Page 1 of 4E & Y Global VC Report 2008 ‘Perspective from India’ excerpt

Ernst & Young’sGlobal Venture Capital Insights and Trends Report 2008

Innovation: The Growing Importance of Venture Capital

_________________________________________________ Perspective from India

Interview with Sudhir Sethi

_________________________________________________ Sudhir Sethi is Founder, Chairman andManaging Director of IDG Ventures India,a US$150 million early-stage technologyventure capital fund backed by IDG, theworld’s largest IT-focused media company.He founded IDG Ventures in 2006 after26 years in the technology and ventureindustry.

Sudhir SethiIDG Ventures India

Ernst & Young:

What were your surprises in the last 12-18 months?

Sudhir Sethi

: When we raised our US$ 150 million fund and startedoperations in September 2006, we focused on early stage technologyinvestments. Our focus was and continues to be in Software Products andServices, manufacturing and engineering, medical electronics, digitalconsumer and telecom / semiconductor sectors.Our first surprise was the pace at which funds are vacating the ventureinvestment space and moving increasingly to the growth investment stage.Our intention is to dominate the venture stage technology focused sectors asan early stage fund.

Page 2 of 4E & Y Global VC Report 2008 ‘Perspective from India’ excerpt

Our second surprise was the extent of competition in our sectors; except fordigital consumer space (internet / mobile VAS), we really do not facesignificant competitive pressures in our other sectors.Our third surprise was on valuations; we find valuations in the venture stageof the technology sector extremely attractive.Our fourth surprise was the maturity of the entrepreneur who today valuesrelationships and value-add from a venture investor; the fact that the IDGVentures team of six investment professionals have significant domain,operating and venture experience sets us apart in the industry. Thiscombined with the IDG network value-add, is a significant differentiator.In the past 18 months, we also found that venture investments in Indiarequire business model innovations to create companies and not just fundconventional deal flow; hence we funded ConnectM, a spin out from Sasken;Aujas a managed security services pure play, through an EIR Program and3D Solid Compression, which was incubated by Stanford and Indian Instituteof Science, Bangalore.

Ernst & Young:

What's the potential impact of the uncertain capital marketson the VC ecosystem?

Sudhir Sethi:

The key potential impacts of the uncertain capital markets onthe VC ecosystem can be classified under:a) Fund-raising and general partner/team qualityb) Deal flowc) Valuationsd) Exitse) Co-investmentsLimited Partners, as we go forward, will become extremely choosy about thequality of teams they back in partnerships. Very few general partners (GPs)in India have what I call a full-cycle GP experience of deal flow generation,investment, monitoring, exists, and fund raising. In essence, first time fundsespecially with teams who have not worked together will find it difficult toraise capital. However, second-time funds with a clearly articulated strategyof investment, with teams who have a partnership having full-cycle ventureexperience will get funded relatively more easily.

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Deal flow is expected to slow down, with new start-up ventures reducing dueto lower entrepreneurial inflow from corporate to start-ups. However, I doexpect quality of deal flow to go up. In addition, we expect deal flow to bemore spread across cities in India including tier-two cities like Pune,Coimbatore, Mysore etc.,I have already seen significant lowering of valuations in seed and early stagedeals. This trend is likely to continue.Another significant impact of uncertain capital markets in increased incidenceof co-investments. Out of our seven investments so far, four are with co-investors (Erasmic, e-Planet Ventures, Softbank and Sasken).As far as exits are concerned, the dependence on IPOs will reducesignificantly; companies have to be built increasingly for exit by acquisition.This also implies founding teams to build significant disruptive businessmodels and technology differentiators to command higher valuations at exit.

Ernst & Young:

What have been the key insights and takeaways from themarkets, mature and emerging, you have invested in?

Sudhir Sethi

: In the past 10 years, I have invested in India; in the USA withIndia as a back end (development location) and in Singapore / Malaysiancompanies looking at India as a market.My first key learning in an emerging market like India is to invest incompanies based in India where the founders know the Indian environmentvery well, especially since India is a significant market for our investeecompanies as compared to yesteryears when the US used to dominate as amarket for India-based companies. Hence, we do not invest in companies if founding team in the USA or anywhere outside India.The second key learning is not to transport a USA investment model intoIndia; for example an investment into the Internet space in the USA assumesa mature online market; whereas an investment in the Internet space inIndia will demand a significant market expansion based on an offline modelas well.Thirdly, in addition, since the India entrepreneur in all probability, cannotbuild a scaled company with India as a market alone (unlike the USAentrepreneur) it is essential for the founding team to have cross borderexperience in business development. The investment bar in an emergingmarket like India is thus higher. Incidentally cross-border experience can beIndia-China and not India-USA alone.With India’s GDP growing at 8.5% and the technology industry still growingat above 25% per annum, attrition is a bigger issue in India than the USA.In addition, employee stock ownership plans (ESOPs) are not valued by