Shah says while the company may close more deals in India that is not the key metric. Good exits are what drive Norwest Venture Partners' performance.
Norwest Venture Partners is a unique investor in India, straddling private equity and venture capital. Its investments include the National Stock Exchange, Yatra.com, Swiggy and Pepperfry. The American venture and growth equity investment firm has about $10 billion in assets under management globally.
In a phone interview, Niren Shah, Managing Director and India Head of Norwest, speaks to Moneycontrol’s M. Sriram on investing during a pandemic, new opportunities, valuation challenges and the importance of timely exits. Edited excerpts:
Q) You are one of the few investors involved in both traditional private equity and venture tech. Has the pandemic changed that?
Our thesis at Norwest India of doing growth equity investments and venture capital investments (from Series B onwards) has not changed and remains absolutely the same. However, COVID has definitely helped us all realise that the Indian digital ecosystem has got a massive impetus and that we have been hurtled at least two-three years forward in our digital evolution.
Therefore, our belief in investing in the Indian tech ecosystem has only got stronger. However, we also believe that once a vaccine is proven effective, things should normalise in some but not all sectors. So we continue to look at growth equity investments even in select offline sectors since we have a very long-term outlook. In addition, COVID has reminded us to continue to look for entrepreneurs that are not only bull-market performers but also have the tenacity, passion and executional ability to weather storms like the one we are in the midst of.
Q) You wanted more venture and consumer internet deals. Given high valuations in some sectors, has this been a challenge?
We believe that these next 10 years will be the golden age for digital companies in India. Late-stage venture investing in India definitely has had the challenge of too much capital chasing too few deals, resulting in high valuations but this is changing somewhat
The other challenge with late-stage venture companies is that as they mature, they get valued at a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization) rather than as a multiple of revenue, which often results in multiple contractions (the company is valued at say 10x of EBITDA during investment but 5x during exit). This gets worse because growth slows down once companies seek profitability by focusing on reductions in cost and marketing. Because of this, even if a company grows 10x, an investor may make only 3x on his investment. Having seen the life-cycle of many tech companies, we are cognisant of this challenge.
Q) March and April were the months of doom and gloom but activity seems to be picking up now. Is the investing market now better?
The current market is definitely a fantastic time for making investments and we are looking at several new investments. In March and April, both private and public markets first went through a phase of panic and then a phase of recalibration (not only related to the uncertainty of COVID, but also the significant impact on overall valuations, fund raising, IPOs etc). I think that phase is now over and we will start seeing many more deals in the second half of FY21. Our analysis at Norwest shows that investments made in tough market vintages tend to perform better as a cohort
Q) Even before the outbreak, there was talk of startups getting a reality check—in terms of valuations, late-stage funding, etc. How different will things be now?
I think the level of burn and marketing had gotten a little bit out of hand in the venture ecosystem, primarily due to the availability of capital. Valuations were arrived at as multiples of revenue and if a company burnt a lot of money to grow quickly, it would get a higher valuation, without much focus on the unit economics.
Driven by the uncertainty of COVID, many companies are focusing more on breaking even. To me, one of the major contributions of this pandemic has been companies getting a reality check on the cost structure and focussing more on making profit.
Q) Is private equity still on the agenda? Which are the traditional sectors that are attractive today?
We are definitely going to continue to focus on investing in mid-market private equity. Sectors we are interested in include tech, financial services, healthcare, consumers and logistics. Each of these sectors are stable and have large profit pools.
Q) The last two-three years have been big for deals at large. What did you take away from this period?
Our biggest learning has been to build robust long-term companies and to focus on exits rather than just new investments. It's important to be disciplined and exit even when you are leaving some returns on the table. We used this period to create partial and complete exits across more than 20 companies and are satisfied that our focus was timely.
Q) You have a large financial services portfolio—from legacy banks to newer lenders like Veritas Finance or Five Star Finance. Have fintechs disappointed you and has the pandemic made it worse?
So far, each of our financial services companies has performed exceedingly well during the pandemic and we benchmark them both to other private and public-listed companies. They are all ahead on collections and credit management. We still believe that this is early in the cycle and we will need to continue to watch this space carefully.
On pure fintechs, I think there are far too many companies in the Indian fintech space and several have focused only on product and tech instead of credit and profitable growth. Companies which do not have sound credit are unlikely to survive. Companies that are not profitable will find it hard to raise debt and improve ROEs. We do expect some consolidation in the sector but we also expect some amazing companies to emerge and become bigger, stronger. We have made one investment in a fast-growing, profitable fintech called OfBusiness and will continue to look forward to making more such investments.
Q) At a time when large cheques for startups are hard to come by, will you increase your cheque size to lead say a $80-100 million round?
This seems unlikely at this point because we are looking to continue to build a granular book. However, we are certainly expanding what is the maximum size of our total investment. So today we are very willing to do a $50-million size deals though $25-30 million remains our sweet spot.
Q) It is often said “never let a good crisis go waste” and that great companies get created during a crisis. Do you see any of this on the ground?
We think there are some great opportunities to fund strong companies. For instance, there were companies thinking about raising capital in February and March but the pandemic impacted their fundraise plans. These fundamentally strong companies will require some capital. So that is the segment we are really going after.
The risk remains that the pandemic could get worse and we could have been invested at lower valuations but we are not waiting to "time the market perfectly" since we are very long-term fundamental investors who are willing to stay invested for five-seven years.
Some new opportunities are also being created. Ed-tech, for example. We will pursue similar opportunities which COVID has opened up.
Q) How have you and your team been coping in these trying times?
We are doing fine given the COVID lockdown circumstances. We have been double-hatting between our day job and a social initiative called CampaignGratitude that our team has innovated and developed.
We developed an open-architecture platform called CampaignGratitude where anyone can start their very own fundraising campaign and also got some corporates to match these donations. From an original target of Rs 20 lakh, we have come a long way and have raised more than Rs 4 crore for six NGOs.
On the work front, we have been working harder than ever, since this a great time to invest, but team motivation remains very high despite the lockdown. But it's important to ensure that we spend time together as a team, so, for example, on Friday evenings, we make it a point to all meet socially (online) to play games, chit chat and just chill!
Q) Will we see Norwest get more active in India? Maybe do four–five deals a year?We have already been doing 4-5 deals each year, including follow-on rounds. But we certainly plan to double down. However, India is a market where the risk-adjusted reward needs to be assessed and monitored very consistently and carefully. So while we may close more deals that is not the key metric. Good exits drive our performance. We’ll certainly do more deals in India, but have to be thoughtful about making new investments to maintain our track record.