Even as startups keep breaching $1 Bn in valuation, the debate about how to become a unicorn continues to rage on, with some also calling a ‘unicorn’ a myth. This could be true to the extent that most Indian unicorns are not making a profit, and it’s the funding that gets them counted among unicorns.
But have you ever given thought to how to become a billionaire VC? Speaking at Computex 2019 in Taiwan, Ravi Belani, managing partner of Silicon Valley-based Alchemist Accelerator who also takes entrepreneurship classes at Stanford, helped decode the formula.
“The main motivation that VCs have, is they need to have unicorns in their portfolio. And, it’s ok if 90% of their companies fail, they know that ultimately only three companies out of the 30 startups in their portfolio are going to be responsible for their disproportionate returns. That’s been the history.”
Belani added, “…And, the reason why that’s important because if you are a venture capitalist, It is almost impossible for you to return funds if you can’t invest.”
The managing partner had spent six years as a venture capitalist at Draper Fisher Jurvetson (DFJ), an American venture capital firm focussed on early and growth stage investments whose portfolio includes Tesla, Baidu, Hotmail, Skype etc. He personally led the investment in Justin TV at around a $20 Mn evaluation, which later turned into game streaming service Twitch and was acquired by Amazon for $970 Mn in 2014.
“That was my first billion-dollar unicorn. Then I also led investments in other startups as well. And, currently a managing partner at Alchemist Accelerator.”
Backed by DFJ and a slew of corporations, Alchemist gives startups $36K and brings them to Silicon Valley for a six-month programme. The accelerator was rated number one accelerator in the world in 2016 by CB Insights in terms of the funding its portfolio startups have raised. In fact, Alchemist beat the more renowned Y Combinator (YC), which was ranked number two.
If Alchemist is famous for anything it is how to fundraise. The key to fundraising is that convincing the VC that you are on a path to build a billion dollar venture and of course there are certain matrices that VCs will be looking at.
Since 2013, 108 out of 230 Alchemist portfolio startups have raised institutional funding of around $606 Mn overall. So, what separates Alchemist Accelerator from Y Combinator (YC) and other accelerators and helps raise startups such massive funds?
Belani told Inc42, “Unlike YC, our focus is only on enterprise startups. So, we don’t have any consumer startups in our classes. Further, in contrast to YC’s 400 startups per class, our threshold is 25 startups per class. And therefore, the ratio of investors to demonstrating startups is significantly better than the YC. Besides maintaining a healthy fund, core of our strength is the top venture partners such as Mayfield, Khosla Ventures, Foundation Capital, DFJ and USVP, and corporate investors like Cisco, Siemens and Juniper Networks. We have over a network of around 3000 VCs, so it’s around 100 to 1 ratio of investors to companies at present. That ratio is unrivalled.”
Since India is the world’s the third largest startup ecosystem, is India on Alchemist’s agenda? Alchemist has over 25 Indian startups in its portfolio, “India is very much our core focus,”Belani averred. However, we run our programmes in San Francisco only; so, we bring everyone here.”
“Moengage which is also funded by Matrix is an Indian startup. We funded Cmpute.io, an Indian startup which later became one of Cisco’s earliest acquisitions in India. We are actively exploring if we should deepen our India focus by building our presence in India which we haven’t done yet. We don’t have a formal programme in India right now; however, we have partnerships with Indian organisations. For instance, we also have a partnership with the IIT Alumni Association here in the Bay Area.”
Alchemist’s Acceleration Programme
Alchemist has a longer programme than what a typical accelerator offers which is usually a three-month-long engagement. “While Alchemist programme runs for six months, some of the startups may take even longer nine months and we find that that’s particularly valuable for the Indian side because three months is just too short especially if you’re doing anything in the enterprise.”
When evaluating applications, Alchemist looks into founders that exhibit very strong technical chops, tenacity, and who have the ability to analyse and process complicated stuff and scale up their vision. “Besides their outstanding educational background, we also look for a set of skills — a combination of speakers skills and an entrepreneurial drive to push things in different ways than make convention. And then we look for a well-rounded team.”
On The Indian Ecosystem
Everybody is very very bullish and excited about the Indian ecosystem, Belani said. The most pertinent question is however how they create billion-dollar empires. In India, there are two types of startups emerging, according to him.
“There are companies that have become very big by just focussing on the Indian market alone. And then, there are companies that have become very big on the global market taking advantage of their experience in India operations. Both are really exciting. There is also a sophistication level among the Indian VCs. They know how to how to build great companies for the Indian market.”
He was enthusiastic about the business models emerging in India for the Indian use-case and solving problems at a local level. “We’re seeing models that have never existed in the US. These India-based models are emerging mainly because the cost structure is so low. So I think that is going to create a lot of billion-dollar startups. I’m hoping that it’s going to not just try to copy Silicon Valley but come up with new models that we could even do in Silicon Valley because either our cost structure is too high or there are certain markets that don’t exist here that exist in India or Southeast Asia or in other markets. So I think there’s a lot of excitement. I think there’s also a lot of carefulness around making sure that you’re building companies that can become bigger than that.”
Understanding The Math Behind VC Investments
Speaking at Computex, Belani said that VC industry in the US is just 0.2% of the GDP in the country. But it is responsible for 20% of the companies that are driving the GDP there.
“Today, it is around 10 companies per year that enter into the unicorn gang. So, statistically, out of thousands of companies started every year, only 10 will get to billion dollar valuation.”
Decoding this ‘VCnomics’, Belani explained VCs make money in two ways. The first is getting money from managing their investments. “Typically VCs get 2% of the burn value as management. So, if we have a $500 Mn fund what that means is that they will get $10 Mn. They get that fund every year, and typically, fund lasts for 10 years.”
The second way, he said, is the carried interest or the share of the profits on the investments that they have made.
So, if a VC has $500 Mn fund, that means $100 Mn is not being invested. So, they actually invest only $400 Mn. And, the reason why that is important because it is built to the incentives they have.
“If you come to me asking $2 Mn, and I give you that. I know if things go well, you are gonna need more money to scale. I also know that if things go badly, you are gonna need more money to survive. Either way, you are gonna need more money.”
So even if a VC gives a startup $2 Mn, it reserves $4 Mn on the books to give to startups later. Even though the VC has 10 years for the fund, after three years, it has already committed the full fund. That makes sense because it has also committed the reserve.
So, what happens when a VC sees a great startup after committing a majority of its fund? Well, it raises another fund. At any given time VCs are getting management fees of three different funds. “I say that because a typical VC partner usually manage $15 Mn per fund and they are drawing around $3 Mn management fee across the funds. Let’s say half of that is expenses. That means they are $1.5 Mn as the guarantee in the new industry in the foreseeable future,” Belani said.
Let’s see how exits work for founders and VCs. A typical CEO of a startup is making $150K a year, while a VC is making $1.5 Mn a year. “As a founder, if you come to me and say “Hey, Ravi, give me $1 Mn, I will give you 20% of the shares. That means the company’s valuation will be $5 Mn. In a year, I guarantee you 5X return. The way that looks to you as a founder if you are making 150K per year, and have 20% shares, if you exit for $25 Mn, that means you have a $5 Mn payout. That is 30x of the annual salary. That’s a big deal.”
But the equation is different for a VC, Belani added. “For me as VC, I am making $1.5Mn per year, you exit for $25 Mn. My fund gets $5 Mn, as we have 20% of the shares. Of that $5 Mn, my carry/profit is just 20% or $1 Mn. And of that $1 Mn, I have to split that with other partners. And, I may end up getting $100K. So, for the same outcome, founders and VCs have a completely different way to look at.”
“What’s worse is that for me, I can’t pay back 500 Mn fund with just a small cheque of $5 Mn. Our exits align once it happens somewhere around $500 Mn onwards.