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VCs hit a sweet spot in spin-offs

Sudhir Sethi, managing director of IDG Ventures India, has seen 551 potential investee companies since September last year. His $150 million fund has invested in 3 and hopes to complete 4 more investments by the end of this year.

But, feels Sethi, as much as individual entrepreneurship is thriving, existing companies with a few out-of-the-box ideas are also not averse to spinning out new entities from the parent company, unleashing tremendous value in the process.

The beneficiaries: venture capitalists (VC) like Sethi, who are inevitably invited to share in the growth, and at a later date, the spoils from these spin-offs.

In June this year, Sasken Communication Technologies spun out ConnectM, with Sasken and Sethi’s IDG Ventures jointly investing $6 million in the venture. The new company offers machine-to-machine solutions in the transportation, industrials, utilities and enterprise markets.

“I see a lot of mid-sized companies wanting to create a host of satellite companies around it, and then spinning it back in about 4-5 years. This has tremendous value unlocking potential,” said Sethi.

Sethi feels it also helps unleash the entrepreneurial instincts of the senior management in the parent company.

“I think we will see much more VC action in these spin-offs,” seconds Sash Mirchandani, senior investment director, BlueRun Ventures, a global venture fund with Nokia of Finland as the major limited partner. A limited partner is someone who funds a venture capital or private equity fund, which ultimately makes the investment.

Another group to have got VC funding for its spin-off is Subhash Chandra-promoted Essel group. Earlier this month, the group’s company ItzCash announced it had got $10 million in investments from Matrix Partners and Intel Capital.

The company, which is into pre-paid cards, will use the proceeds to fund product innovation and expand the payments market.

“There are smart corporates who have seen the opportunity in associated sectors in their ecosystem. They are cash-rish and they have taken a call to behave like VCs, incubating certain businesses over a period of time,” said Avnish Bajaj of Matrix Partners.

He says these industrial houses realise later that these businesses are not core to the company, and keeping them within the group could not add as much value as spinning them off.

“The first step to get that done is to get in outside investors. And to add credibility, VCs are the preferred choice, as VC ownership is perceived to create shareholder wealth, much more so than if the business is run as a family enterprise,” adds Bajaj.

Private equity firms have already been investing heavily in subsidiaries of major companies.

Temasek, the investment arm of the Singapore government, and a private equity fund of JP Morgan Chase had paid $7.5 million for a 25% stake in Apollo Hospitals’ subsidiary Apollo Health Street in May 2005.

Again, a JP Morgan subsidiary and IDFC Private Equity had picked up a 21.6% stake in a L&T subsidiary, L&T Infrastructure Development Projects, for $122.2 million in April 2006.

Then, there’s Shriram EPC, a subsidiary of the Shriram group, which got $10 million as growth capital from UTI Ventures in December 2006. The company had also been funded earlier by ChrysCapital and Bessemer Venture Partners.

All this means, venture capital and private equity firms, already inundated with investment opportunities, have found yet another sweet spot to source their deals.

Source: DNA India

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