family at the inception, to angel and venture investment during growth to, eventually, public equity, if all goes well. Each of these sources of funding come with their own expectations on returns and disclosure, so an entrepreneur needs to balance these based on his own comfort levels. One of the most important characteristics for most institutional investors is that the business seeking funding should have a broad and deep management and executive team, rather than being over-dependent on the founder-entrepreneurs. There needs to be a demonstrated track record of growth that has been delivered by this team, and a clear future direction to sustain and grow the business.
It is a curious cycle: structured, process-oriented and systematic businesses that are not dependent on one person (the founder) are more likely to attract outside money, and outside money coming in puts more pressure to create transparency and broadening responsibility with which many entrepreneurs are uncomfortable. Most of them start their own businesses so that they do not have to report to someone else, but the moment there is external money involved, you realise that you are answerable to someone else. This is often a tough call for an entrepreneur – not just in India, but worldwide – a traditional, patriarchal and feudal mind set will just not work with external investors involved, especially in today’s environment where information and opinions flow more freely than ever before.
One of the most common mistakes Indian retailers make while trying to get funding is over-estimating the market demand. The second is underestimating the complexity (and costs) involved in starting and growing the business to profitability. Once you have put a business plan out there, it not only becomes a hook for your prestige, but valuation norms are also driven by the figures that have been agreed upon. This can cause business decisions that seem to look productive in the short term – such as adding stores to grow sales immediately – but are harmful in the long run, such as adding stores in locations that are not sustainable. We have seen such decisions being made in the last 10 years, where businesses have spectacularly imploded after over-expanding too quickly. Investors as well as bankers are rightfully more cautious today while evaluating businesses to fund.
A key thing to remember is: no matter how badly you want the money, it is not just about the money. From an entrepreneur’s perspective, who provides the money can be even more important than how much and how quickly the money comes in. For example, a particular investor could bring in a business perspective and relationships that are directly relevant to the entrepreneur’s business, which can add value well beyond the money that flows in. An example in recent years is Anita Dongre’s rapid growth with the strategic investment from the Future Group, which not only benefited the entrepreneur but also allowed the investor to gain a handsome exit. Commonality of objectives and a shared view of the time frames involved are also important, so that business decisions have the full support of the investor.
Timing is important: If you get an investor in too early, you may be losing on the valuation and selling out too much of the business to one investor. However, holding out for the ‘ideal’ benchmark valuation is possibly worse, because there is also a cost to the time and opportunity lost in getting the required funds.
Later-stage retailers still have avenues to raise debt and private and public equity, whereas start-ups and early stage businesses that can add significant entrepreneurial colour into the business are the ones that are struggling to get funded.
If I were to focus on one piece of advice to an entrepreneur looking towards VC funding, it would be this: don’t try to extract what you think is your complete lifetime’s worth from the first deal that you sign. If the business is successful, and the first investors are happy with their returns, they and others are likely to come back to you in far greater numbers, offering much higher valuations.
About the Author
Devangshu Dutta is chief executive of Third Eyesight (www.thirdeyesight.in), a specialist management consulting firm focused on the consumer and retail ecosystem, and managing partner of PVC Partners.