With the onset of funding winter, founders are now better behaved, says Mukul Gulati of Zephyr Peacock

The pandemic may have wreaked havoc on existing businesses, but it created a bubble bigger than the dotcom one in the startup ecosystem as cheap money was chasing just about any idea. With the go-go days of funding behind us, private equity players say that founders are no longer behaving like overgrown teenagers. In a freewheeling chat with Business Insider, Mukul Gulati, President and Chief Investment Officer of Zephyr Management, says that founders now see the writing on the wall and don’t have to be lectured on profitability. Edited Excerpts:

As a private equity player, what do you like about India and how has your journey in the country been

Mukul Gulati: Zephyr’s been in business for 30 years globally. We are headquartered in New York. Our founder is Tom Barry, who is a legend in the world of emerging markets. He’s an American, but in his heart, he’s a globalist. He came up with the idea many years ago before anyone invested in the emerging world to invest in Africa. When apartheid was removed in South Africa and Nelson Mandela got elected, at that time, we helped start one of the first funds in South Africa. And the idea was to bring private capital, support the private sector, and bring modern management practices to the emerging world. And since then, Zephyr has become much more established in the African continent and has sponsored private equity funds in other markets in Mexico and in Korea.

We’ve been in India for about 17 odd years. I joined the New York office and came to India, to Bangalore to help start our business. And we started off doing sort of growth capital, not tradition, not classic venture. What we do today is actually a little bit of venture and a little bit of growth capital.

How is India different from other markets you are present in?

Mukul: In India, we realised that we needed a local approach. And one aspect of that approach is that you cannot take management teams for granted. In America, generally, it’s the business model that matters and you can find good management. In India, and it’s true in other parts of the emerging world, execution matters the most. And execution generally is driven by the founding team or the management team. And that’s sort of been a big lesson for us and sounds pretty obvious, but you can’t overemphasise that aspect.

Over time, we learned what our role as investors is. Because obviously the execution needs to be done by the management team. We thought over time, the role that we could play is not that of a spectator but a true value-add partner. over the last 10 years, that’s the approach that we’ve taken. And we’ve become multistage investors. If the idea is right, and it sort of matches what our view of the sector is, then we can go early.

With the easy money era coming to an end, how are investors or LPs looking at investing in India?

Mukul Gulati: The sophisticated LPs understand there were excesses in the system and the excesses are gradually working their way through. And as the bubble is winding down, there may be some good investments available. So for many of our existing investors and some new ones that we are talking to, that is the main point of view. It’s not everyone because not everyone is that sophisticated, but I would say majority of the people see this way because they saw this play out in their US portfolios.

What kind of excesses did India’s ecosystem see compared to North America?

Mukul Gulati: The so-called ZIRP (Zero Interest Rate Phenomena) resulted in a lot of fundraising post-COVID. It was true for US fintechs and other startups, series A valuations at $50 million plus. There were a lot of excesses and the root cause was easy money. These excesses were even more prevalent in India. There were more egregious instances of hollow businesses getting insane valuations. What I saw most, noticed more in the US, was that while the businesses were okay, they shouldn’t have been valued at such prices. In India, it was a little bit of both. Some businesses were just never going to make it, leave aside valuation as the business is just not working.

Many of these businesses have folded since. And then there are some where perhaps decent businesses, but got overvalued and will take many, many years to grow into those valuations. The bursting of the bubble is actually healthy for the Indian venture capital ecosystem.

What about founder behaviour? Has it improved?

Mukul Gulati: Now we see that the founders are better behaved. We don’t have to give them a speech about on how they should not focus on valuation, but on cash flows and profitability. We sounded like preachy aunts and uncles to these young founders that we are from a prior generation and we don’t have good advice to give them. And now they take us seriously, partially because they understand this is how the market works. For most of our businesses, survival wasn’t an issue because we were not dependent on filling cash flow gaps through external funding.

You’ve had a few exits. How easy or hard is it to exit aid from the Indian market?

Mukul Gulati: Exits are never easy. Exits are particularly challenging in emerging markets. The exit environment in India is improving, but by no means it is like what it is in the Western markets. They’re improving in the sense that public markets are maturing. They’re more liquid.

However, public markets have also become more selective over the last few years in terms of what kind of issues they’ll absorb. The Indian IPO market will want a certain size. So the bar has risen, which is good because you don’t want small illiquid companies. Another thing that’s happened is that with the recent ups and downs of sort of tech-based companies in the stock market, I think that people want some emphasis on cash flows and profitability. And so from that perspective, the IPO market is a little bit more selective too. In fact, I would argue that the IPO market for emerging businesses is better in India, than many other places, including America.

And the second way the exit environment that has improved in India is sales to financial sponsors. Because we have so many private equity funds that operate in this $400-500 million plus fund size range, a $50 million, $100 million transaction is quite attractive. And this is mostly a five-year phenomenon that wasn't the case 10 years ago, but it started five years ago when many more funds either have dedicated sort of funds for India or they have pan-Asia funds and all are sort of US-based players. The large global funds are all active in India and they all want to write big checks and they don’t have enough deal flow at that size. And the third point is that, you know, strategic sales, frankly, are still fewer in India than you would otherwise imagine for an economy of India’s size. You know, and foreign investors remain somewhat cautious.

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