[Ask Your VC] Revolutionary vs evolutionary. What wins?

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YourStory presents ‘Ask Your VC’– an opportunity for you to connect with a VC virtually, through a forum of questions and answers. You ask the question, we ‘connect’ you with the expert to get meaningful and relevant insights pertaining to the entrepreneurial eco-system.

How important is traction vs a potentially revolutionary idea that is yet to gain traction? How do you decide to invest in a company that has great traction but no revenue model?

‘Potentially revolutionary’ seems to imply very little traction so far. It also implies expectations of explosive growth. That's the key to thinking about this: if revolutionary, not evolutionary, is your game, then showing traction in the form of revenues and cash flows isn't as important as sign-ups, usage, going viral and other non-financial metrics. Then your job becomes one of convincing investors on how you will achieve these metrics.

Now, does this mean that pitching non-financial metrics will always work? Not necessarily. Investors in India and other parts of Asia do care a lot about monetization and for good reason. Broadly speaking, non-financial measures of traction are not sufficient to attract large cheques. There is absolutely nothing wrong with working on an evolutionary business instead of a revolutionary one -- and this often results in a better outcome.

What is the recommended strategy -- acquiring a deeper user base on one platform (iOS, Android) prior to investing in creating parity across all platforms or starting with multiple platforms with the intention of acquiring a broader user base? 

For the Indian market, acquiring a broad user base on mobile simply means servicing the Android market. iOS is the de facto standard for launching new apps in the US, but Android clearly rules in India.

Why do we see more product companies than services companies? When investing, do VCs also tend to have a bias?

Actually, if you ask any tech-focused investor in India, they will lament that there aren't enough product companies in India. Even some of the companies that claim to be product companies actually have a strong services orientation.

In contrast, VC-funded startups in Silicon Valley are predominantly product or market-place startups, and rarely services companies.

The reason for favoring product companies is because they have high gross margins and high operating leverage. Generally speaking, services companies have low fixed costs and high variable costs, which means that the cost of servicing customers (usually manpower) moves in tandem with revenue growth, necessitating constant investment back in the business. In contrast, product companies don't have particularly high growth in variable costs as sales grow.

Note that this doesn't mean that product companies are ‘better’ than services companies. For example, a services company may be able to more quickly respond to changes in customer needs, whereas a product company may need to go back to the drawing board. The first big development of the Indian IT industry in the 90s was clearly based on a services model and several entrepreneurs and their employees and investors made a lot of money.

Note also that the distinction between a product and a services company isn't always cut and dried.

Should you approach a VC or should you wait for a VC to approach you?

If you are looking to raise money, you must actively approach investors and other sources of capital, ideally well before you're down to your last few days of cash in the bank. Do this in an organised manner and get to know the people you're going to be working with. Try to control the process as much as possible.

Occasionally, a VC will approach you. Don't get distracted and don't assume that a VC's approach automatically means that an investment is imminent.

In my opinion, smart VCs are the ones who cultivate relationships over the long term and watch interesting companies over a period of time before formally proposing an investment. Other VCs may approach you simply because they want to study your industry.

How often do employees of VC-backed startups get stock options?

In India, this varies a fair bit. My usual suggestion to entrepreneurs I have worked with is to give options to all employees but I recognize that this may not always be feasible or even desirable. A few things to note about Indian startups:

Indian startups tend to have a lot of employees. I have invested in companies based in India, Singapore, the US and Australia. For a given stage of development, Indian startups have much larger teams than companies in most other countries. So the likelihood that a given employee, especially a junior one, will receive a good-sized option grant is quite low.

Even in companies where options are awarded to many or all employees, they are not always valued by staff, and often not even understood properly. I've been on the board of a company where employees complained that they "received only 10,000 options" whereas their friend in company XYZ received 10 times as many options, not realizing that this isn't an apples-to-apples comparison. I have sometimes taken the effort to explain what stock options are and how they work, but it clearly remains a poorly understood topic.

Some founders can be very frugal with dilution. “I’m paying them a salary so what more do they want?” is a common attitude and I often wouldn't even consider it an unreasonable view. I have heard good arguments in favor of giving options only to senior staff.

If you're an employee of a VC-backed startup and you do want stock options as part of your package, good for you. I would recommend you bring this up with your startup's founders. A long-term-oriented founder should find your attitude refreshing and positive.