Recently, NRN Narayan Murthy, co-founder of Infosys, while speaking at the Nasscom Technology and Leadership forum 2023, called out VC’s (Venture Capitalists) of running what looked like a ponzi scheme.
“A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise to invest your money and generate high returns with little or no risk. But in many Ponzi schemes, the fraudsters do not invest the money.”
In the true definition of the scheme the original organizers rarely invest their own money. But in case of Venture Capitalists, they do invest their own money. This money is also called risk money. The VC’s back a team of individuals and an untested idea. Nine out of ten investments in such teams and ideas fail, the one idea that works often delivers massive returns to the VC taking care of his other nine bets and delivering more than his sum total of investment.
The way VC’s make money is when the team and idea become successful and others want to be part of the idea and the team. And this is where it gets tricky. For the original VC’s to make money, the idea and the team need to be successful or at least look successful. VC’s thus put a great emphasis on going after the top-line, which can also be called sales / turnover to show to the world that their bet is paying off. They more often than not push the team to somehow show numbers which indicate success and often the managements bow down to this pressure and even cook up their books or bring about fake sales / turnover. This is enough for the original VC’s as follow up investment then takes place. When this follow up investment takes place, the original VC’s dilute their share holding and take a partial exit. They recoup some of their investment. The follow up VC’s who come in when the idea and the team is more stable and less risky, pay a premium to enter the business and they too are in it to make money. So, they too follow the model of the original VC’s.
Eventually the aim of all VC’s is to exit this investment retaining a small share of the equity. And this happens when the company goes public, raises money through an IPO. At this IPO stage most of the risk is transferred to public investors.
There have been many cases where the public has ended up losing money because they bought a heavily over priced IPO. But then these are all adults here and everyone investing is coming in trying to make money for themselves. Sometimes the bets pay off, sometimes they don’t. The advantage of bringing in an IPO is that the money is then free from interest payments. Also the risk has been spread over millions of small investors, who individually don’t have a say in the affairs of the company.
Yes, the VC’s push for top-line but then that is their business model. They are not there as investors for the love of idea or team, they are in there to make their investment work and exit successfully. This can be compared to a war.
And it is said that all is fair in love and war!
Public should be wary of making investments in IPO’s where the valuation looks insane. That is the only way not to lose money. But then greed plays a role goading people to invest. Also there is a lot of money that is available to be invested and equity is a considered a good investment class. Thus no matter what, IPO’s of such companies see bumper subscriptions. And in a way that is good too, because it gives the management team bandwidth to carry out their business.
Provided of course that the management is not corrupt and indulges in diversion of funds or paying itself top dollars knowing that their idea may not work and one day they will run out of cash and then it will be the public who will be left holding the baby….
