IT product makers catch the fancy of VCs, PEs

In a change of strategy signalling a broader shift in focus from information technology (IT) services companies, venture capital and private equity firms are increasingly looking at IT product companies for investments.

A recent example is of Sequoia Capital, which has invested in India’s leading provider of internet security tools, Quick Heal Technologies (QHT). In a growth-stage funding, the private equity firm, which manages funds capitalised at close $1.8 billion across investment stages in the country, acquired an undisclosed stake in the anti-virus software company with an investment of Rs60 crore.

Sumir Chadha, managing director, Sequoia Capital India sees more such investments in the time to come. “What we see today are early signs of this trend taking shape and I think it will be more visible in the near future. The growing appetite for internet through broadband, wireless and mobile handsets is the key business driver for IT product companies in the country.”

Chadha’s enthusiasm for IT product companies is clearly visible from the fact that QHT is Sequoia’s third such investment.

In April 2010, Sequoia, with Indian Angel Network, invested $5 million in Druva Software, a global player in storage and data back-up solutions.
Similarly, another Indian IT product company, Ideacts Innovations Pvt Ltd, raised series A and B funding from Sequoia (2007) and SVB Capital (2009) to the tune of $5 million and $3 million, respectively.

Sudhir Sethi, founder, chairman and managing director, IDG Ventures India says the shift from IT services to product companies has been happening for some time now. “In the past 12 months, we have evaluated 700 companies and approximately 45% of those, or 315, were product companies.

We continue to look at product companies and have so far committed Rs130 crore across five investments including 3DSOC, iViZ, Manthan, Perfint and i-Create,” says Sethi.

Driving the change is a perception among the private investment fraternity that the Indian consumer is today willing to pay for IT products, which was not the case earlier.

Rahul Khanna, director, Clearstone Venture Advisors Pvt Ltd says there has been a significant increase in the penetration of IT products such as desktops, laptops, netbooks and telecom products like multimedia mobile phones and smart phones in the Tier I and II cities, with every household having a combination of such items.

“This apart, there is huge demand for IT products with the medium and large enterprises doing business in India and overseas. And the best part is that such products can very easily be delivered over the web,” says Khanna.

The key differentiators in the case of IT product companies include high risk investments and founders with high domain knowledge.

“With product companies, investments tend to be high risk as there is a clear development cycle of 2-3 years before revenues start flowing in. A product company requires a founding team with high domain knowledge and specific skills like product architecture, product management etc, which service companies do not require. The revenue model of product companies tends to be more towards licence fees and not an hourly billing rate as is the case with service companies. And lastly, the sales cycles and skills demanded of the sales force in a product company are a class apart,” says Sethi.

Among various IT product categories being looked at by investment firms are mobile applications, products targeted at the healthcare and education sectors, business intelligence and analytics, digital/ enterprise and consumer security and medical devices.