Leo Capital’s Rajul Garg On Building An Early-Stage Thesis For All Seasons

Entrepreneurs turning fund managers is seen by many as a ‘pivot’, especially when we are talking about a three-time founder. But for Rajul Garg, founder and managing partner of Leo Capital, the transition was a natural extension, and a way to find a voice in the tech ecosystem.

“I was an entrepreneur and I could really add value to the early journey of the company, but as an angel, I had little say. As a VC, I could add this value to all organisations by having a bigger voice,” Leo Capital’s Garg told Inc42.

Having founded PineLabs, GlobalLogic and Sunstone Education, Garg was hungry for a new challenge and that’s when he launched Leo Capital, a Singapore-based early-stage fund, along with seasoned angel investor Shwetank Verma. Having been an angel investor since his Pine Labs days, Leo Capital was a formal extension of Garg’s penchant to find the right technology and enable the startup to become a high-impact organisation.

Now in its third fund, Leo Capital has raised a total corpus of over $230 Mn since its inception in 2017. The fund invests between $500K and $2 Mn in seed to Pre-Series A rounds of startups that are catering to domestic consumption. Garg claims the fund has no sectoral bias and indeed, its current portfolio of 39 startups (including three exits) covers areas such as consumer internet, commerce, healthtech, logistics, edtech, fintech, insurance tech and more.

These include the likes of healthtech startup BeatO, social commerce startup Bulbul, edtech Edureka, browser testing startup LambdaTest, women-focused social community startup SHEROES, among others. It was also an early backer of social commerce startup Meesho, which is today valued at $5 Bn+.

Leo Capital’s latest investment is in WhatsApp marketing platform QuickReply.ai, which raised $1.14 Mn in a seed round, where Garg’s fund was the lead investor with an infusion of $750K.

The key takeaway from our conversation with Garg was about how a fund needs to build its ancillary support infrastructure around its core thesis. A lot of Leo Capital’s decisions and processes over the past six years have been dictated by its thesis of having a bigger voice in the development of a startup’s product or service.

As Garg told us, “Even if the market turns, we cannot fundamentally alter who we are. So that’s our key motivation to continue doing things our way.”

Edited excerpts from our conversation

Inc42: Talk to us about how you brought your angel investing experience and entrepreneurial roots to the VC ecosystem?

Rajul Garg: The key points in my journey have been the experience at IIT Delhi before I graduated in 1998, then launching Pine Labs and building that till we raised funds from Sequoia and then GlobalLogic, which also saw an exit. After this, I branched out to the education sector with SunStone. So each of these experiences was pivotal for the Leo Capital story.

And of course, besides the entrepreneurial journey, I was also fortunate enough to have the liquidity to invest as an angel, which I started around 2011 after Pine Labs. I was investing in startups that I came across through my network.

By the time it was 2015-2016, I could see that many startups in my portfolio were growing rapidly. I was the very first cheque for these companies so I was glad to have contributed, but I also realised that I had an entrepreneurial mindset and that meant I wanted to add more value. As an angel investor, you don’t have a big voice in the company, which is a factor of the equity you hold, that’s is how Leo Capital came about.

My thinking was that with the fund, I can hopefully stay longer with some of these companies and see more of the value. What we are trying to do is help build large, sustainable businesses.

Inc42: Was it easier to get taken seriously as a VC fund after your years as an angel investor? 

Rajul Garg:  Definitely, feel so. For us, the launch of a fund was organic because of our angel investing. In 2016-2017, I was already getting requests from startups for angel investments. I would get a lot of calls for advice because I used to run this breakfast event for founders. So, essentially we had a readymade deal flow for Leo.

And particularly, I would say in Delhi, because I’d been in the city since 1994 from my IIT days, we had a bit of cachet and most entrepreneurs knew us. In fact, I do remember signing term sheets, even prior to our regulatory approval, for companies that we really liked. But coming from angel investing, a fund is a whole other ballgame.

Because I think with a fund, the burden is a little bit different. The diligence into startups, the deal sizes and the constraints we had were different from how angels invest. So for the first few years, we were learning the ins and outs of running a VC fund. Anyway I think as a fund manager, even a five-year-old VC fund is still relatively young. So we gave ourselves that breathing room to learn and grow in this role.

Having said that deal flow honestly has never been an issue because we had been enmeshed in the ecosystem for over a decade. And your network keeps on growing. The reference network is perhaps the strongest source for deal flow, and we get a lot of organic cold calls today too from founders.

Inc42: Could you talk to us about how Leo Capital formulated its frameworks for deal evaluation and what level of automation is involved vs manually sifting through leads?

Rajul Garg: So I think this process actually is dictated with the fund structure itself more than anything else. Like when he started we were just two people and we were very much running things cowboy style and even though we were writing larger cheques, we approached it like angels.

Now we are eight people and we have four full-time investment partners, along with support staff and full back office for portfolio services and all that kind of stuff. So I think as you grow, you become more institutional and therefore impose a burden on yourself for greater governance, better diligence and so on.

We do a lot more progressively year after year in terms of how we look at a deal. For example, things like reference checks which we would not do as diligently as we do now given the larger issues in the ecosystem, especially for founders we don’t know at all. We will talk to more customers.

The deal making cycle itself has been extended by several weeks in 2023, compared to the early months of the fund, where we would have a few meetings and since we were coming in early, there wasn’t much of a business to diligence as such.

Many micro VC funds still operate like that on a volume basis. But we did not want to be volume investors. As a result, we do have time and it is important to us to get to know the team well, get to know the space well, and that burden has continued to increase and improve over the years.

We’ve still not crossed more than eight to nine investments in a year over the last five years. We look for significant ownership i.e a good double-digit 12%-15% because our genesis was about having a voice in the startup.

Inc42: Through our CapitalX and AngelX programmes, a lot of aspiring fund managers ask us how they can build the team for a new fund. What are your thoughts on this?

Rajul Garg: Well, the venture capital world is not new and there is a lot of precedent on what works and what does not. But I will say that fundamentally, the VC business is a services business and it‘s not a product.

So, relationships are important and partners are important because they know things that you don’t know. Just like in the IT services industry, we have companies of all sizes, there’s room for funds of all sizes and the relationships they build will vary according to their size.

Secondly, the thing that we often forget is that there are two sides to this market. You need to be able to raise money and you need to be able to deploy capital. Deploying capital can get competitive in times like we saw in 2021.

Your fund structure in terms of the people has to be geared towards meeting both these sides. We started out to prove that we are an operator-run fund, and hence, the fund or value aspects are designed in that way, and our team too.

Besides, the human capital requirements of a fund will change when you’re in markets like that, and you may have to reprioritise for leaner years. Even funds go through downturns and you may have to reduce your ownership targets, you may have to dilute your sector focus, which I have seen funds do.

Having said that in Leo Capital’s context, we wanted a fund that could justify taking the double-digit equity and fundamentally, we will not change that. You’re building up a track record as a fund that does that, and you cannot suddenly change that or founders will lose faith.

Inc42: But surely, if things are not going well, it’s time to revisit the thesis right? 

Rajul Garg: In this regard, I think just like startups, we have to listen to market feedback. Let’s say, for example, you are losing a lot of deals and you’re making offers but entrepreneurs are going with somebody else or you’re not getting the allocation you asked for.

I think that would be clear evidence that you need to build differentiation in your service as a VC. Maybe you need to change your messaging; maybe you change your thesis. But the number one parameter is the market feedback.

Inc42: You mentioned earlier that you are sector-agnostic, but surely there are some areas that you are excited about for the next 15-18 months. Rather how do you decide where to focus?

Rajul Garg: First of all, we are a tech-centric fund, so we have to know this stuff. What is moving and how fast. So we have a view on whatever is new. It can be wrong, but it’s important to have a view. Like we do on AI, blockchain, GAN or whatever comes up.

This is really important as a fund, especially if you are sector agnostic, but also if you are focussed around a particular sector. Say, you are a consumer fund and you need to evaluate a certain D2C brand, so you need to know what’s moving in the market at the very least or have a view on a certain D2C model.

In technology, the viewpoint is crucial because of the timing and that’s helped us sharpen our focus on certain sectors. We have our own data points of how we validate that, on what the competition looks like, the market size, the adoption cycles, or talking to enterprises who are the potential customers for deeptech products. Their IT purchase managers and CISOs can be really helpful in gauging what enterprises are likely to buy next and therefore what startup segments to focus on.

It also helps build a sort of tribal knowledge within Leo Capital, that we can rely on as market cycles repeat.

Inc42: How do you draw the line when it comes to being hands-on and becoming a micromanager for the founder. Not many founders would appreciate VCs poking their noses into the ops. 

Rajul Garg: But fundamentally we believe that an entrepreneur is the key driver of the business, and they now know more than we do. Our job is to support them and not supersede them, or to become their boss. So it’s a delicate balance

Most investors, in my view, are a phone call away these days for founders, but what you talk about matters. A lot of funds take up many hours of a founder every week, but that’s the time they could have spent focussing on the business. So how quickly you cut to the chase also adds value.

Leo Capital was a seed investor in LambdaTest from our first fund, and since then, it has raised many more rounds. I feel the startup has seen constant strategic navigation, as they were entering a competitive market with companies like BrowserStack, Selenium etc.

So the investors at later stages asked the founder how they would compete and grow their ARR. They were a $100K ARR startup pitching like a $50 Mn ARR. And I remember having these conversations with Lambda on the innovators dilemma and the way S-curves work, which gave the founder a lot of ammunition and confidence, and it helped him position the company correctly.

Now the company has grown, but it would have been hard, I believe, without our contribution at that stage.

Inc42: Corporate governance has become a buzzword in the startup ecosystem in the past year. How has this impacted you as a VC?

Rajul Garg: Firstly, I would say that we are lucky that we haven’t had any real governance issues across the Leo Capital portfolio so far.

At the stage at which Leo Capital invests, a lot of the business rests on founders. Investors love aggressive founders, especially when they are hearing a pitch. But this can later become a problem.

As early-stage investors, we evaluate the founder from the point of view of business metrics, and their approach to sustainability even at a pre-revenue stage. So we question founders on whatever is in their control. So we ask them for proof or data to back their revenue or profit projections.

Now, when it comes to fraud or malfeasance, even when you are on the board, it is hard to detect when the founder chooses to do it. There’s just so many layers between the reporting and the reality. And the cost of getting deep into the business is high and when we are talking about replacing a founder we need to have a big burden of proof right.

Instead of waiting for things to go bad, we need to build filters at the time of investment itself. We’ve tightened and tightened our processes around that and then I think staying in touch with founders and building your trust in them is also important. Like I said, being a VC is like a service business.

Inc42: The other side of that service is LP management, of course. We are hearing a lot of chatter about LPs asking questions to fund managers over some of their investments. Have you experienced this too? 

Rajul Garg:  We started fundraising in mid-2017 and I don’t think we really stopped raising funds even for a month since then. This is a constant process and like your founders, you want your LPs to be with you for as long as possible.

But I think the nature of LPs has changed a lot. In fund one, we had a higher proportion of individuals, friends and families with some smaller institutions. For fund two, we wanted a stable source of capital i.e. larger institutions, who can invest in fund after fund.

In the first fund, only 6 Mn or 7 Mn out of the 26 Mn came from institutional investors, and this proportion changed to 50% in fund two. And in the current fund, up to 65% comes from larger institutional LPs. We aren’t even pitching to individual LPs anymore actively. Our ongoing activities are all focused on institutions.

I like to use the analogy of SaaS startups, where they start with SME customers to larger enterprise customers. And enterprise customers are less likely to move away if you continue to give them value. That’s how we have built our relationships with large institutional investors. For an institutional investor to add a new manager for a new fund is a big deal, so we treat this very seriously and look at it from a multiyear perspective.

The key, in my opinion, is expectation setting. The LPs in all of Leo Capital’s funds know we don’t do deals in bulk; they are very confident in our thesis and therefore, we hear a lot fewer questions from them. They do expect communication, so we have quarterly reporting calls.

We’ve been reasonably lucky since I know some funds have LPs that can be extremely demanding. In our case, as we have grown, our back office has become stronger. We hired a full-time corporate development person this year who is working on all our communication and reporting to LPs.

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