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An ecosystem without its own wealth is a colony: Blume Ventures’ Fafadia

In an exclusive interview with Moneycontrol, Ashish Fafadia, Managing Partner at Blume Ventures, holds forth on the mechanics of the VC’s latest fund, why it was challenging, why India should not become a colony for foreign funds, and whether Blume can repeat its success.

Mumbai / March 12, 2021 / 10:35 AM IST

"The added layer of complexity in India is that this is a market with momentum. So pricing of the company can change virtually every year," says Ashish Fafadia, Managing Partner at Blume Ventures.

Recently, Blume Ventures pulled off something rare. In one fell swoop, it solved arguably the decade-old investor’s (and the startup ecosystem’s) thorniest issue — securing exits from its first fund, from 2010. Internet investors in India have on an average taken far longer to return money to their investors (Limited Partners or LPs) than peers in Silicon Valley or China. This is because large acquisitions have been few and far in between and IPOs a mirage so far. So Blume faced a peculiar situation, where time was running out on its first fund, and yet many companies from that fund still have scope for growth.

It raised a Rs 350 crore Fund 1x last week, which Moneycontrol first wrote about last month where it is buying out its own stakes in older portfolio firms such as GreyOrange, Purplle, Exotel and IDfy via so called secondary deals, while also keeping some money for investing in the growth rounds of other promising companies. This fund replaces old LPs with new LPs. By resetting the clock, Blume has time to exit these firms, while its older LPs get some money back.  The fund is also entirely raised from Indian investors — HNIs and family offices — significant given that investors have for a long time lamented the lack of depth in India’s private capital markets.

In a detailed, exclusive interview with Moneycontrol, Ashish Fafadia, the man who spearheaded this fund and Managing Partner at Blume, broke down the mechanics of the fund, why it was challenging, why India should not become a colony for foreign funds, and whether Blume can repeat this.

So, Ashish, this fund is very interesting because of its structure and what it sets out to do. Pending exits from old funds is a problem for a lot of VCs. How did you come to this idea?

So, our Fund 1 is a 10-year fund. When you’re looking at a 10-year fund, typically, it never happens that the fund will miraculously give an exit from all its companies in the tenth year. So, one has to be alert all the time and start figuring out how I am going to exit it. Sometimes serendipity drives the fund in such a way that starting years 5, 6 and 7 you have had exits -- then it’s a good thing. We had reached this point where in the ninth year, we had returned half of our money to the LPs. We were thinking what to do about the rest. This was in 2018 when we were pitching our opportunity fund (a fund which invests only in the best performing portfolio firms).

At that point in time, we basically made up our mind that we are not going to just go ahead and sell these companies. We will go and find a partner who will help us achieve the right balance, where we will want to make sure that our investors have the ability to exit and take money home; and we are able to continue our journey with these companies.

If there is a good merger and acquisition (M&A) opportunity we will certainly sell. It will be good for everybody. But we are not going to do a secondary sale because the discounts can get pretty crazy (secondary share sales are sometimes done 30-40 percent less than the primary valuation of the company). Sometimes the discount may not be crazy but in a few months that company raises at double the valuation. And you look back and say oh we gave up too early.

Is this also because with the odd exception, M&A in Indian startups is mostly distress sales? We don’t really see conglomerates or large startups buy expensive assets thinking they can still grow from here…

I don’t fully agree. In our own portfolio we’ve had multiple M&A exits, say Mettl (acquired by Mercer), where there was an option to continue to build. So, the partnership with an incoming acquirer was so compelling that we said, ‘okay let’s sell’. You’re right in observing that more M&As are distress sales as compared to M&As done for a very significant value. There are opportunities for profitable M&As too. But for every good M&A, they will be two or three that are in that distress zone.

You had decided the boundary conditions. How did you come to the idea of doing LP level secondaries, where Blume continues managing the fund?

So, in Singapore and Hong Kong, this is fairly common. Not so much in North America. A large number of secondary buyers are on the lookout for quality fund managers. Like TR or New Quest Capital.  They say we’ll buy out the positions, you continue managing and you’ll get a share of profits and carry later (carry or carried interest is the money VCs make when profits from a fund are distributed; this is the largest portion of VC returns and the cornerstone of the model).

So, they will basically go and do a full portfolio buyout. And generally portfolios were small and concentrated. Like private equity funds. So, it was very easy to buy out the whole portfolio lock, stock and barrel. This didn’t need a crazy quantum of work.

But now, the added layer of complexity in India is that this is a market with momentum. So pricing of the company can change virtually every year. So, if you have a very big portfolio like Blume had, and you’re analysing and figuring out how to buy out the whole portfolio, it’s virtually impossible. And if you try to do due diligence on all those 10-12 good companies, it is going to be very hard to complete that process in 6 to 12 months and by then the round’s price increases. And your expectation goes up.

So, assume half your LPs want to get out. Out of a Rs 100 crore fund, Rs 50 crore worth of LPs -- whose mark-to-market value is Rs 150 crore -- are okay to sell now, and you consolidate all of that. If you sell units of a fund, how do you tax it?

And how do you adjust carry here? Because the person who has got 150 from 50, owes carry to the fund manager. There is no contract between the fund manager and the individual LP to get carry from his pocket. The contract is that you will retain the carry in the fund and give it to the manager, not the other way around. These technicalities make it a little tougher.

Right. There are a lot of moving parts. So how did you deal with that? 

We kept it very simple and clean. Rather than go down this route and get into ambiguities or take chances, we basically said we will showcase our top dozen investments. We have only put businesses where they can grow 5x from here. Their valuation can grow five times from here, and that may be a bit of a vanity metric so I will say their revenues can grow 10-12 times from here. These companies and their management teams have done a good job of scaling up; they have attracted high-quality people to work for them. And they have raised enough money to have visibility for the next 12-18 months. They have the chops to go out and sell a narrative.

We have seen these companies in action the last 10 years and know them well. This is where Avendus showed up and said: “Boss, why are you taking this outside (India)? We will create a fund here. We will set up a new AIF in India.”

Your main VC funds are also registered in India right? Generally as funds get larger, and the foreign LP portion gets bigger (as in Blume’s case), they choose to register in Mauritius or Singapore.

That’s what generally happens, but we have not done that. We have been beneficiaries of a significant domestic corpus. Family offices have always trusted and backed us. If you look at our journey from Fund 1, we raised about Rs 120 crore from Indian families and a few institutions and government bodies. Same for Fund 2 and 3. We then raised Rs 175 crore across two opportunity funds and Rs 350 crore now. We have realised the fact that we have managed to find acceptance with families in India; there has been acknowledgement of the effort that we have put in, and people are willing to take that leap of faith. This is all rupee capital. A third of the money we have raised in our lives is rupee capital

There’s a personal reason too, why we haven’t become a foreign fund yet. My personal belief is any ecosystem that does not create its own wealth is basically going to be a colony. You might not be a colony like colonies used to be in the 18th and the 19th century.  But you will be a digital colony or a political colony. You have to create your own wealth.  And if you keep going out, and just doling out capital to overseas capitalists, it helps them and it helps you. You need a hybrid. You need Indian local capital formation and wealth creation happening.

The benefit comes when you create your own brand, your own wealth, your own supply chain. And so I do believe very strongly that if we don’t take some pains and efforts to create strong market grounds, if we keep selling our good companies to foreign companies, our companies who aren’t looking for innovation will struggle. Out of the $17 billion from Flipkart’s sale to Walmart, $2-3 billion was India’s wealth creation. It was the biggest tax collection, sure, but is that your endgame? We need the right combination of domestic and foreign capital.

That makes sense. When did this fund’s work really start?

Over the last few years we have had a relationship with Avendus. We keep catching up and exchanging notes on what’s happening, what we were trying to do, etc. Their wealth clients were looking forward to a fund like this, and tech is a sector where they are underexposed.  So, we started in August (2020). 1-1.5 months ago we were speaking to them. Then Avendus did diligence for two months.  Two months pitching to LPs. And one month to wind up.

Who were the HNIs in this fund?

I can’t name them, but if you Google the top 1000 families in India, you will have a good idea. We have also had corporates invest through their balance sheets.

Corporates, listed ones especially, have a lower risk profile, so how does a VC fund -- among riskier investments -- make sense to them?

That depends on how much they are investing right? If they have a treasury of Rs 1,000 crore and they give us Rs 5 crore, that’s less than 1 percent.

Did you have a lower limit on how much a single LP can invest? If you have too many LPs who have put in small cheques, that’s also harder to manage right?

We did not have one explicitly, but were targeting that people who come in should be coming in with at least three to five crores. And if there was a very strong pull factor and someone wanted to invest Rs 2 crore, we didn’t say no. We took it. The focus was on can we cut the friction and have you all take a leap of faith on what we are trying to do?

And what were the largest investments?

It went to as high as 10 percent of the fund size. There were quite a few putting in 4-5 percent of the fund size, and a couple of 10 percent.

You have also said you will do primary rounds in a few companies such as Dunzo, Slice and smallcase. What was the rationale behind this?

We actually said that in the companies where we are doing secondary, if the round is oversubscribed, we will also do primary. So, you go over and above pro rata allotments. The companies you mentioned are actually like a backup list. If for some reason, the secondaries don’t raise as much money -- they may not even need it -- then as a backup, if money is left to be deployed we can also do primary rounds in these companies.

Interesting. So if you deploy the Rs 350 crore entirely in secondaries, with no primary round, is that acceptable to LPs?

Yes it is. But there will be some primary rounds for sure. Step back for a second. What has happened is, we created a growth portfolio available for Indian investors. Right? We have basically brought to them a combination of B2B and B2C businesses in a concentrated manner, pre-disclosing the names and saying I’m going deep after this. I’m saying: ‘Here are my reasons why I’m doubling down on these six companies, and we will also postpone our reward (carry on exit).’

And we have another six companies from Fund 1. In the future we will do something for those as well. That might not be in India, one reason being that those companies are domiciled overseas, in Singapore or the US (This includes Grey Orange, Instamojo, DataWeave and TookiTaki). According to Indian restrictions, you can’t invest more than 25 percent of your investable corpus in overseas companies. So, that limits how much we can invest. Therefore, we might need foreign capital to support us on that. So, we’ll try and figure that out. But yes, there are some inbound (conversations) which have happened. Those conversations are happening.

For this fund, are all the LPs investing in Blume for the first time?

No. There are some LPs from Fund 1 too.

Isn’t that counterintuitive? Wasn’t the point to give old LPs exits?

Not at all, because the LPs who have stayed on are a small percentage. Honestly, if even one LP wanted an exit from Fund 1 and we facilitate that, it is well worth it. He was not compelled to hold on. So, some of these LPs are happy to hold on, while others have been replaced by new LPs.

A lot of PE funds from 2007-08 have told their older LPs, you can get an IRR of 8 percent (below par by VC/PE standards) and exit now, or you can stay on, but new LPs will get precedence. We didn’t go down this road because when people gave us money they expected more returns than this. Why would we do a structure which is going to be diminishing people’s returns or not be transparent about it.

We wrote to every single LP -- we were not obliged to -- saying that we are doing this transfer and this is the price it is at. You can come back to the fund. And you wouldn’t believe, 95 percent wrote back and said we’re doing a good job. They were happy that the fund manager has made an attempt to do this. Only some wanted back whatever returns there have been so far.

The other big question is, what was it like to raise this fund from home, over Zoom calls? Rather than the many flights and meetings these things usually involve?

I think it worked out wonderfully for everyone. The LPs were not having to entertain us and do back and forth to fix an in-person meeting. We would have had to take a dozen flights, spent time outside our cities and homes. Here we could do six-seven back-to-back calls a day.

But at the same time, wasn’t it harder to establish some of those relationships over Zoom? To create comfort and set the context?

This is where Avendus gets the thumbs up. They basically made sure that people understood what was being done and why it was being done. So, when people were coming to talk to us, they understood the Blume brand and the journey over the last decade. Most of the calls were between 60 and 90 minutes.  One in every let’s say six calls, the LP wanted to speak to two of the three of us (Fafadia, Karthik Reddy and Sanjay Nath, managing partners at Blume). One in every six wanted to speak to at least two of us separately. So, that is perfectly fine. There’s no issue. And some commitments came just by the LP checking with Avendus. We did not even speak. They checked on us, they saw the strength of our partnership and thought its right to invest.

You still have a few more Fund 1 companies, and maybe some early Fund 2 companies where timely exits can become an issue. Can you repeat a structure like this again? 

I think so. This requires three things. It needs the right thinking and the right structure. We didn’t go and act greedy. We didn’t ask for 2/20 (2 percent management fee and 20 percent carry, the general terms VCs agree to). We charge only 0.5 percent management fee for this. Who’s doing that in India, where they are betting only on the carry?
We are losing younger people in the team who are making a little more than what we made a few years ago. These are people 15 years younger than us. Salaries can’t be the driving factor for us.

If you’re aligning incentives correctly, and you have a good partner (like Avendus, in this case) it is possible. Can Blume just do this by itself? Raise a Rs 350 crore fund like this? Honestly, no way. We have established overseas relationships on our own, but for the Indian base, we have to give IIFL and Avendus credit for putting us on the map. We can do this again because the companies are compelling. And this time we can go to Hong Kong. The time pressure is less.

Isn’t it exhausting to constantly be fundraising, rather than investing and spending time with founders? 

If you take this view that my actual job is to spend time with companies but I am fundraising, then it feels even more taxing. Fortunately we are a large enough team today where the portfolio is getting the attention it deserves. We are not taking our eye off the ball.

Six months in every three years, there will be this intensive fundraising period. Today, we are getting to a place where 2-3 people will do only fundraising. We have a strong finance team. It is taxing; I won’t mince my words. But in every firm, a few people will do a combination of things. You have to put the bread on the table. This is our bread on the table.

For some large funds it is easier. One or two partners go out and in a few weeks it is done. It will take us time to get there. For us, raising a fund easily will happen when we can deliver a phenomenal exit without raising a secondary fund.

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M. Sriram
M. Sriram
first published: Mar 12, 2021 10:35 am