Do we need to revisit the way VCs invest? Is a start-up performing at optimal levels in terms of capturing its domain, building a target market, and placing excellent governance structures to build a brand? These are some of the questions Operator VCs are trying to answer as they shift away from a typical VC model to lend operational investment to their investee portfolios.
Operator VCs are fast gaining popularity due to their success in terms of the value addition they provide by providing capital plus mentorship and operational expertise to their portfolios. This is visible with the quick market gains that operator VCs are making with Google Ventures, an operator VC with a ‘create, evolve and reflect’ model, having close to $2 billion in assets under management and having a dedicated additional injection of $300 million each year. Similarly, Andreesen Horowitz, whose agency-like model has been replicated by larger VC funds, has also reshaped itself into a registered investment advisor and has around $12 billion in assets under management. Operator VCs may further take center stage in light of the pandemic promoted lockdown and consequent economic slowdown, with multiple startups requiring such support, financial and otherwise, for their recovery. Yash Dholakia, Principal at Tomorrow Capital, an operator VC, joined Anirudh Rastogi and Ishita Shome of Ikigai Law to discuss the opportunities explored by Operator VCs and what differentiates an Operator VC’s mindset from a typical VC. Tomorrow Capital is one of the few funds in India working through an Operator VC model with a $100 million fund under management.
The full discussion can be found here.
The conversation opened with Yash walking us through what operator VCs are and discussed what Tomorrow Capital does differently from a typical VC in terms of the value add and the capital plus propositions in the form of strategy, back office resources, network outreach, domain expertise and on ground support that they offer to their portfolio investees as an Operator VC. He also explained how Tomorrow Capital factors this into its cost structure, the manner in which its heavy involvement with the investee translates into a more nuanced sectoral understanding of the start-ups that they typically onboard and how having presence of Tomorrow Capital has in fact helped some of its portfolios gain traction when exploring fund raising from other VCs and Operator VC funds. The discussion then steered towards the criteria/considerations that Tomorrow Capital has for the selection of the portfolio of companies they choose to invest in. Yash went on to lay emphasis on the classification of risks that they assess for potential investments. Tomorrow Capital made some noteworthy observations on how it evaluates various investees and runs its diligence on its potential portfolios. The discussion also delved deeper into the deal documentation and how it deviates from the typical VC documents, for example the speakers discussed at length regarding the various deal terms such as founder obligations, exit options and indemnities clauses typically found in their deal documentation. Yash also elaborated upon the economics and control provisions that Tomorrow Capital usually likes to see reflected in its deal terms. The conversation closed with an overview on how Tomorrow Capital is positioned to explore the current market to make investments in light of CoVid and a general discussion on the effect of Covid on the investment climate.
Key issues discussed:
- What is an operator VC? (01:45)
- The need for Operator VCs in the market. (04:48)
- How do operator VCs mentor and guide companies, and differ from a conventional VC? (10:04)
- What are the incentives, especially financial, to having an Operator VC model? (19:10)
- Tomorrow Capital’s criteria and considerations for selecting the portfolio of companies to invest in (25:29)
- How is risk classified and assessed for a potential investment deal? A look at Tomorrow Capital’s diligence exercise. (32:25)
- Mechanisms or controls placed by Tomorrow Capital on its investee companies (47:41)
- The differences and similarities in the functioning of other operator VCs. (59:06)
- As an Operator VC with much more insight into the workings of a Company, how different are the negotiations and clauses in investment deals and documents? (01:09:10)
- What are the investment exit options for Tomorrow Capital and how do they differ from conventional exit options? (01:18:42)
- How does the present investment climate look like in the light of COVID-19? Will there be a change of considerations for investment? (01:21:30)