India has a rich culture and ecosystem of social enterprises, non-profits and many other social purpose organisations that serve the needs of many segments of society within a vast landscape. However, for a foreign investor looking for impact investing or other philanthropic opportunities in India, it can often prove to be a challenging journey. Devangshu Dutta (Third Eyesight/PVC Partners) and the Audrey Selian (Artha Platform) together provided a landscape overview of India, highlighted key challenges and pitfalls to look out for, and shared an insider view for international investors in this first part of AVPN’s India series.

(Published in the March 2012 of Images Retail, this is a compilation of Devangshu Dutta’s responses to questions put to him by the magazine’s editor on the subject of funding in the retail sector in India.)

India is one of the largest markets that promises a sustained consumer-led growth in the foreseeable future, due to the shift from a fragmented retail ecosystem to a more modern and consolidated industry.

Modernisation and consolidation will happen not only in front-end (retail) operations, but also in the supply chain of both products as well as tertiary suppliers such as equipment and service providers. Well-informed investors are looking at the entire ecosystem rather than only funding the front-end of the retail business.

The biggest challenge for private equity and venture funds 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 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: 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 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 five to six years, and investors as well as bankers are more wary 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. 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. If I were to focus on one piece of advice to an entrepreneur looking to raise funding from a VC, it would be this: don’t try to extract what you think is your complete lifetime’s worth from the first investor 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.

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.

In many countries early stage seed, angel and venture investments are provided incentives in terms of tax structures – this is something that the venture community in India has been lobbying for with the government, and if provided, could improve the ‘investibility’ of early stage retail businesses.

[Readers may also find it useful to go through the brief presentation on Slideshare: “What does it take to create a fundable venture?”

For someone who loves books and dislikes naming favourites, it’s tough to quickly make a list of only 10 must-read books. There are so many valuable books an entrepreneur can learn from that this list is only a starting point, rather than “the Top-10”. But, then, one of the most important things an entrepreneur can do is to overcome his or her own resistance at some of the most inconvenient times. So here goes!

1. Good to Great (Jim Collins) – this book delves into some fundamental strengths that entrepreneurs need to seed into their business fairly early. Interestingly some of the companies listed in the book may no longer be called great (a weakness with most management books quoting specific examples), but I believe the principles stand the test of time.
2. The Tipping Point (Malcolm Gladwell) – some small things do become big. Every entrepreneur and start-up would love to know how and why; Gladwell’s book offers a different perspective – from epidemics to better governance. Much learning for the start-up and the small business owner.
3. Losing My Virginity & Screw It, Let’s Do It (Richard Branson) – one autobiography is usually enough for most people – trust Richard Branson to not fit into that mould. I’ll count them as one. As an entrepreneur who went from selling records to creating one of the most diverse brands covering airlines to telephone services, Branson will certainly have something for everyone. The books offer a view into his struggles as much as his successes.
4. The High Performance Entrepreneur: Golden Rules for Success in Today’s World (Subroto Bagchi) – if for nothing else, read it for the first chapter: “How Do I Know if I Am Ready”. Of course, once you’ve gone through that chapter, it is remarkably easy to go through the rest of the book, which offers guidance from Bagchi’s own deep experience as an entrepreneurial manager and as an entrepreneur.
5. Fortune at the Bottom of the Pyramid (C. K. Prahlad) – who says you have to have millions in the bank and service only rich customers to be a successful entrepreneur? I must admit I came very late to this book, and am yet to complete it, but it is an excellent reference source for case studies of innovative and very large businesses being grown in markets that are typically treated as poor or low value, environments that many Indian entrepreneurs can relate to.
6. Made to Stick: Why Some Ideas Survive and Others Die (Chip Heath, Dan Heath) – Inspired by the Tipping Point, the Heath brothers describe what it takes to get your ideas across, and make a lasting impact. A must for entrepreneurs looking for funding, to hire great people and keep them motivated, and to capture lasting customer relationships.
7. It Happened in India: The Story of Pantaloons, Big Bazaar, Central and the Great Indian Consumer (Kishore Biyani) – there are too few books about or by Indian entrepreneurs, so this is one growth story in desi style that many start-ups would be able to relate to. It is not as polished as most other entrepreneurial autobiographies, but valuable nevertheless.
8. The New Business Road Test: What Entrepreneurs And Executives Should Do Before Writing A Business Plan (John Mullins) – an someone who turned from corporate life to academics and further to being involved with entrepreneurs, Mullins provides a great framework to help the entrepreneur filter and refine his concept of the “next big thing” into a real business.
9. Venture Capital Funding: A Practical Guide to Raising Finance (Stephen Bloomfield) – while written from a UK and European perspective, it is a valuable reference for anyone looking for external funding. A practical guide to the whys and the wherefores, the jargon and the structures of venture funding written for an entrepreneur.
10. And last but not the least – pick your favourite philosopher or guide. No matter whether we are overtly spiritual or completely agnostic, there are times, many times in an entrepreneur’s life, when we need to step beyond the intellectual construct of business, look beyond plans and strategies, and next year’s targets. Depending on how you are feeling and what you need at that particular time, this book (or these books) can be versatile in offering you guidance for your next steps, direction to correct your course, or simply a platform to stabilise yourself.

The thing about lists is that even if you find one item on the list that makes a substantial difference to you, the list has been useful. Among the above, I believe you will find more than one that will create such an impact. Happy reading!

[Column written for The Economic Times, 13 November 2009]