Monday, May 07, 2007

The IIMs as Venture Capitalists

Coincidence is an amazing thing, isn't it? Here I am, thinking about how it's been a while since I fisked anyone and almost immediately the folks at DesiPundit are kind enough to supply me with the perfect fodder - yet another nitwit blithering on about how the IIMs have got it wrong and what they should really be doing to make his invertebrate little life easier.[1]

Mr. Gaitonde's post starts by criticising the new IIMA policy of allowing students to take a year off after they graduate to pursue their own ventures while retaining the option to come back for placements next year. Having criticised the policy (and I'll come to his argument there in a minute, well, maybe five minutes depending on how fast you read) he goes on to list three things the IIMs could do for budding entrepreneurs, which are - provide them with low-cost financing, help them in dealing with regulation and provide office space, and make industry databases and reports available to them [2].

Let's start with these three initiatives. Why, exactly, I wonder, should the IIMs do this? The last time I checked, they were educational institutions, not angel investors - their primary purpose being to provide quality business education, not to provide succour to wannabe start-ups. Of course, to the extent that they want to promote entrepreneurship among their students, they may make a few minor modifications to their placement rules. That's very different from playing an active role as an incubator for start-ups. I'm not sure that the IIMs want to be doing the latter. And I'm not sure that they should.

(It's not clear to me, incidentally, whether Mr. Gaitonde actually wants the IIMs to become angel investors / incubators, or simply to do all the work of these entities without sharing in the upside. The general idea in his post seems to be that the IIMs should provide all this assistance out of the goodness of their heart, or for some kind of unspecified 'fee' - presumably one lower than the market rate - without any discussion of how they might share in the profits of the enterprise.)

I'm not sure that the IIMs should do more to help start-ups because I see no reason to believe that they have any special competence / ability to do so. Mr. Gaitonde himself states that "Academicians do not understand managers. Managers do not understand entrepreneurs" (of course, this says nothing about whether academicians understand entrepreneurs - logical consistency is clearly not our budding entrepreneurs strong suit). Why then do we believe that the IIMs are well-positioned to provide assistance in working through regulatory issues? Or providing support / advice to young entrepreneurs more generally [3]? And all this talk about low-cost capital and office space. Do the IIMs have access to lower-cost funds from the market, that they should be passing on, without a risk premium, to entrepreneurs? Do they have even the basic ability to manage a debt portfolio or investments in new ventures, let alone a superior capability to do so? Why should the IIMs price funds they provide to entrepreneurs lower than the market? If venture capitalists, banks and angel investors won't invest in a project, why should the IIMs? Sure, they have government funding, and everyone knows that you don't need to earn a return on government funds, you can just hand it out in sops and let the taxpayer bear the cost. But is that kind of profligacy really what we want the IIMs to be encouraging? A similar argument holds for office space.

The point is - there's a market for ideas out there. Venture capitalists, angel investors and incubators exist, and IIM graduates have, if anything, better access to them than anyone else. Sure, these opportunities are limited and it's really, really hard to get the kind of support you need, but that's a reflection of the probability of eventual success. If a start-up isn't able to access what it needs, or finds the market price for those services / facilities too high, then there's no reason for the IIMs to second-guess the market and subsidise ventures that the market has found unviable. And even if you believe that the entrepreneurship market is underserved and there's an opportunity for additional incubators / angel investors, that need is best served by specialised players with experience and / or ability in meeting the needs of entrepreneurs, not by the IIMs stepping in to play a role that they weren't designed for, and are unlikely to be good at. This is especially true when you consider adverse selection - since the IIMs are clearly not the best place to turn for advice / support in starting a new venture, start-ups that can get backing from more specialised / expert sources will end up going elsewhere, leaving only the projects that can't get support from anyone else still knocking at the IIMs door.

Finally, let's say that you do believe that the IIMs have the ability / competence to provide superior guidance to young entrepreneurs (why you might believe this is beyond me, but let's say for a minute you do). Why should this guidance be available only to former students? If the IIMs are going to run an incubator, one would hope that they would choose from the full set of available projects, not only from the handful of ideas that their students come up with. It's not as though selection into the IIMs is based on entrepreneurial ability. A large proportion of students have no work experience, and even those who do have been out of industry for two years by the time they graduate, so they're unlikely to be the most clued-in people around. There's really no reason to believe that in any given year the projects IIM students come up with are likely to be the best new ventures out there. So even if the IIMs do set up an incubator, it would make sense to delink it totally from the business school and invite ventures from a more general pool.

What we really have here, then, is not a sensible call for policy reform, but the wish-list of a whiny adolescent who wants to be handed his opportunities on a silver platter. Wouldn't it be great if someone gave you money at less than the market rate so you could it invest it your own two-bit schemes? Wouldn't it be wonderful if someone else sorted out all your regulatory issues for you, leaving you to sit around in your free office space and play entrepreneur? Wouldn't it be marvelous if you didn't actually have to ferret about for information but had someone make it available to you? The only way these policies 'help' is by protecting entrepreneurs coming out of IIMs from market realities, at the cost of the IIMs. That's not support, it's patrimony. And not only is that bad policy for the IIMs, it's also potentially harmful for the entrepreneurs themselves - protectionism, after all, breeds incompetence.

But what about the reform the IIMs have introduced - the change in placement policy? Mr. Gaitonde claims that this policy will hamper innovation, basing his argument on the fact that successful innovations often take more than a year to become profitable.

Two things. First, successful start-ups may take years to become profitable, but there are often ways to gauge whether the idea seems to be working or not. Any half-way decent business plan will have short-term milestones, and checking achieved performance against those milestones will usually provide at least a tentative sense for whether the project is likely to turn out to be viable. And while it may be too early to say whether the project is going to succeed, it may not be too early to see that it is definitely going to fail. I can think of several people I know who've started something and realised it was going to work out within an year. So having an easy exit route back to placement even one year in may still be useful, at least for a subset of those who take the plunge.

Second, even if the new policy isn't likely to be too useful, given the short-time horizon, how does it make things worse than they are? Before the reform, students interested in starting up their own ventures straight out of an IIM could only do so by foregoing the placement process entirely. This meant giving up on an incredible valuable opportunity (placement) in order to pursue something that was little more than a pipe dream on paper. As someone who toyed with the idea of starting a venture of his own coming out of WIMWI and gave up on it because he didn't have the nerve (in hindsight an extremely wise decision, looking back I can see that I just didn't have the experience / capability at the time to pull it off), I can attest to how well nigh impossible that choice was to make. Now, students have the option of taking a year off, testing the waters, getting some additional information (however imperfect) on whether their idea is likely to work or not, and then making a choice on whether they want to pursue it further or want to fall back on placements. Sure, some students will take the safer route and give up on ventures that don't seem to be doing too well in favor of placements. But is it likely that, under the old regime, these students would have tried to launch their venture at all? If the uncertainty of the venture proves too much for them one year in, wouldn't that uncertainty have been even greater when they were graduating, and wouldn't they almost certainly have caved in at that point if the option of taking a year off weren't available to them? I personally think having that year to explore the option with minimal downside is really valuable and will encourage at least a few more students to take the plunge, but even if that's not true, it's hard to see how greater flexibility is going to harm innovation.

The one sensible issue that Mr. Gaitonde raises is the unfairness of the policy to graduating students - it's certainly true that these students will face additional competition from the returning job candidates (though in part, this effect may be offset by the lowering of competition among the current batch, as greater numbers of the graduating cohort opt out of placements to pursue start-ups). That's reason for the current students to complain about the policy (though I'd like to think that they won't be so petty). But it doesn't in any way mean that the policy is bad for encouraging entrepreneurs.

On the whole, I'd say the new policy is a small, but useful gesture towards encouraging more IIM students to pursue entrepreneurship. Does it solve all the problems that these entrepreneurs are likely to face? Certainly not. But it's not the IIMs' role to do that. What it does do is provide a little additional flexibility, making it a little easier for IIM students looking to start their own ventures by giving them a valuable option. I'd be surprised if you see more than a handful of students using that option - and so the effect of the change on entrepreneurship overall is likely to be marginal - but it will still be a positive change.

[1] Notice that I'm explicitly stating that I'm in the mood to fisk someone and this post just happened to fall into my lap. So spare me the 'but he's just a hapless little boy with a good heart and doesn't deserve to be treated so brutally' comments.

[2] I'm not sure what reports or databases the author is talking about, but in my experience most databases made available to educational institutions are specifically earmarked for academic use only and are not meant to be used for commercial purposes. Those are the terms under which the providers of this information usually charge these institutions an academic rate. Often, this information is available to commercial subscribers as well, at a suitably higher rate. So I'm not sure that making them available to ex-students is even feasible.

[3] Don't get me wrong. I'm very fond of some of my old profs. They're wonderful, intelligent people and they taught me a lot. But I'd trust them to mentor a start-up they way I'd trust Cuthbert Calculus to babysit.


Tabula Rasa said...

haha! a true falstaff fisk after *ages*. could we mandate one per month or something, please?

the one point i think you missed highlighting was the irony in the actual viability of the supplicant's plan. i mean, this is someone arguing on the side of budding entrepreneurs who are being "unfairly pressurized by this arbitrary one-year deadline", but he hasn't considered that iims *don't* have access to funds at lower than market rates (which they'd deal out amongst graduates of uncertain cgpa while suppressing their own hard-felt cash requirements much like the mother in the archetypal hindi movie), and *can't* provide office space apart from maybe a bench at the chaiwala by the boundary wall.

Veena said...

Yes, second TR. We need one a month.

The second part of the post which is about this policy I entirely agree. Also the idea of IIMs playing around with what is rightfully my inheritance doesn't sound too good.

However, I am a little puzzled by this competency thing - Are you really saying that the IIMs, the premier business schools of our land, have absolutely no competency in entrepreneurship / helping budding entrepreneurs? Not just practically (I completely trust you here), but theoretically they are not even meant to have this competency? So "providing a good business education" has nothing to do with running a business of your own? Now you tell me.

Heh Heh said...

Loved the post.


The issue is one of relative, rather than absolute competency. Even if we were to assume that most IIM professors are *good* at providing a business education (a claim that I find somewhat doubtful - I have a dimmer view of competency amongst the IIM faculty than Falstaff has) and consequently are good at helping start-ups, there are agents that are far better at start-up funding out there and hence are likely to have lower costs of capital. The market for providing business education is quite separate from the market for providing start-up funding, and it most optimal that this kind of specialization occurs. This is one theoretical aspect.

Skills aside, there is the more serious issue of accountability - even if the IIMs do it out of goodness of heart, they are not in the *business* of start-up funding (i.e. are not benchmarked against the market) and hence have no real incentives (even if they had the ability) to weed the bad business plans from the good business plans.

The basic point is that schemes that are systematically based on goodness of heart and have no solid economic rationale are utterly wasteful.

Falstaff said...

TR: I'd be happy to oblige - you don't need to mandate it, all you need to do is find something worth fisking and mail me about it.

And yes, the irony hadn't escaped me. I sat there thinking - okay, you don't have the money, you don't know how to get government clearance, you don't have an office, and the key information you need comes out of a database in your b-school library. You're not much of an entrepreneur are you?

veena: See heh heh's comment. He says it as well as I could. And I'm not saying that providing a business education has nothing to do with running a business of your own - I think there's certainly a great deal of theoretical value that you do pick up in the classroom, but if you were paying attention in class (and not sitting in the NR dreaming of the day when insti would give you soft loans) you've already got most of it. What the start-up really needs is a) knowledge of the market and b) the practical nitty-grittys of making a business work - neither of which your average academic is likely to have any experience with.

To draw an analogy - imagine you're constructing a house and need someone to come in and do all the wiring. Who would you rather have - an experienced electrician that your contractor provides or an Electrical Engineering prof from IIT?

heh heh: Just to clarify, I never said "most" IIM professors were good at providing business education. I said "some". And I suspect you and I would agree on who that handful consisted of.

Incidentally, did you see the link from Desipundit to TTR's blog? Who knew the man had such hidden shallowness?

Veena said...

Heh heh and Falstaff: Thanks for cthe clarification. No, I wasn't suggesting that IIMs should now go into the business of funding start-ups. It just sounded a little strange to me that they don't have atleast a couple of people in the faculty who have started (and hopefully sold!) a couple of companies, and would therefore actually know the practical nitty-gritty of running a business, and so might be actually useful in mentoring these start-ups. Does WIMWI have some sort of entrepreneurship cell? If so, who does it consist of?

Veena said...

Hey, looks like its time for the popcorn run. In addition to Flagstaff, you will also be now known as False Staff!

Falstaff said...

veena: To the best of my knowledge, no prof at IIMA has ever started up and sold companies.

And yes, I saw. It's always gratifying when people choose to convert their defense of their arguments into a personal attack. It shows that they can't think of a way to refute the argument. Also, well, what can you say about someone who thinks 'False Staff' is clever.

Tabula Rasa said...

actually, i suspect 'false staff' may have been the original source of the name. the bard liked unsubtle puns.

Harman said...

You wanted a debate. Lets have one. I don't agree with many things you have to say. Here goes:

1) "The last time I checked, they were educational institutions, not angel investors."
IIMs (or B-schools, esp with govt. funding) should not be seen as only educational institutions in a limited sense. Their larger mandate is to promote & benefit business & economic activity - research on business, policy advisory to govt., consultancy to business, start-up incubation, etc.

Some people will argue that educating managers is just one of the many responsibilities that a govt. B-school has. and I agree.

2) "I see no reason to believe that they (IIMs) have any special competence / ability to do so."

Thats a very unflattering and myopic (short-term) view. As you must be aware, Universities in US have been playing a very active active role in promoting business enviorment. And this includes setting up venture funds to support start-ups. You will find many examples if you Google it out.
one example -

If you want IIMs to contribute in the same way, you have to let them start. Of course, this will involve bringing together faculty (for which I have high regard for unlike some others), alumni, professionals.

3) "I see no reason to believe that they (IIMs) have any special competence / ability to do so"

Well! The answer in short is "NETWORK" . e.g. Alumni can advise start-ups if they have a platform. A University incubator can be the perfect platform
Don't underestimate what a network of dedicated people can do for an entrepreneur .

I just realised I can go on and on. But I won't. Just a last thought.
Universities (like Berkeley) create Silicon Valleys & not the other way round. BTW Google was incubated in the campus and a prof intoduced Larry & Sergey to a angel investor. But thats besides the point.

p.s. you can see my comments at the 2paise blog about how i think rahul's suggestions cn be modified

Harman said...

One more thing.
As someone who works in the VC industry in India. I feel start-up funding in India is at a start-up phase (i know that not too clever either but couldn't help it).
There aren't many angels around. VCs are actually doing PE investments (if you don't know the diff, i am sorry).
There are need gaps which the IIMs venture funds can fill -
1)micro VC - looking at small ticket funding like aavishkaar
2)social venture funding - basically looking at greater benefits to society from a venture rather than just financial return (ERR instead of IRR)

So those 490 can actually have a second chance which the "super efficient" VC market in India is depriving them off.

Falstaff, If I am not mistaken, Prof Handa at IIMA has been a very successful venture investor & mentor. and I know of a couple of Profs more (ever heard of Prof Mankekar). So you might want to reconsider your opinion on faculty ability to fund and mentor entrepreneurs.


Just Mohit said...

But he's just a hapless little boy with a good heart and doesn't deserve to be treated so brutally ;-)
Saw Rahul's post while I was in London, and thought i'd fisk him well & good. In retrospect, am glad i didn't. Reading your post was so much better!

Falstaff said...

harman: Two things. First, what you're suggesting sounds very different from what Rahul was (is) talking about. Could a full scale angel investing fund, part sponsored by the IIMs, managed by professional fund managers with appropriate incentives, taking an equity stake in the ventures they fund (just like any other VC) and leveraging the alumni network be value adding? Yes, perhaps. That's very different from saying the IIMs should hand out cheap funding and office space and let entrepreneurs use their databases.

If the IIMs wanted to get into a project like that (and I have no reason to believe they do) they'd probably be best served by entering into an alliance with an existing venture fund rather than trying to go it alone. Or, at a lower intensity, they could try and set up closer ties to potential angel investors to help provide young entrepreneurs better access to the angel investors that exist (which, as far as I know, is what the entrepreneurship cells of most of the IIMs already do / try to do) And the handful of profs who may have some relevant experience (and there aren't more than a handful, trust me) can always provide support on an individual basis / by consulting for funds looking to invest in start-ups. IT's not clear to me why they'd be more effective if the IIMs were putting up the money.

Overall, the point is that any successful initiative like this would require the IIMs to create an almost completely independent structure - a sub-set of the organisation with completely different incentives, mostly new staffing, and a funding model that looks, ideally, very different from what they've got today. It would also need them to be far more effective in tapping alumni networks than they've been so far. That's a mammoth task, and it's not clear to me why the IIMs would do it any better than, say, a couple of ex-IIMA entrepreneurs who decided to start-up their own start-up investment fund.

(Out of curiosity - why do you think there aren't more angel investors in the country? If these opportunities you speak of are real, and it's possible to invest and them and make money, why aren't people doing it? Is it that the whole market is somehow myopic? Or is that VCs don't believe they can make money investing in start-ups - which makes one wonder why the IIMs can)

Finally, I think there's the question of priorities. Is diversifying into angel investing really the highest priorities for the IIMs at this point? I'd say it absolutely isn't. The IIMs have a lot to do to improve their performance as a business school - they need to get their research in shape, need to manage the implications of the rapid growth they have planned on quality of teaching, upgrade syllabi, improve quality of faculty (hopefully trying to attract more international talent), continue to improve placement opportunities, etc. For them to be trying to branch into distant new ventures like angel investing when their core activity of providing business education is in sore need of improvement seems irresponsible and foolish.

Harman said...

I am glad we agree on some things. First, there is a potential role for B-schools in start-up incubation. So B-schools are not just meant to teach.

I also agree that this will require an effort & level of committment that not many B-schools have shown. But that should not stop us from ideating.

What should be the modalities
1)go alone or partner a fund
2)whether this is top priority
is a matter of discussion.

My opinion: This acn help bring faculty closer to industry. Things can move parallely and we don't need to wait for research, consultancy to pick up before incubation can be started.

BTW, You seem to believe too much in markets. I am referring to
"If these opportunities you speak of are real, and it's possible to invest and them and make money, why aren't people doing it?"

It takes time for markets to develop. Not every need gap that exists is filled instatneously. By your argument, all new business proposals would be rejected saying - if there is scope, why isn't anyone doing it?
Indians needed cell phones long before the telecom revolution, yet BSNL (DoT) didn't do it. Reason - regulations prevented pvt players from taking advantage. Maybe, its the same with the venture industry.

Also, there are areas where markets fail. Like I said, private players with year end targets will not look at responsible investing. e.g. They will not look at the employment potential of a business idea while evaluting it and so on.

You are blessed with the gift of eloquence. Fisking someone's ideas, just because you are in the mood is not the best way of utilising it

Falstaff said...

harman: Sure. I don't have a problem with B-schools playing a role in encouraging entrepreneurship - I don't think it's their primary role or should be high priority for them (and therefore certainly don't think the IIMs should be getting into it at the present moment) and I don't think they can or should go it alone or even take the lead role in it - though they may well play a more advisory role.

As for believing in markets - I'm perfectly well aware that market failure exists. I just think it's silly and dangerous to assume that the market has failed / is failing without evidence. Any time someone speaks to me of an opportunity I like to ask the question - if it's so great, how come no one has ever done it before / no one else is trying to do it? As long as the person proposing the idea has a good answer to that question - if they can point to some unique capabilities / resources they possess that makes them superior to the market, or provide a coherent explanation for why the market may not be operating efficiently - I'm perfectly willing to believe the opportunity is real. I've just seen no evidence so far that that's true here. Which is why I'm asking - repeatedly - if the IIMs can do this, why can't other people? Until I hear a convincing answer to that question I'm going to continue to be sceptical. As "someone who works in the VC industry" I would think you'd understand that.

simone21 said...

Read Rahul's original post and its rebuttal here and his subsequent posts...not to mention the interesting debate at his comments section.

Was highly amused at the way tunnel-visioned Falstaff's myopic, childish and obdurate insistence at clinging on to his rhetoric about 'market rates' and IIM's role to provide 'quality business education' and also his repeated ponderings about why IIM's should start enabling initiatives aimed at fostering innovation.

He has failed to get the reason behind the post...or that a suggsetion may have its pro's and con's that can be debated before operationalising. He worries about operational issues when an idea was floated to be brainstormed and debated.

He fails to understand the logic behind the argument that VC funding in India is still at a nascent stage and we need more VC's and towards this direction IIM's can do their own two bits worth.

One cant escape the fact that IIM's with their tremendous potential to provide valuable inputs to 'foster business innovation' have failed to realise that potential. IIM's like IIT's have a lot more to provide than just excellence in quality management and technical education.

I guess IIT Mumbai, by fostering its own incubating arm is a move that is decidedly against the stated objective that Falstaff believes in.

Ok, Falstaff mentions that, if no one has done it before..then it is not worth pursuing. Well, no wonder he chickened out of going the entrepreneur it involves leadership and pioneering abilities to tread a new path. There are so many out there who could do with a lil help / aid. I agree that entrepreneurs should work within the system and suceed inspite of it, but that doesn't mean we cant do our bit to improve on an existing system. Nobody is asking handouts or things on a platter...I gez falstaff failed to get the original intent of the post

Oh and another thing he has conveniently forgotten to acknowledge is that he was erroneous in stating that he didnt believe that any of the Prof's at IIMA has any experience at venture investing.

Another point falstaff deliberatly doesnt answer is your question as to why should IIM's even get into placements, if its stated aim was to provide 'quality education'...presumably because IIM grads are there in the first place because of that (the number of placements advertised by these insititutions every year)...I mean who has even heard about an IIM grad armed with the best business education the country can give reviving a defunct company or starting a new company. Majority of these grads end up as consultants at the very same Investment agencies. Usually their claim to fame is the $$ they were valued at when they were placed..

I believe that Falstaff was in the mood to fisk and he ventured into this and then got so enamoured of his own ability to play around with jargons and verbiage, that he failed to see the original intent. Oh and like a true boy school debater, he refuses to admit that the other has a point too.

IIM's I believe have a lot more to do than just provide 'quality education'..well when we have people like Falstaff around, do we get to debate :)

Falstaff has a way with words and I am a regular visitor to 2x3x7 and I like his writings...those that are fictional...and some are really hilarious, but it is when he caters to his 'readers' to gain a few ooh's and aah's that he falters...

Ink said...


Wimwi has an entrepreneurship cell which has Prof Rakesh Basant and Prof Sunil Handa as the mentors. The details of the cell are on the IIMA website.

Incidentally are you guys pass-outs from wimwi? Is so which batch?


Harman said...

Hi Falstaff

Came across this article. I hope you will get a new perspective after reading this. Have shared it with Rahul as well.

Some portions to which I wanted to draw your attention

1. “Ms Vivek believes that India needs funding models that will work and leverage on Indian strengths, "rather than the US models which are resized and cut to a different size!"
She thinks the time is probably ripe for more Indians to get into the act and fund startups that are able to understand the uniqueness of the Indian environment. “

The need gaps I talked about, if you remember.

2."What sets successful entrepreneurs apart is their staying power, i.e., the ability to stick through the bad times." She believes that in addition to basic capabilities and domain knowledge, the key team members should have the drive to succeed. "There are many challenges and ups and downs in business, particularly in startups and companies in high-growth stages. The business may flounder in between and may not look so great, but they team should never give up."

Your argument about 1 year being enough to judge whether you are doing well or you need to fall back to ur safety net.

3. “Ms Vivek is active as Venture Advisor and Guest Faculty of IIM-Bangalore. Prior to her current role, she was a full-time faculty member in the Finance and Control Area at the institute”

Talk about IIMs not having the competencies and all that

harman said...

sorry here's the link