“Startup entrepreneurs turning investors in VC firms in India,” ran a recent story in Mint. It was a story that largely went unnoticed—as there were hardly any discussions or debates on this story in any startup circles nor was there any buzz around it on social media.
But as someone who has now spent more than 15 years in the startup ecosystem in India, I had only one thought as I read line after stupefying line in this story: How in the world did we get here??
If the angst seems misplaced, let’s take a step back and look at the classic startup model:
- You start up.
- You raise some money (or choose to bootstrap).
- You build a business and reach a point where you can exit—either in the form of an acquisition or a public listing.
- You become an angel investor and/or LP (an investor in a venture capital fund, or “limited partner”) yourself.
Now let’s look at how this is now being played out in India:
- You start up.
- You raise money.
- You raise more money.
- You become an angel investor and/or LP.
Notice the difference?
Most of these celebrity founders who are now LPs in VC funds haven’t actually taken their company to an exit.
Without any meaningful exits, how did so many Indian founders become so rich?
Say hello to the wonderful world of “secondary exits”.
So what is a secondary exit, or simply, a “secondary”?
A secondary exit is simply a share purchase transaction where, instead of issuing new shares to an incoming investor, the existing shares held by the founders (or other investors) are sold to the new investor instead.
The original intent of secondary shares was to help “clean up” startup’s cap tables, especially of those that have many angel investors. But somewhere along the line, it also became an option for founders to sell part of their holdings. Why would VCs agree to something like this? The justification for this lies in the accepted power-law that governs VCs return—more than 90% of the profits come from the one or two really-big unicorn-scale exits. Giving the founder some degree of liquidity helps align interests as the founder now can swing for the fences rather than accept sub-optimal exits simply because she had a housing loan to pay off.
However, in India, this has been taken to extreme heights.
Instead of selling say 2-3% of your shareholding for say Rs 1 crore or so, founders have cashed out to the extent of tens, if not hundreds, of millions of dollars.