How to build a startup without angel or VC investments

A lot of entrepreneurs think they need piles of money to make their startup a success, but that’s not always the case.

Know your Speaker:
Shiven Malhotra, Angel investor & mentor for startups
Shiven’s career has spanned three continents having worked with KPMG auditing technology in the US, in Goldman Sachs’s stock trading desk in the UK and in India as part of the start-up team for Kotak Commodities trading desk.

Shiven was born and raised in New Delhi. He finished his schooling from the The Doon School and then studied Economics at the University of California at Santa Cruz.

Shiven is also a semi-professional photographer and an avid trekker. His big plan for the future is to trek to the Everest base camp.

Finding the right o-founders – Teaming up for start up success

Choosing a co-founder is the most important decision you will make when starting your company. Your co-founder(s) will be like your spouse – you will spend most of your time every day with them‚ and you will need to agree with them on all the big decisions. Having a co-founder can certainly be a big advantage‚ in terms of vetting ideas and offloading the work. However finding a co – founder may be a complicated issue. Agreeing on the terms and conditions of partnerships‚ exit strategies and compensations from the beginning‚ improves the understanding of what is expected of each party. So how do you go about finding the right one?

 

Selling to enterprises – large and small

The first sale never easy. Selling is about building long-lasting‚ mutually beneficial relationships and often proves tricky for start-ups. This session will give you insight on how your start-up can land giant‚ fat accounts that will launch your business into the big leagues and at the same time standout in a crowded marketplace.

 

What percent of equity can be shared with a company that develops the prototype of the product?

See if you can pay in cash. Only if it is just not possible to make cash available to pay for prototype, then consider paying in equity. At the prototype stage, when the risk is the highest, the vendor should have a significant upside in case the venture takes off as expected. 

 

If on an equity model, I would suggest you look at the total amount required to build the prototype, and give a 3x – 5x of that in equity value at the time of the 1st round of funding. E.g. if the estimated cost of prototype is $10,000, and if the equity is agreed at a 5x, then if the angel1st round is raised at a valuation of $500,000, then the vendor should get 10% equity at the time of the funding. Ordinary shares.

(The negotiations get complicated and difficult to value if the equity if the basis of returns are for the 2nd round of funding… i.e. if the vendor and you agree that he should get about 5x or 10x of the cost of prototype development in the 2nd round, then the amount of equity will vary significantly based on what the expected valuation of the venture at that stage would be… and that’s a difficult one to agree on… the entrepreneur, naturally, will be super optimistic while the vendor may be a bit more modest in estimating valuation in 2nd round).

However, before you embark on your prototype stage, I would urge you to think hard about the business case, validate the concept with potential customers/users, work out your cash flow and fund flow needs, think of what this is likely to scale to and see what the financial outcomes of this are likely to be for all involved… including the vendor.

What should new entrepreneurs be wary of when it comes to launching a new business?

Well, there are some lessons that I have learnt in my journey…. and as an entrepreneurship evangelist, have had the opportunity to observe many startups start up, and fail. Here are some observations:

  • Don’t underestimate the costs and time that you will require to meet your milestones – often entrepreneurs, enthused by their deep passion and conviction in the concept, expect things to happen sooner than it would, and they usually expect to achieve it in lower resources and costs than it would. Running out of cash is the single biggest horror that a startup or early stage company can face.
  • Plan for the worst-case situation… not the best case. Most entrepreneurs prepare business plan, which look at the most glorious of outcomes. While that is a possibility, it is prudent to think hard about what aspects could go wrong, and think of plan to mitigate those disasters. If the venture does well, enjoy the ride, be sharp and steer it towards success. However, if you have planned well for disasters, you will be able to manage the startup even during times of significant challenges.
  • Ensure that co-founders are aligned on the vision, the pain in the journey and each other’s views on key decision points in the journey (e.g. how would you react if you were to get an offer to sell of for $ 10ms… what will be your decision if the offer was $2mn?)
  • Talk to customers. Don’t plan on the basis of your enthusiasm and conviction. Test the concept with customers/consumers. Even before the product is ready, have conversations with potential customers/consumers to get their feedback and thoughts on what they would like to see in such a product.
  • Be very, very careful about whom you hire as your first employees. Make sure that they are in it with some level of conviction and passion for the concept. Pure commercially inclined employees will not have it in them to pull through the ups and downs, the course correction, and the challenges of the early stages of your journey.
  • Keep your costs low. Be frugal. Plan your cash flow and fund flow requirements well. Make sure you are well funded. Dont assume that you will be able to raise the balance amount as you proceed along in your journey.

What career should I take if I want to be an entrepreneur?

If you are clear that you want to be an entrepreneur, I would recommend you to take up a sales job. Any company, any where… take a job that requires you to go out in the field, meet customers, pitch your product, negotiate and sell.

Selling teaches you many things about the practicalities of business life. Rejection by customers teaches you to be modest about your assumptions on conversions. Dealing with rejection teaches you to deal with failure and challenges.

What is the best way to find a cofounder online?

It is usually better to find a co-founder within your circle of known folks. However, if you have tried all of that and are unable to and if you must cast your net wider, LinkedIn is what I would bet on to ‘narrow down my choices’ and then target specific people for a ‘conversation’.

If you connect with someone whom you think could be a good co-founder, once you have a match of excitement for the idea and a sense of commitment, I would encourage you two to have long and detailed conversations of various scenarios about the business to ensure that there is broad agreement on the vision, direction, aspirations, values, expectations, goals – personal and professional, family circumstances – financial and personal, etc.

Of course, in all of this, the chemistry has to match and you need to be able to tolerate each other’s working styles. (Generally it is good to work with someone you know because you are likely to be aware of their personality, working styles, weaknesses, etc. and therefore the chances of stress due to ‘new discoveries about your cofounders personality’ is likely to be lower).

Essentially, if you decide to co-create a company with someone you have not known before, you should try to speed up the process of getting to know as many aspects of each other’s personality and aspirations that may impact the business in some way.

Understanding pricing or revenue models

How much to charge your customers is a critical decision for entrepreneurs. I.e. pricing is a critical component of your business strategy. While getting your pricing strategy right is no guarantee of success, getting is wrong is one sure shot route for failure. Obviously, how much consumers are willing to pay is dependent on the value they see in the solution you offer, be it a product or a service.

 

There are quite a few Revenue Models available for startups to consider:

 

Cost Plus mode: where the seller decides the price of the product based on the cost of the product. This is usually done for physical goods e.g. shoes, garments, computers, pens, etc. Doing this model for online services is not feasible because there is no real cost of the physical goods. How much premium you can charge over the cost is dependent on a number of factors including competition, alternate options, the overall value-proposition that the customers see in your offering, and often, also the personality & equity of the brand.

Value based model: For products or services that do not have an individual unit price [e.g. Microsoft Office software], the seller decides the price based on what they believe is possible to be charged from the consumer. This is the toughest part and may require some experimentation and in-market tests to arrive at the price point that you could charge.

Distribute the product free but customers pay for services: In some markets telecom companies follow this model where they give away the telephone instrument for free, and people pay for the usage. In some cases, e.g. printers, the base product is not given free but is offered at a very low price, often lower than the cost price, with the hope of recovering it through sale of related products and services e.g. cartridges and printer servicing.

Free for consumers – ad supported model: E.g. Angry Birds

Freemium: Free for basic, paid for premium services. E.g. sugarsync.com, linkedin, gmail, etc.

Portfolio pricing or package price: This strategy is applicable when the seller has a range of products and/or services and may want to engage the consumer for the entire portfolio. E.g. Insurance companies which offer for corporates a portfolio comprising of life insurance + car insurance + fire insurance + health insurance

Subscription model i.e. users pay a per month/per year e.g. book libraries, dropbox and other online storage sites, SAAS platforms, etc.

Pay-per-use model i.e. users pay as they use it e.g. Platforms like Webex have a pay per use model

One-time payment i.e. users buy a license to use e.g. Microsoft Office

Tiered or volume pricing: Typically used to group buying benefits. E.g. an enterprise software where the license fee per user reduces as more licenses get bought. The pricing in this model is often defined in slabs as relevant to the category.

 

Entrepreneurship – the time is now

In my view, easier availability of early-stage capital than ever before, public celebration & adulation of entrepreneurial heroes, a well-deserved respect for entrepreneurism and also society’s willingness to accept failures in entrepreneurial ventures make it easier for younger people to consider entrepreneurship as a career.

I share below some observations that will hopefully provide some food for thought before you embark on your entrepreneurial journey.

Enterprises have to be built around a concept that has a meaningful value proposition to your potential customers and around which you can build a strong, sustainable business model. Entrepreneurs tend to overlook the challenges when they are driven either by a desire to be an entrepreneur or when a concept stokes their interest.

Often, entrepreneurs assume that a business plan is to be written only when you seek venture capital or debt. However, a business plan is nothing but your plan for your business and in order to manage your enterprise you need to be able to create a document using some framework that helps you think through the steps you need to take in your entrepreneurial journey.

Don’t focus on the excel sheet. Focus on the business model. A 5-year excel sheet projection is just that – an excel sheet exercise – a set of assumptions. It is neither a reflection of the potential nor a reflection of your ability to meet that milestone. However, an excel sheet exercise provides you a reference point to consider different possibilities of scale and help you plan the intermediate steps in reaching those milestones. I.e. it is not important to detail the calculation for a Rs.98.74 cr revenue by 2012 as it is important to be able to state “We believe we can be around a Rs.75 cr to a Rs.100 cr. enterprise by the 3rd year of operation and here is how we plan to go towards those milestones”.

It is ideal to gain experience about building and managing businesses before you create your own enterprise. Most successful entrepreneurs have built businesses after gaining significant experience across functions in different organizations. Though often celebrated, entrepreneurial successes of people with no prior work experience are a rarity.

One of the most common observations of investors, both domestic and foreign, is that entrepreneurs in India are afraid of thinking big. They tend to think it is prudent to be very conservative in your projections, especially if you have no past record to prove your scaling-up capabilities. However, unless you are creating a life-style concept, it will be important to provide a true picture of the potential and your aspirations, especially if you are seeking venture capital. Of course, the aspiration to scale has to be based on a validated assessment of the potential and backed by a strong, sustainable plan to deliver on that potential.

Your ability to scale should be restricted only by your aspiration and not by capital. In today’s environment, it is far easier to raise early-stage capital than ever before. If your concept is right, if the market potential is large and if you have the capacity and capabilities to deliver on that potential, you will find the capital to fund your dream.

On the other hand, if a number of investors reject your proposal, it should be a signal for you to consider what aspects of the model seem to worry investors – relevance of value proposition, market potential, business model or your ability to deliver on the potential. Once you have identified the issue or issues, you need to revisit that in your plan and see what changes you may want to make in order to address any flaws in your plan.

Just because you do not get funded does not mean it is a bad idea or your plan is wrong. Often, especially with new concept, it is difficult for investors to take a bold step. It is therefore also important for you to find investors who have a strong belief in the domain that you wish to be in and convince them about your ability to deliver on that potential. If you still do not get funded and do believe it is a concept worth fighting for, you need to find innovative ways of building a proof of concept.

Importantly, don’t be a lone ranger. Connect with other entrepreneurs. Seek guidance. Ask those ahead in the entrepreneurial journey to share their experiences. Organizations like TiE and NEN offer excellent opportunities to network and seek mentoring from accomplished and successful entrepreneurs.

To end, I would like to clarity that entrepreneurship to my mind is not just about starting or owning an enterprise. It is about an entrepreneurial spirit that inspires individuals to take ownership of an assignment of area of responsibility. It does not matter whether it is in your own enterprise or whether in an organization where you work or whether the organization is a commercial enterprise or a not-for-profit entity. Do well in whatever you choose to do. Do it diligently, honestly, ethically and with enthusiasm and commitment. And THINK BIG.

As the advertisement of a spirits brand says ‘Its your life, make it large’.

If I have the talents to build an MVP myself, should I hold off on a co-founder to raise capital and make some early hires?

A product is NOT a business … no matter how good that product is. A business has to be built around that product or concept. 

 

So, if you are good at product development, perhaps you need some support on the marketing/sales/commercial side of the venture.

Also, with most investors you are likely to have a better chance of getting funded if you have a co-founder. (Also… entrepreneurship is emotionally draining too, and hence getting a co-founder is a good idea.).

Remember, investors invest in the business case around a concept or product, and the ability of the team to implement that idea in the market. A good product is a good starting point, but neither a necessary condition, and certainly not a sufficient condition for funding. (Why do I say it is not a necessary condition.. because if you have a good product, it is obviously very good. But if you don’t have one, you can easily build one or get one built if you have the right business case that allows you to raise capital to build and market a good product.).

 

How to build a startup without angel or VC investments?

A recording of webinar hosted by Virtual Learning Center of The Hatch Institute on Sept 20, 2012.

About the session
A lot of entrepreneurs think they need piles of money to make their startup a success, but that’s not always the case.

What are the top questions young entrepreneurs should be asking themselves?

From a business point:

  • What are we doing (concept) and why is this important (what need or opportunity does it address)
  • Who will use this
  • Who will pay for this, to whom and how much and how often? (Customer segment and business model)
  • How am I going to do all this (the operating plan)

 

From a personal point:

  • Why am I doing this (motivation – to make money, to change the world, to do ….)
  • Are the people I am doing this with (my co-founders) the ones that I feel really, emotionally close to (if not, won’t last)
  • At what milestones will I say “I am successful”
  • What will be the parameters for me to give up and move on
  • How much time can I pursue this without a salary
  • What alternate opportunities am I giving up to do this… and why am I happy doing that

7 simple steps for writing a business plan:

 

  1. Start with a ‘story’ – ‘See the film in your mind’ about your venture – what do you want to do, how large do you want it to be, what will make you happy, what are your aspirations, etc. Imagine it as a business a few years down. This gives you a good view of ‘what you want to aim for’
  2. Work out rough milestones and goals: Your long-terms goals and aspirations should then be broken into short-term and long-term milestones, which are the stepping stones to your eventual destination.
  3. Think deeply of how you will implement it: This is the critical aspect of planning your implementation. This also gives you a view of the cost structures, the infrastructure & people needs, processes, etc.
  4. Work out the ‘structure’ of an excel sheet: Now, after you have done the thinking, it is time to use an excel sheet to evaluate if there is a business case in what you plan to do. Before you start entering numbers, work out the ‘structure’ detailing every cost head and revenue stream.
  5. Start working in the excel sheet – assumptions are critical: An excel sheet exercise with the wrong assumptions is going to give you a very wrong direction, and perhaps wrong hopes. Be realistic. Be conservative.
  6. Work on multiple ‘scenarios’: Life does not play out the way you plan it. Real life situation will be different than your excel sheet plans. It is therefore essential for entrepreneurs to work out multiple scenarios to see how the business will pan out under different outcomes.
  7. Finally, articulate it into the ‘presentations’: Once your ‘Business plan’ is ready, you then articulate it into different presentations. Even an executive summary is one articulation of the B-plan. You can have an executive summary for introductions, a 8-10 slide ppt for first meetings and more detailed documents and presentations for follow-up meetings where specific details are going to be discussed.

How do I design a startup workspace?

Having a decent office does play a very important role in the early stages of a company.

It is very difficult to recruit talent without a good office Perhaps rightly so, people create perceptions and first opinions about a company by looking at the office.

Ideally, startups should try to co-locate with someone… could be another startup or an early-stage company that has some spare space. More people around makes your team feel like a larger company, and there is learning from others too. Of course, shared pantry, conference rooms and other resources helps save costs.

No cubicles and dividers… one room with everyone sitting on similar sized tables is ideal.

Bright and cheerful places make happy colleagues. Dull and dark places also make it difficult to hire people. Investing in a better office, with better lighting and decor eventually pays out in the form of better people accepting your offer.

Spend as less as possible on things that you do not need – copiers, fax machines, coffee machines, etc… rent ACs if you need it. Keep capex low…

Working out of home in the initial phases is not practical beyond a point. No matter how serious and committed you are to your venture, working out of a ‘non-office environment’ [i.e. home or Cafe Coffee Day type outlet] just cuts down on your productivity. It is not just about inadequate infrastructure and support system, an office environment and the people around you just add to the feeling of being a real company.

Without an office, business plans tend to get restricted by space available Inadequate or no office space and working out of coffee shops does leave you vulnerable to taking decisions based on restrictions of space.

 

 

Hiring technical resource for Startups

Many developers love working for startups and some who will only work for startups. Good startups.

Hiring for a startup is like any hiring: your network is easiest, resumes hardest. You can do a few things to limit the field and attract the right folks if you’re gathering resumes:

  • Find places to post your requirments  frequented by startup types
  • Remember being a startup is major selling point, say it loudly and often, and ask for startup experience.
  • Ask for technology experience popular in startup circles, i.e., not .NET, not JEE.

Elance can work for assembling a programming team, but it’s not a great solution as their contract requires you keep Elance as a middleman for future work between the same two parties

If you’re looking for alternatives for finding outsourcing, try also asking on Quora who are all the great developers that build early product versions for early stage startups.

 

What happens to the shareholding of a founding team member in case he decides to quit the company?

Ideally, the founder’s shares should vest over a 3-4 year period. This is not just in the interest of the investors, but also protects the entrepreneurs in case one of them decides to leave.

In simple terms, if there is a 3-year vesting period, then every month the promoters get 1/36 part of their equity.

For example, if there are 4-founders, and one of them who has 18% equity decides to leave the startup after 15 months because the venture faces significant challenges, then in a 3-year vesting period clause, the leaving founder will get to keep only 7.5% of his 18% equity, with the rest of the equity now available for the company and the board to offer to another person who may be brought in as a co-founder or at a management level to fill in the gap left by the leaving founder.

In case the equity that has not vested to the leaving promoter is not given to a new person, then in the case of an event like a M&A that equity is distributed to all the remaining shareholders, including the promoters in the proportion of their holding in the company.

 

Handling disagreement between founders

One of the common reasons for issues in startups is disagreement on the way forward.

 

These issues and disagreements come up typically at two inflection points –

(a)  Either when the startup is doing very badly and tough decisions are to be taken e.g. to further reduce the already low salary or (

(b)  When the startup is doing really well and tough decisions are to be taken e.g. to sell out and take the cash or to stay on and grow even more.

 

How does one address this? Well, one way is to anticipate it and have a philosophical discussion and agreements with the co-founders on how different situations will be handled. This discussion should happen at the beginning of the journey and NOT when the situation arises.

 

What will be the decision in case of difficulties? What will be the decision in case there is an option to sell out? It is possible to build some of these agreements into the shareholder agreements or articles.

 

Some questions I ask our portfolio companies to discuss among themselves are:

1)    Who among the founders will be the CEO, and why (If you do not decide at the beginning of the journey, this can be a tricky one to settle. If you do not fight over it, your spouses may.). If required, would you be open to a professional CEO.

2)    If someone offers to buy you out for Rs10cr in a year, what would you do…

3)    What will be your measure to say that the venture as ‘failed’ and give up

4)    What is your plan B?

5)    How long can you go without a salary (or survival salary)?

 

One way to protect the venture in case of conflict is to vest the shares of the founders. I.e. If there are 4 founders in a company with 25% shares each, they may decide that this 25% will ‘vest’ over a 5 year period. This means that if one of them leaves at the end of the 3rd year, he/she will get only 15% equity and the rest will be shared between the remaining founders. This can be documented and formalized.

 

 

Should a start-up outsource Software/App Development?

If coding/ development is not your core competitive advantage or the driver of your business you’ve no resource capabilities and time for that, then you better outsource it to some good firm, specialized in serving start ups.

However if the technology is fairly off-the-shelf development, say wordpress customization or a standard shopping cart application, then it might make sense to outsource it to a firm which specializes in that area.

But being a start up, do a lot of scrutiny and analysis of the company you are going to work with, remember outsourcing is not a simple customer-vendor relationship, it is more of a partnership, and an engagement which is based on mutual trust, needs understanding, and team approach.

Also it depends on the startups expertise in managing outsourced projects. If it’s something you’ve never done before then it can be much harder to do it well.

But make sure that you are pretty clear with your specific project as well as business requirements before you outsource, and ask as many questions as you can if you are new to this; for example ask questions and details about proposed project management and planning to the payment modes, to the payment mediums, or calls/ meeting schedules and so on. The more clearly you share your expectations beforehand with your potential vendors, the more likely you win with a successful outsourcing campaign, and then you can reuse that.

Astartup is based on the vision of the founder(s). Success of this vision depends on how clearly the founder(s) is/are able to articulate his/her/their vision to the team including the developers. Having a development team in-house constantly absorbing the founder(s)’ vision, and possibly even providing feedback to the founder(s), is invaluable.

Initially it may seem like a good idea because of the money saved on benefits that would normally be paid for a full time employee but if your startup will be doing any amount of coding, it’s not wise to outsource this function.
But, if you’re truly seeking the commitment of a team member, then outsourcing may not be the right step for your start up.

 

Startup should outsource if:

  • you don’t have any in-house talent in the first place and have found the ideal outsourcing partner: one you can trust like a member of your team. one that can scope your project and meet your vision. has a track record of delivering on time/on budget, can bootstrap an in-house team for future iterations..
  • you are in a hurry (it takes time to build a team)
  • you don’t want/can’t commit to the long term cost of an in-house team too early or your product once built won’t require the same level of talent to maintain
  • you own the code/IP outsourced and can bring it in-house at any time
  • your tech lead is used to dealing with outsource partners

Startup should hire if:

  • you have a tech lead that already knows how to build software in-house (processes, environments, etc…) and is good at finding top engineering talent
  • you have the money and time to hire and equip the team
  • your product is going to grow in complexity and will require long term in-depth expertise that is hard to pick up
  • your vision of the product and its purpose are not settled (ie. you need a lot of prototyping)
  • your startup is all about software

Is it prudent to consider SAAS platforms for startups?

SAAS or Software As A Service platforms like MartJack, Shopify, etc. provide a quicker and far less expensive way to test your concept. However, many of the SAAS platforms may not be appropriate as your business scales up. The most common reason for not using SAAS platforms is because by its very nature platforms are ‘generic’ and not ‘custom designed’ for your needs. I.e. you may have to live with some of the limitations, or forgo some of the features that you needed.

As always, your decision should be a well-thought out with pros and cons debated thoroughly, and the final decision should be taken purely on the business needs.

In the 2011 and 2012 time period, we have seen a number of e-commerce players using the SAAS platform to launch quickly, get traction, build the foundations of their business – indlcuing customers, and then raise the next round of funding to build a more robust and customized product.

This startegy also allows the startup to test the concept, understand better their tech needs as well as gather the resources to build the most appropriate tech platform. Of course, it allows them to launch faster.

However, if the tech platform is going to be the core of your business, obviously a SAAS solution may not work.

 

Selecting your investors

Startups are usually not in a position to be choosy about whom they can accept funding from, and quite often after a number of rejections end up taking money from whoever willing to fund them.

 

However, while signing up your investors, it is critical to check the following:

  • Will you enjoy working with them? While this is a difficult one to take an objective view on when you really, really need their money, it is a critical question to ask. Attitudes to investee companies, style of working, matching of personalities are critical components in ensuring that investor & investees enjoy working with each other. In startups, in my view, it is ideal that the founders and investors can have a friendly relationship. And this does not mean not being professional… but an easy going, non-formal style of working is helpful in a startup stage when things are not going to be as predictable as they are in a growth stage company.

 

  • Is the personality, ethics, value system, aggression, compassion, etc. of the investors in line with the personality of what I want to build. Different people have different styles of operating and if these styles are in conflict, it may lead to disagreements in how you handle the business, especially how you tough situations.

 

  • What’s their outlook to your business and are they willing to wait out the difficult times? While your investors and you may agree with the potential, some investors have a ‘spray and pray’ approach. I.e. they invest in many companies, especially in emerging sectors, and see which ones quickly show signs of success. They are quite happy then to disengage with the slow movers and back the early-successes. In such situations, if your startups does not really take off as expected, and most don’t, you may be left in a corner.

 

  • Do they have experience of working with startups at your stage. There are clearly different investor groups who specialize in different stages of the company. Angel investors will invest in the concept stage, early-stage VCs will invest in the post proof-of-concept stage and VCs/PEs will participate in the scaling-up stage. Different stages of a company require different competencies and therefore different interventions from the investors. Investors who usually deal with growth stage companies may not have the patience or experience in dealing with the nimbleness and direction changes that a startup may have.

 

Of course, it helps to connect with companies that the investors have funded and understand about their experiences with the investors.

 

 

 

 

 

Managing investor relationships

Companies with a healthy relationship with their investors are happier companies. Unhealthy relationship between investors and founders can be quite stressful. That’s why it is critical for startups and their investors to work as a team and be on one side of the table.

While some responsibility of ensuring a healthy relationship is obviously with the investors, founders have a critical role to play in this process.

Clarity on goals and objectives

The starting point of course is to ensure that your investors and founders are aligned on the goals & milestones and objectives of the company, and the parameters on which progress is to be measured.

Agree on the communication and intervention processes

Getting investor agreements on the periodicity and format of reporting and engagement is helpful in ensuring that the intervention is structured and planned. A monthly review is suggested for startups, though in concept stage companies founders may benefit from the experience and the business relationships of investors and hence may engage more frequently.

Communicate early on challenges and issues

No one expects to have a smooth journey and challenges and roadblocks are part of the journey. Your investors are critical stakeholders in your progress. Hence, if there are challenges and issues, often investors can assist with solutions. Communicate early and be transparent.

Reporting and templates

Investors and founders should agree on the format for reporting progress. Information that captures the key parameters should be drawn and presented every month to investors.

My suggestion is to provide a short summary of the health of the venture, capturing critical aspects that will be relevant to investors. I would suggest the following:
  • Overview – a one-para summary of what has happened since the last interaction (e.g. on product, customers, people, brand, etc.)
  • A para on how the business is progressing as per the plan (including what is working well, and what is not progressing well – could be on customers, pricing, costs, people, cost of servicing, etc.)
  • Highlight challenges or red flag any thing that you see as issues
  • Outline what you wish to achieve in the next month (I have noticed that investors may not pay too much attention to this para, as usually it is transactional and mundane. However, if it is not there, it usually creates discomfort. Just having even the regular stuff in this is reassuring that all seems to be well.)
  • If needed, seek assistance in any area that they can help
Another reason why I think a good, crisp report every month is a good idea is because it allows you to also reflect on the progress and helps you identify red flags for yourself earlier too.
In most cases, investors want to help. These type of reports provide investors a good view of where they can help, and allows you to seek out their support when and where required.

 

Have formal board meetings, including structured meetings with your advisory board members

Apart from it being mandatory governance requirements, quarterly board meetings are a good forum to engage with a wider group of stakeholders where progress, challenges, issues and direction changes, if any, can be discussed.

Understanding valuations

Simply put, valuation is about how much the shares of your company are valued at.

In a private limited company, ownership is decided on the basis of equity shares. The % of shares you own defines the % of your ownership of the company. 

Let us understand with an example. I am of course over simplifying for the purpose of ease of explaining and understanding.

 

Ramesh and Suresh start a company. They both own 50% each of the company.

 

A few months later, Ramesh and Suresh approach an angel investor who decides to invest Rs.50,00,000 [INR 50 lacs / USD 100,000] in their company for which he takes 20% of the company. In this scenario, the post-money valuation of the company would be Rs.250,00,000 or Rs.2.5 cr [USD 500,000]. This is because Rs.50 lacs got the investor 20% equity, so the value of 100% is Rs.250 lacs or Rs.2.5 cr.

 

Stated differently, the company got a pre-money valuation of Rs200,00,000 or Rs.2cr [USD 300,000]. In this scenario, Ramesh and Suresh now own 40% each in the company, with 20% being owned by the investor.

 

Later, the company decides to raise Rs.10 cr [USD 2 mn] from a VC who takes 20% of the company. In this scenario, the post money valuation of the company is Rs.50cr [USD 10 mn]. Stated differently, the company raised Rs 10 cr at a pre-money valuation of Rs.40 cr [USD 8 mn]. With this round, Ramesh, Suresh and the angel investor each get diluted by 20% and hence the capital structure or cap table stands as follows:

Ramesh                       32%

Suresh                        32%

Angel Investor             16%

VC                             20%

 

In both the rounds, the money invested by the angel investor and the VC has gone into the company and not to Ramesh and Suresh.

 

Going further, the company does well and the VC decides to increase their holding to 26% and offers to buy 6% of the shares held by the angel investor for Rs. 10 cr. [USD 2 mn]. Now, the valuation of the company is Rs.166 cr or USD 33mn. Even at this stage, when the valuation of the company is Rs 166 cr, Ramesh and Suresh have not made any money. However, the angel investor has had a successful exit with a 20x return on his original investment, and still retains 10% in the company.

 

At this stage, the capital table will look like this:

Ramesh                       32%

Suresh                        32%

Angel Investor             10%

VC                             26%

 

At a later stage, Ramesh and Suresh decide to dilute their holding and decide to sell 5% equity each to another VC for which each get Rs.20 cr [USD 4mn]. At this stage, the 2nd VC decides to also buy the 10% held by the angel investor for Rs.20 cr. Hence, now the valuation of the company therefore is Rs.200cr or USD 40mn, and the cap table will look as follows:

Ramesh                       27%

Suresh                        27%%

Angel Investor             —-%

VC                               26%

VC 2                            20%

 

This of course is a rather simplified version of reality, but done only to illustrate the concept.

 

 

What are preference shares and convertible notes with reference to angel investing?

Preference shares typically have attributes of both debt and equity instruments.

It resembles equity in the following ways :

  • Dividend on these shares are payable out of distributable profits
  • Dividends are not an obligatory payment and are entirely at the discretion of the directors
  • Dividends are not tax deductible payment

 

Preference shares are similar to debt in many ways :

  • Dividend rates are fixed similar to any debt instrument
  • In case the company goes into liquidation, the claim of preference share holders precede the claims of equity share holder
  • Preference share holders normally do not enjoy the right to vote

 

From the perspective of angel investors, investing through the preference share route provides the investor certain benefits without directly exposing to the risk of the equity shareholders who normally are the promoters. The investors have the comfort of getting a minimal return on their investment and a priority over the equity shareholders out of the liquidation proceeds.

From the perspective of the promoters of the company, the burden of servicing high cost debt is not there as the dividend on preference shares are typically not guaranteed and often lower than the cost of debt for an early stage company and in the absence of voting right, the promoters face minimal interference from the financiers in the regular management and operation of the company.

One can structure the instrument to include additional features such as accumulation of dividends, call option, convertibility to normal equity shares, redeemable such as in any debt instrument and power to vote.

 

Convertible notes on the other hand are structured as a debt instrument but comes with an option for it to be converted into equity shares on a given future date or within a specified time frame at a pre-specified price.

Angel investors find comfort in this instrument as it comes with certain advantages which are :

  • A fixed interest payment till conversion which is assured
  • The conversion price is normally at a discount to the estimated value of the company, hence the investor can take part in the upside
  • The conversion is normally at the option of the investor which gives the investor a protection from the downside

 

From the perspective of the company the promoters enjoy the following advantages :

  • The interest payment are at rates lower than a regular debenture because of the convertible feature which offers upside to the investor
  • As there are no voting rights attached, the company can operate with minimal external intervention.

 

How is the valuation decided for a startup?

Valuation is decided between the investor and the entrepreneur. At the early-stage/concept stage, there is no science or formula to arrive at a valuation. Hence, you go by generally accepted benchmarks in your country, and eventually conclude a deal at what the entrepreneur and investor feel is a fair valuation.

What valuation investors may offer for the same plan depends on a variety of factors, including the quality & experience of the team, the investors view of the potential of the concept, the competition, how easy or difficult it is for other competitors to enter the market, is there any IP or competitive advantage which this team has, etc.

In all this, the quality of the team is he most important consideration for investments at the concept stage or early-stages. The same business plan, with exactly the same details could get a very different valuation for a team of college students executing it than what an experienced team would get for the same plan.

 

Raising funds from angel investors

Angel investors are individuals who invest their own funds in early stage companies or startups, unlike VCs who manage the pooled money of others in a professionally managed fund.

 

Angel investors typically invest at the power-point or paper concept stage i.e. at the very concept stage of a company. In effect, they are taking a bet on the team and on their belief that the concept would work.

Angels would most likely invest smaller amounts, which is usually sufficient to cover the fund requirements for going past the proof-of-concept stage. Angel rounds will most likely be followed by rounds of institutional funding like VC and strategic investment or acquisition.

At the stage at which angel investors invest, the risk is the highest. This is because neither is the concept proven, nor the business model nor the team’s capability to deliver proven. Moreover, because angel rounds are usually followed by further rounds to fund the capital requirements for growth, angel investor’s equity in the company gets diluted in further rounds of investments.

Because their investments carry their highest risk and dilution,  the valuation offered by angel investors will be the lower than those offered by VCs in the subsequent rounds when the business has been significantly de-risked.

Often, angel investors invest in domains they are passionate about, and therefore bring invaluable experience to the startup through their participation as advisors and/or board members. Angel investors, apart from capital, are expected to help startups with advice, networking & introductions and oversight of business. Some angel investors also go to the extent of representing the startup in PR or meeting important customers or in interviewing potential senior employees. Most certainly, angel investors are expected to assist the startup in accessing institutional capital for subsequent rounds of funding.

How to find the right angel investors?

Apart from individuals who invest in startups, many angel investors are part of an angel investor network.

Angel networks help angel investor members co-invest in startups that have been shortlisted for presentation to angel investors. Angel groups not just review and shortlist startups from many proposals received, but they also help startups fine-tune their business plans, rework strategy and make the business case more compelling.

As angel investors, maturity in understanding the investment process, especially while dealing with challenging times during for the startup, is invaluable. Hence, even when you get investments from angels who are investing for the first time, it is prudent to have a co-investment from a more experienced angel.

 

Some points to remember when selecting angel investors:

  • Evaluate what the angel investor gets to the table in addition to capital: How willing is the angel investor / angel investor group willing to assist you in your entrepreneurial journey. But do remember that this can be a double-edged sword. You want the advice and guidance, but do not need operational interference.
  • Does the angel investor’s vision match your vision, aspirations and goals: This is critical as a mismatch in goals and vision could lead to conflict on the direction the company could take.
  • How ready is the investor to lose his investment: This is a critical point. Angel investments carry the highest risk, and most angel investments are not even able to recover their capital. While you would aim for the best outcome, the angel has to be prepared for his capital to be fully wiped out. Hence, it is important that the angel investor understands that they should invest only as much as they can comfortably lose.
  • What is the network of the angel investor with the institutional investors i.e. VCs: Angel investors with deep connections with investor groups and investors are great help while raising the next round of capital
  • Do the paperwork well: even if it is limited paperwork, and significantly lesser documentation than would be required in an institutional funding round, do evaluate the term sheet carefully. Even if the angel is not keen on proper documentation, do insist on completing the paperwork. This is especially true in the case of a friends & family round when the paper work tends to get ignored.

 

 

WHAT SHOULD A BUSINESS PLAN COVER?

A business plan is a ‘Plan for your Business’. It is not a document that you make for the investors. It is a document that you should prepare for yourself. Writing down your business plan helps you think through the assumptions clearly, and often writing helps you identify impracticalities in the through process.

businessplan

 

 

 

 

 

 

 

 

Yes, for investor presentations too, a business plan is necessary. Broadly speaking, a business plan should communicate the following to an investor:

  • What are you selling and to whom?
  • How large do you see the company growing to – what is your own aspiration for the company?
  • How are you going to implement it?
  • How are you going to make money?
  • Why are you the right team for the investors to invest in ?

Your goal in the first presentation to an investor should be to help investors understand why your venture is a good case for investment.

The initial pitch presentation (this could be a ppt or a word document) should not be more than 12- 15 slides, covering the points mentioned below. At this stage, details and numbers are not necessary. At the preliminary stage the review committee, as well as investors, are keen to understand if the concept addresses a real opportunity, if the business case is strong, if the team is well rounded & competent & committed and the traction that the team has been able to achieve so far.

Components of a Business Plan

1) Cover slide

  • Company name and logo
  • Contact details (city, e-mail, mobile)
  • Url
  • One line that clearly describes the concept/product/service

2) Team

  • Highlight what will each member of the team do in the venture, and why he/she is best suited for the role
  • Indicate if the person is a co-founder or founding team member or an employee – against each, indicate the % of equity held (currently or planned if not yet distributed)

3)  What is the issue / pain point that your product / solution addresses

  • Explain why your customers need your solution
  • Mention what they are currently doing and how your product/service is a better solution

4) Product / Technology Overview

  • Highlight the uniqueness of the product or service or technology and NOT the technical details of list of features of the solution 

5) Business model

  • This is about how you will make money from this business opportunity.
  • This is NOT the excel sheet. In simple terms, this is about who will pay how much and to whom for you product

6) What is the size of the market opportunity?

  • Be clear about who and where is going to buy your product/service and how much they would pay for it.
  • Mention the size of the opportunity in the markets you are planning to address (e.g. In India, there are ____ number of parents who will buy our service at Rs/$_____ per year. This translates into a market potential of Rs/$_____ per year. In year 3, we plan to tap US and Canada, and the size of the opportunity there is Rs/$_______ (No. of parents ______ x Price per year_____)
  • This section is NOT about what your plans are, but about what the size of the market is. This section should therefore give a sense about how many customers are there in your target market and at the price that you are selling your product at, what is the revenue potential if all of them were to buy (not that they will, but this is to give an indication of what the size of the market is) 

7) Current traction

  • What have you achieved so far – product, customers, revenues, etc.
  • If you have, include photographs (e.g. if you have physical stores or products that you manufacture or office pictures). 

8) Competitive landscape

  • Who are you currently or in future likely to compete against and what is your plan to win this battle?
  • Explain why this is better than competition (a comparison chart is usually not seen seriously by investors because all presentations tend to show a comparison chart that will be favorable to your solutions/product)

9) Financials current and projections

  • Summary of your business plan excel sheet for 3 years (Note: the detailed excel sheet is NOT required. Just key figures at annual level for 3 years is sufficient for the preliminary evaluation. If there is sufficient interest from investors in the venture, then we will evaluate your excel sheet and business case in detail)
  • Break up your costs into Capex and Opex (In Opex highlight major cost components – salaries, marketing, etc.)
  • Cover the unit economics i.e. how much revenue do you get per transaction/customer, how much does it cost you to service that customer/order

10) Funding needs, use of funds and proposed valuation

  • Describe how much money you want to raise and what these funds will be used for
  • Mention if there are other co-investors (or others who have already committed)
  • Clearly indicate how long these funds will last and what you will be able to achieve with these funds (E.g. This investment of $______ will last us for _____ months. With this, we will be able to get to _______ customers and _______ in revenues)
  • Clearly mention if you are going to require follow on capita, and if so, how much (e.g. post this, we will raise a Series A round of $ _______ )
  • What is the valuation you are seeking for this round

11) Current equity structure, fundraising history and investors

  • Table of current equity holding (cap table)
  • How much money have you invested
  • Mention previous investment history including year, amount and investors.

12) Exit options

  • How do you think the investors can exit (i.e. who will buy their equity or do you feel that this can be an IPO)
  • IF you can, give examples of exits in your industry (or comparable examples)

 

Understanding the concept of Exit Options

Exit Options is nothing but different ways through which investors can ‘cash out’ of an investment. To understand the concept of exit options, let us understand how Venture Capital works.

Angel investors, VCs and Private Equity Funds buy equity in a company when they make an investment. I.e. they buy shares of the company at an agreed price. Let us say they buy 100,000 the shares of the company as a per share price of Rs.100. Investors make this investment NOT to earn dividend but to have substantial gain through increase in the value  of the shares that they have bought.

Over a period of a few years, depending on the outlook of the investor, the investor would want to ‘cash out’ of their investment. For this, they will have to sell their shares to someone else. Who all they can sell the shares to are what is called the exit options.

Typically, there is a hierarchy of exit possibilities. i.e. angel investors, who invest in the earliest stage of the company, typically seek an exit by selling their shares to VCs who invest when the company’s concept and business model is proven. Often VCs would get complete or partial exits by selling shares to another VC who invests in the company after the company has gained some traction and needs further capital to scale up.

 

In addition to selling shares to the next round of investors, the following exit options are available:

  • Sale to a strategic partner e.g. a travel services company may sell stake or be acquired by a large travel portal
  • Sale to a bigger brand in the space: e.g. a local online food ordering site may be acquired by a global brand when they want to enter that market
  • Of course, going IPO is an aspirational exit option for many
  • Buy back: When the promoters or company buys back the shares of the investors. This is the least preferred option for investors and is usually used when the company is not able to provide any other exit option to the investors.

What you need to know about a business plan

  1. A biz plan is not a product. It is a process.
  2. Entrepreneurs have to understand the business dynamics around the concept. Just domain expertise without understanding of how business works is not enough.
  3. Investors are interested in ‘how you will do what you intend to do’, rather than just knowing what you are planning to do.
  4. Business model is about ‘who will pay how much and to whom and for what’
  5. The quality of your business plan is dependent purely on the quality of your assumptions. If your assumptions and logic are incorrect, no amount of great planning will help.

Should you write the executive summary first or last? Why?

The executive summary is a summary of your business plan. Hence, it is to be written last.

 

Here’s my suggestion on working on a ‘business plan’.

  • Start with a ‘story’ – ‘See the film in your mind’ about your venture – what do you want to do, how large do you want it to be, what will make you happy, what are your aspirations, etc. Imagine it as a business a few years down. This gives you a good view of ‘what you want to aim for’
  • Work out rough milestones and goals: Your long-terms goals and aspirations should then be broken into short-term and long-term milestones, which are the stepping-stones to your eventual destination.
  • Think deeply of how you will implement it: This is the critical aspect of planning your implementation. This also gives you a view of the cost structures, the infrastructure & people needs, processes, etc.
  • Work out the ‘structure’ of an excel sheet: Now, after you have done the thinking, it is time to use an excel sheet to evaluate if there is a business case in what you plan to do. Before you start entering numbers, work out the ‘structure’ detailing every cost head and revenue stream.
  • Start working in the excel sheet – assumptions are critical: An excel sheet exercise with the wrong assumptions is going to give you a very wrong direction, and perhaps wrong hopes. Be realistic. Be conservative.
  • Work on multiple ‘scenarios’: Life does not play out the way you plan it. Real life situation will be different than your excel sheet plans. It is therefore essential for entrepreneurs to work out multiple scenarios to see how the business will pan out under different outcomes.
  • Finally, articulate it into the ‘presentations’: Once your ‘Business plan’ is ready, you then articulate it into different presentations. Even an executive summary is one articulation of the B-plan. You can have an executive summary for introductions, a 8-10 slide ppt for first meetings and more detailed documents and presentations for follow-up meetings where specific details are going to be discussed.

 

Should startups seek funding from VCs or Angel Investors?

While there is no right or wrong answer to this question, there are a few points you may want to consider:

Most VCs would not invest less than USD 1 mn. So, if you need lesser than USD 1mn capital, angel investors may be more appropriate.

Decision-making is much longer for a VC as they have to follow their own processes and internal approvals. It can often take between 30 – 90 days after the VC has broadly agreed to invest. On the other hand, since angels are making investments in their individual capacity, decision making is faster.

Most VCs are likely to ask for some control over decision-making, and most would certainly ask for board positions. Angels on the other hand may not seek board positions.

VCs may not be able to participate closely with the operations, while angels who invest because of their interest in the domain may find great joy in assisting you with your daily challenges. Depending how deep your team’s expertise on critical aspects of your business are, you may want to consider whether you want someone who can help you on the operational front or you need someone who is hands off.

VCs and Angel investors are ‘expected’ to give you different kinds of advice. Angel investors, because of the stage they participate in are expected to help you with the fundamental of the business at the starting point and guide you through the ‘setting up’ stage. They are also expected to help you with advice on what kind of investors to connect with, how to pitch and, often, help with the introductions too. On the other hand, VCs, because they usually participate after the concept is proven, are expected to give entrepreneurs advice on scaling up and of preparing the company for scale, fine-tuning the business model if required. They could also help with introductions, PR and in hiring senior employees.

Most importantly, VCs usually invest after the concept and team have been proven. I.e. after market validation of the idea and after the team has demonstrated that it can deliver. Angel investors invest at a paper/power-point stage and give just enough money to prove the concept.

So, when seeking investments, evaluate what your needs are and what your situation is and then decide if you want to approach VCs or angel investors.

 

Angel investors, VCs and other funding options for startups

While most entrepreneurs think of VC funding as the most obvious way of funding their startups, there are actually many different ways in which you can fund your startup.

 

Getting risk capital i.e. angel investors or Venture Capitalist – VCs

Angel investors or VCs are investors who give you capital in exchange of equity in the company.

Angels and VCs buy equity in a company for a price and expect to make a profit by selling it at a higher price. Just like it happens in the stock market, but in this case because your company is not listed, VCs make money by privately selling the stock they hold in your company to someone else.  E.g. an angel investor may ‘exit’ by selling his/her stock to a VC and later the VC could exit by selling the stock they hold to either a Private Equity firm or to a strategic investor, or in rare cases by diluting their holding during or post an IPO.

The money that angel investors give is collateral free. I.e. you do not have to mortgage your house or something to get money from angel investors of VCs. In case the company fails, investors lose their capital and entrepreneurs do not have to return the capital. This is the one and only reason why angel investors and VCs will evaluate plans thoroughly before making a decision to invest in a company. In effect, they are taking the following risks about your venture:

  • That you and your co-founders are a great team that is capable of scaling up the business
  • That your concept will work
  • That the market is large and therefore there is potential to build a large company

Because of this, funds raised from angel investors, VCs and later from Private Equity funds is called ‘Risk Capital’.

While angel investors and VCs provide capital without collaterals, and thus allow you to start up without having your own capital or collaterals for a loan, it is probably the most expensive form of capital. That’s because you are giving away equity in exchange for the capital you raise.

Let us understand this with an example. I am of course, simplifying and exaggerating for easier understanding, but the principle is correct.

Let us assume company A raises INR 10 lacs [i.e. USD 20,000] from an angel investor and gives the angel investor 10% equity in the company. Assume further that this company is able to successfully scale up and is receiving a INR 5 crore [USD 1 mn] funding from a VC for a valuation of INR 20 cr.  [USD 2 mn].  Assume that the angel investor exists at this round by selling his stake to the VC. In this scenario, the VC would get about INR 1.5 cr for his/her share holding in the company. The illustration below gives a sequential view of the capital structure of the company after every event i.e. when the angel invests, when the VC invests and finally when the angel exits by selling his/her stake to the VC.

Share holding at starting Phase
Entity

 Investment

 No. of shares

Price per share % holding
Founder

 1,00,000

 50,000

2

50%

Co-founder

 1,00,000

 50,000

2

50%

Total

 2,00,000

 1,00,000

 

100%

Share holding after angel investor invests INR 10 lacs and takes 10% equity
Entity

 Investment

 No. of shares

Price per share % holding
Founder

 1,00,000

 50,000

2

45%

Co-founder

 1,00,000

 50,000

2

45%

Angel investor

 10,00,000

 11,111

90

10%

Total

 2,00,000

 1,11,111

 

100%

Further, a VC invests INR 5 cr and takes 25% of the equity
Entity

 Investment

 No. of shares

Price per share % holding
Founder

 1,00,000

 50,000

2

34%

Co-founder

 1,00,000

 50,000

2

34%

Angel investor

 10,00,000

 11,111

90

8%

VC

 5,00,00,000

 37,037

1350

25%

Total

 2,00,000

 1,48,148

 

100%

If the angel investor sells his/her shares to the VC, then the VC would have paid the angel investor a sum of Rs.150,00,000 i.e. Rs.1.5 cr to buy the angel investors shares in the company. The capital structure of the company would be as below.
Entity

 Investment

 No. of shares

Price per share % holding
Founder

 1,00,000

 50,000

2

34%

Co-founder

 1,00,000

 50,000

2

34%

Angel investor

 10,00,000

VC

 6,50,00,000

 48,148

1350

33%

Total

 2,00,000

 1,48,148

 

100%

Bootstrapping

Bootstrapping is the art of going as far as you can without external funding. I.e. pooling together your own resources, usually at a pre-concept stage or at a prototype building stage.

Often, people bootstrap their startup while still keeping their job at some. Whether you should bootstrap or go for external funding is a factor of how much money you need, and for what. I.e. if you are building a solar micro-grid, it is unlikely to be funded through bootstrapping as it is likely to be a capital-intensive business. However, on the other hand, an e-commerce venture can most likely be bootstrapped… often by using SAAS platforms, etc.

When to bootstrap

  • When your concept is yet to be proven … and can be proven with limited capital
  • When you too are unsure if you would like this to be your lifetime career and want to give it a shot
  • When you have the resources to go past the concept proof stage

 

When not to bootstrap

  • When the capital required for the proof-of-concept stage is more than what you can garner from your current resources

Even when you don’t need the capital, it is sometimes good to pitch to investors as it gives you a good feedback on your concept. If many investors say no, it may be worthwhile evaluating the concept and pan thoroughly before diving into the game.

You may want to consider the points below before you take the decision to bootstrap:

  • Evaluate whether your idea has a good business case – speak to some experts, pay attention to those who are not excited about your idea. After all, even if it is not costing you a lot of money, your time invested has a lost opportunity cost.
  • Prioritize: to bootstrap efficiently, you need to make your limited resources go far. Take a call on what is critical and what can be put off till you receive adequate capital.
  • Keep the expenses side as low as possible. That means having a very, ver lean team. That means hiring multi-taskers rather than specialists.
  • Consider SAAS and outsourcing: Even if that is not your most preferred option, you should take a call on what is important. Is getting ‘something’ out in the market more important or getting ‘The most perfect product’ most important? SAAS platforms may not give you the customization possibilities, but often they can shave off a significant percentage of your funding needs. You can always develop your own platforms after you have proven the concept and the model.

 

Debt

In other words, taking a loan.

Institutional loans often require a collateral, which many entrepreneurs may not have. Even if you have the collateral, do a real hard evaluation if the business model and concept is fully ready for you to take an individual risk on. Often, getting other external investors gets you more parties to take strategic decisions with, and provides an invaluable group to bounce ideas with.

 

Friends & Family round

For startups which need limited capital to start up, a friends & family round may be an option worth considering.

Points to remember in a friends & family round

  • Treat the friends & family round as a formal fund raising round too – pitch to the interested investors as you would to a group of angel investors or VCs
  • Complete the paper work and other formalities too – issue equity shares
  • Manage the relationship as a professional investor relationship – send quarterly reports, have a board, etc.

 

Get strategic investors

  • Larger companies for whom your concept is an adjacent or related opportunity may find it interesting to investing as a strategic investor.
  • Adjacent opportunity – e.g. Educational content platforms could be an adjacent opportunity for a large company in the education space
  • Related opportunity – e.g. healthcare services for the poor is a related product for a microfinance company
  • A strategic investor, apart from providing capital, also helps validate the concept for external investors thus making it easier for raising the next round of funding or for getting co-investors in the current round.

How much money should you raise for starting up?

Obviously, this depends on the nature of the business, what is required to be done, your and your team’s capabilities, the competition, etc.

There is no one ‘real number’ on the investment required as that number would be different not just for different businesses but also would be different for different execution strategies for the same business plan.

In fact, there are startups in the online space which have done excellent progress with some angel investments, while there are others which are scaling up nicely with crores in funding, largely for marketing investments.

Broadly speaking, concepts that have been proven and just need great execution + marketing to build a scale business will need to raise larger capital. Concepts that have yet to be proven in the market place could do with lower levels of funding in the initial stages. This is because you don’t need senior employees and huge marketing at pilot or proof-of-concept stages.

What is essential therefore is to have a realistic estimation of the costs and investments required to reach the milestones.

Most often entrepreneurs go wrong in estimating funding needs. They are unrealistically conservative on costs, and impractically optimistic about revenues. Underfunding your venture i.e. raising lesser money that is practically required can have serious consequences as you could run out of cash sooner than expected, thus leaving you without capital to continue the venture… or having to rush to raise another round in a distress situation.

One question investors are most likely to ask you is how much money you need in the round that you have approached them for. While most entrepreneurs give a one-figure reply, my preference is for entrepreneurs to provide a perspective of what can be achieved with different levels of funding. E.g. with INR 50 lacs [USD 100,000] you could develop the solution on a SAAS platform, hire a base team, prove the model in one market and prepare the company for scale. However, if you had INR 200 lacs as a commitment, even if the first tranche was the original INR 50 lacs, you could accelerate the hiring and scale up as soon as the key performance indicators were on the right trajectory. On the other hand, if you got just R. 25 lacs [I.e. USD 50,000] you would just develop the product, outsource the online marketing to an aggregator agency, and prove that the concept works.

You need to bear in mind that if you business is successful, you are most likely to need MORE CAPITAL. Most entrepreneurs assume that very quickly their business will be cash positive and that they are not likely to require more capital beyond the first round.

Working on a realistic business plan is therefore critical in determining how much money you are likely to need for your venture.

 

 

 

 

 

 

What should be the answer to “What if Google builds the same product as yours tomorrow”?

The right answer for you is the one that YOU have identified for yourself. If there indeed is a possibility of Google doing what you intend doing, then as a part of your own risk evaluation you need to identify what your response could be.

In a few cases, the answer was “Well, if Google really wants to get into this business, they would be the first one that they should try to buy.”. And that would work well with investors !!!

How do we know that we are ready to launch a start up with a product or service?

There is a saying “If you have 10 hours to cut a tree, spend 8 hours sharpening the axe”.

Similarly, launch when you know you have all the competencies and the resources required to run the business. I.e. when you have worked out your business plan, evaluated the business case, spoken to customers and are convinced that the value proposition makes sense to them, when you have tested the product, when you have understood the dynamics of marketing & sales, when you have evaluated the cost of acquiring customers, when you have identified – and some what validated – all the assumptions that you have used in your business plan…. that is the time when you are ready to launch. And of course, you need to ensure that you have the required capital to sustain the business till you either (a) hope to become self-sustaining of (b) when you hope to raise external capital – whether as a loan from banks/family/friends or as risk capital from angel investments/ VC/family & friends.

HOWEVER… despite all this, and even after you are ready, you will have to evaluate what is the best time to launch. E.g. if you are selling something to schools which they will use in their classrooms, launching in the middle of a school term may not be prudent.

5 mistakes to avoid when pitching to investors

With most VCs, you will get just one chance to present your business case. VCs are usually a skeptical lot because they see a lot of bad presentations.

Here are some mistakes to avoid when pitching to investors

  • Poor assessment of the risks in your venture: All businesses have competition. VCs are not looking for businesses without risks… in the businesses they are in tested in, they are looking for teams who understand the risks and have a plan to manage the risks.
  • Poor assessment of the competition or assuming that there is no competition: If there is no one else doing what you are doing, how are the consumers currently solving the problem? E.g. in a online food ordering business, just because there is no other brand dos not mean that there is no competition. ‘Calling up the restaurants using menu cards available at home’ is your competition.
  • Exaggerating management strengths: Remember, most VCs will do due-diligence… and most are experienced enough to know what is practical and what is fluff. E.g. for a professional with 2-years experience to claim “In my role as Client Services Manager I was responsible for formulating strategy and operations planning for fortune 500 clients” is usually not going to be an accurate representation of your role. However, “was involved with” instead of “was responsible for” is perhaps closer to reality.

Also, giving the right picture of your current skill sets and capabilities helps investors understand what assistance they may need to bring to the table, in case they decide to invest.

Investors are not looking for ‘we know all and we have been there done that’ teams… those are rare to find. Investors are interested in honest teams who are passionate about the domain and are smart enough to learn the things that they currently don’t know.

  • Impractical and unrealistic growth projections: While aspiring for scale is important, planning ‘how’ you are going to achieve it is critical. Without a plan, aspirations of scale are merely a statement of intent. Investors invest in a team with pans… not just on statements of intent.
  • Don’t include names of ‘advisors’ if they are not genuinely involved. Plain show & tell names just because you know a few people don’t impress investors.

 

The process of pitching to investors

Often first-time entrepreneurs underestimate the time it may take to raise funds for your startup. Unless you get seriously lucky or have easy access to a number of investors, it is prudent to estimate anywhere between 3 – 6 months to get funded. And that is if you have a good plan and a great team.

 

Well, its relatively easier with angel investors and much easier with angel groups like the Angel Investors Consortium. That’s primarily because they invest smaller amounts in a wider range of companies but also because individuals are making decisions and hence do not have to go through more complex processes of VC funds.

 

Here are a few steps that are involved and approximate time it could take with institutional investors:

Step 1 Identifying the right investors 2 weeks
Step 2 Getting the first meeting, including time taken for trying to reach someone to get meetings set up 1 – 2 weeks
Step 3 Meetings with the evaluation team 1 week
Step 4 Presentation to Investment committee 2 weeks
Step 5 Term sheet 1 week
Step 6 Term sheet agreements 1 week
Step 7 Due diligence and signing of documents 1 – 2 weeks
Step 8 Funds hit your bank  

Total time

9 – 12 weeks

 

Here are a few steps that are involved and approximate time it could take with institutional investors:

Step 1 Identifying the right investors 2 weeks
Step 2 Getting the first meeting, including time taken for trying to reach someone to get meetings set up 2 – 4 weeks
Step 3 Meetings with the first layer of filtering 2 weeks
Step 4 Meetings with the senior layer 2 weeks
Step 5 Internal presentation to Investment committee 2 – 4 weeks
Step 6 Term sheet 1 week
Step 7 Term sheet agreements 2 weeks
Step 8 Due diligence 2- 4 weeks
Step 9 Signing of documents 1 week
Step 10 Funds hit your bank  

Total time

16 – 20 weeks

And these are fairly optimistic timelines with the investors who finally fund you. There will be several you would meet who may, out of genuine interest to invest, progress the discussions but may not conclude the deal for several reasons. And there will also be many who may decline to invest in the first meeting itself but still it will have taken 4 – 8 weeks to get the “No” as an answer.

 

Given the lengthy process, the entrepreneur should try to be selective about which investors they should approach. Investors, especially VC funds are clear about the kind of companies, the stage and the domains they would invest in, and that information is usually available on their websites.

 

One of the first things that entrepreneurs need to do is make a shortlist of who the ‘right’ investors would be.

  • To begin with, you need to decide if you are ready for angel investors or for VCs. Click here to know more between VCs and Angel Investors.
  • When applying to investors, check their websites and see if they have invested in businesses similar to yours and if your domain is within their interest areas. E.g. if you are a life-sciences company, there is no point in approaching investors whose focus areas are Mobile & Internet and Consumer Businesses.
  • Check if there are synergies between any of their portfolio companies and your business, and if there are, then evaluate highlighting the same during your presentation.
  • From among the many people at the VC, identify who in their team is more likely to be excited about your idea. This is easy to find because most VCs will have profiles of their team members, including details of which companies or domains that person is involved with.

 

Once you have identified the investor, and the person who you are going to connect with, try seeking an appointment by making a call to the office. Most likely, you will be asked to send the presentation to a generic mail id used for receiving business plans. Well, this is not something that you can always avoid. The truth is that investors get so many calls and mails requesting for meetings that it is almost impossible to accept all requests.

In most VC offices, business plans received will be reviewed with some level of seriousness, though most probably by the junior most executives who may not necessarily be experienced at taking a gut feel call on what seems like a good business case. If you are lucky to get past this stage, you will be asked to come and meet an associate. And that’s just fine. This is the first line of filter in a VC fund and an associate is expected to do a thorough evaluation based on their internal criteria, and then if and found suitable, are expected to move the deal up to a partner who can decide if the deal is to be presented to the investment committee.

If you pass the first line of filter in a VC fund, and this can take a few meetings, you would have to present to the next level. This round, depending on the interest of the fund, could take a few meetings with revisions and discussions on strategy, scale, funding needs, etc.

Once there is broad agreement on key areas, and if the deal fits into the internal criteria of the fund, the deal will be discussed at the investment committee meeting where the terms of the term sheet will be outlined.

After presenting the term sheet, the entrepreneur is expected to run it past someone who knows the legal stuff around term sheets…. And when you ask someone’s opinion, the person feels it obligatory to suggest a few changes. It then takes a few meetings and discussions to finalize the term sheet and sign off.

NOTE: some VCs would discuss the terms of the term sheet offline over meetings and dinners, and therefore the draft presented to the entrepreneur on which there is an informal agreement on key points like valuations, control, vesting, rights and downside protection. However, the time taken would still be approximately be the same.

Once the term sheet is signed off, the due-diligence will start. Also, the startup may have to complete some tasks as part of the ‘conditions precedent’ and that could be things like filing for patents, getting an independent director on board, getting customer contracts signed, etc.

After all this is done, the final signing of the documents and receiving the cheque are the logical next steps.

 

Why do early stage investors not invest in a company’s later stage rounds even if the company is successful?

Well, different investors participate in different stages of a venture. These stages carry different risks, apart from being different in the amount of capital consumed.

At the very beginning, which is where angel investors or seed stage investors participate, is the highest risk-stage of the venture. I.e. at this stage the venture carries a concept risk [i.e. will the concept/product/service work, will the business model work] as well as the execution risk [i.e. will the team deliver] and scaling-up risk [i.e. will this model scale and can this team scale it]. Angel Investors work closely with the entrepreneurs complementing the skill set gaps in the current team. The role of the angel investors, apart from providing capital, is to help the team prove the concept and the business model.

As the venture progresses and the concept and business model is proven, the venture needs to prepare for scale and that is when additional capital is required. At this stage, angels usually step back as the venture needs larger capital, which is usually got from institutional investors like VCs.

Institutional investors typically assist the company in building the foundations for scaling up – organization structure, processes resources, infrastructure, etc.

Post this round, capital is usually required for scaling up. This is the stage when growth stage VCs or PEs come in. At this stage, the model is proven, the teams capability to execute is proven and now the capital is required to significantly scale the operations, and perhaps explore new revenue streams, new markets, etc.

Therefore, in each of these three stages of a venture – i.e. concept stage, execution stage and scaling-up stage – different investors participate with different levels of involvement and different inputs required for these three different stages.

 

What do investors think of concepts with competing startups doing exactly the same thing as you?

Investors recognize that most concepts will have direct or indirect competition. In many cases, there will be a few other startups or established companies planning ventures that are fairly similar to what is being presented by a team.

Investors prefer honest answers, and the comfort of knowing that the team has indeed evaluated the competition and have some thoughts around how they intend to be one up in the game.

In some cases even a honest answer saying “Well, they are pretty similar to what we are doing. However, there is room for more than a few payers and we are glad that we do not have to create the market all on our own. We do however see us having a significant edge over them in the quality of the team.”.

What investors are not comfortable with are boastful claims with little substance to back it. We have often heard many entrepreneurs say “Oh, their product is just not as good as ours”. One should remember that while having a great product is certainly an advantage, having a better product is not necessarily a guarantee of success or leadership.

 

How should I pitch if investors don’t understand my domain?

Investors do not have to be domain experts in the companies they invest in.

Investors are keen to understand the business case for the concept/product/service that you want to introduce. Hence, the following steps help in setting the stage for your presentation of your business case:

  • Clearly articulating what problem your are solving or what opportunity you are addressing is important. This helps those who are not familiar with your domain get a sense of the opportunity.
  • Establishing ‘what’ it is specifically that you propose to do is critical. Often, this is the part where entrepreneurs ramble and have long winding speeches for. Instead, it is good to have a sharp, short one/two line pitch about what you intend to do. E.g. We plan to make the vaccination process convenient by creating a ‘vaccines-at-home’ service. Vaccines have a 40-50% gross margin and additionally we plan to charge a premium for home visit and the assured quality of experience.”
  • The next part is explaining ‘how’ you intend to do it. I.e. The implementation plan and what it would take to make this concept work.
  • The potential and the scale of your aspiration: Especially for investors who are not familiar with your domain, it is important for you to explain the size of the opportunity and how large you want your company to be.

 

What startup pitch phrases do investors hate the most?

I have 3 that stand out as most common:

 

  1. We have no competition: If there is no one else doing what you are doing, how are the consumers currently solving the problem? E.g. in a online food ordering business, if there is no other brand does not mean that there is no competition. ‘Calling up the restaurants using menu cards available at home’ is your competition.
  2. “We are cheaper, hence we have a stronger value proposition”: Well, in many instances what the entrepreneurs meant was that they will sell cheaper.. which is different than being a lower cost producer. And, at least in my observation, most often the assumption of ‘we are cheaper’ was based purely on being a smaller and hence leaner company and not based on any fundamental competence or process that allowed them to retain the cost advantage, if any at all.
  3. “According to Gartner, the market is USD 80 billion by 2015”: Now, this has no relevance to a startup. More so if any case all you were trying to achieve anyway was USD 10 – 20 million in revenues in 2015. Startups should build their model ground up and not top down. I.e. they should think in terms of how much it costs and what does it take to acquire and service one customer and hence what is the possible revenues within what you are trying to do.

 

Terms of a term sheet

Term
Simple explanation
Implications to early stage companies
Liquidation preference Liquidation preference defines how monies received on liquidation are going to be split between different classes of shares. [Just like different categories of creditors will have different rights in terms of liquidation.]The term sheet will specify what ‘preference’ the investor will get over ‘common stock’ owned by the entrepreneur/founders/existing share holders. E.g. the term sheet may suggest that, in the case of a liquidation, the investor will get 2x their investment before the balance, if any, is split between common share holders.

A liquidation preference may also allow the investor to instead convert their holding into the proportionate % of common shares and sell, if it is higher than the money they would get on selling at the price they would get if sold at the preference value.

In some cases, if the term clarifies, the existing investor may be allowed to convert to common stock and hold their holding. They would do this if they believe that the new buyers of the company will increase the value of their holdings.

Liquidation is not necessarily only if the company fails. It could be merger or a strategic sale or whatever. In these situation, what level of preference multiple is offered will decide what is left for the entrepreneur [and other common share holders] in case of liquidation.In case where the investor is allowed the option of converting to common shares AND holding on to their shares, it may casue issues with the acquirer if they do not see value in the investor holding on or if there is a strategic interest clash.

As with every other term, the negotiating power of an entrepreneur with a proven track record [professional career record or previous successful entrepreneurship experiences] wil be higher than the negotiating power of a relatively newer entrepreneur. In bad times, the prefernce multiples asked could be ridiculous.

Drag Along This term requires the minority share holders to sell their equity to an acquirer if a majority of the shareholders agree to a sale.To illustrate with an example, if an entrepreneur owns 40% of the company with 2 VC firms holding the balance 60%, if they decide to sell their stake, this clause will force the entrepreneur to also offload his/her shares, even if he/she did not want to exit. Implications are obvious. If the company does not do well and if the investors decide to bail out with whatever value they can realize, the entrepreneur would be forced to sell his/her stake even if they believe that there is merit in continuing with the venture.Sometimes an investor may want to exit because the venture [or the domain] does not fit into their strategic thinking any more. In this case, if the investor wants to exit, even if the going is good, the entrepreneur may have to sell his/her stake.
Preference shares Preference shares are shares that enjoy more previliges than common shares. These could be in availining dividends before common share  or preference share holders may also have greater rights to the company’s asssets and proceeds in the event of liquidation. Here too, the implications on the entrepreneur are based on multiple factors including the multiple of liquiditation preference, if it is included, etc.In most cases, simple preference shares which give an investor rights over assets in case of liquidation and dividends before common share holders are not considered unfair by entrepreneurs as it represents only a fair demand that the investor is seeking to protect his/her capital and the entrepreneurs acceptance indicates a high level of confidence in the venture to allow an investor to protect his/her capital.
Indeminity Well, this is a pretty straight forward one in which the investor who sits on your board seeks an insurance cover to as an indeminity cover should there be a legal case and the investor needs to protect himself/herself. Depends on how much protection is sought and how much the insurance premium is, and how that amout is in relation to the amount that is raised.I.e. the investor and entrepreneur need to evaluate if and if yes, how much, indemnity insurance makes sense. Especially if it is going to cost a lot and if the amount of capital raised is little.

Also, if the capital is raised for, say, concept testing where the exposure to liability is nil or limited, then it may not make sense to invest in insurance premium [again, if the capital raised is limited]

Anti- Dilution Anti dilution protects the investor’s capital in case the entreprenur decides to, for reasons of market conditions or strategic relevance or whatever, to accept capital from a new investor at a valuation that is lower than that at which the investor had invested.In a situation where a subsequent round is raised at a lower valuation, anti dilution right allows the company to revalue the original valuation and thus issue additional shares to the investor. This, in my view, is a fair clause and entrepreneurs should be condifent enough and acccept it. Fighting this clause would necessarily mean lack of confidence in estimating a higher value for the equity in subsequent rounds.

How to analyze why a startup has failed?

Startups could fail for a variety of reasons. I’ve tried to list a few that come to my mind:
  • The Concept was not relevant for the intended target audience i.e. was your targeting wrong? Could the concept have been more meaningful for a different set of customers (e.g. in a different geography, in a different age group, in a different income group, etc.)
  • The Product or service was not good enough or as promised i.e. was there an issue with the quality of the product or service? If customers were signing up but not retained, it indicates that the concept was relevant but the experience with the product or service was not good enough
  • The business model was not right e.g. for a services business could you have done a pay-per-use or pay-per-month basis instead of a one-time license fee?
  • Pricing was not right
  • Implementation was not right
  • Processes were not in place for the startup to scale up
  • The startup was resource starved – e.g. not enough budgets to market, not enough people resources to implement, etc.
  • Was the communication not good enough? Was the media plan not good enough? i.e. was the messaging through your brand communication material relevant, meaningful and compelling for your audience? Was the brand personality in line with what your customers expected?
  • Was the media planning not good or inappropriate? i.e. Media planning has two key components – reach and frequency. Reach is about how many people within your target audience you reach. Frequency is about how many times you reach those folks. E.g. for Rs.10 per CPC, with a budget of Rs.10,000, you could reach a 1000 people once, or you could reach a 100 people 10 times. Some concepts need reinforcing of the message, and hence higher frequency before customers convert. Analyze if your planning of media reach and frequency was right

FailureFeeback2

Analyze your experience on each of these points, or any other that you may think of, and evaluate what could have been done differently.

Pitching to investors

Apart from having a good business plan, which is of course the most critical thing, HOW you present your case to investors will determine whether you will get their attention and interest or not.

Because investors often listen to very bad presentations, good quality presentation itself offers a substantial edge while presenting to investors.

The most important thing to remember is that YOUR FIRST PRESENTATION IS AN ELEVATOR PITCH… NOT A FULL SCALE BUSINESS PLAN PRESENTATION WITH EXCEL SHEETS, TECHNICAL SPECIFICATIONS AND OPERATING DETAILS. In the first meeting, investors want to quickly judge whether they are interested in investing in the company.  Hence, the focus should be on communicating the concept and the potential and not the finer details.

Here are a few quick things to keep in mind

Start by introducing what you do and for whom… without any preamble

Investors will be interested in the details AFTER they have got excited about the concept, the scale and the team.

Hence, while presenting, ensure that your pitch focuses on what you intend to do, how you plan to implement it, how you will make money from it, what your scale of aspiration is and why you and your team is the one they should bet on. In fact, your opening statement should clearly state what you do and for whom. I.e. “we are an online music discovery platform where independent artistes upload their music and consumers buy or listen” or “we help small companies manage their sales processes”.

Most entrepreneurs make the mistake of diluting the pitch with a lot of detail of the operations, which of course will be of interest to investors… but only after and only if they have an interest in participating in your journey.

The initial pitch presentation should not be more than 8 – 10 slides. Click here to see template of the investor pitch presentation.

Investors are interested in the business case… not just details of the concept or the product

A concept and product is different than the business case for the same. Most first-time entrepreneurs make the mistake of thinking of the concept as the business. E.g. for someone presenting for a e-tailing venture, the investor would be interested in knowing your competencies or plans on supply chain, warehousing, procurement, customer acquisition, etc. Not just about how cool your web platform is.

One common mistake made by many first-time entrepreneurs is to elaborate on technical details. Technical details of your product/concept, and operating details will be relevant in the subsequent presentation… which will come about only if the investors get excited about the opportunity and you as a team.

Focus on key aspects rather than fluff around your business case

In most cases you will get a 20-30 minute window to present. You will have 10 – 15 minutes to make your case with 10 – 15 minutes for Q&A. In fact, in most cases, you would have either got their attention or lost them in the first few sentences. Rehearse your opening lines… once you get through this, the rest is the easier part. If you don’t get their attention and interest in the first few sentences, the rest really won’t matter that much.

“According to Gartner the market is 8 bn USD globally” has no meaning

At startup stage, investors are interested in knowing what you are going to do in the next few quarters. Of course, they would be keen to know whether the market is large and how large. But in most cases, industry reports on the size of the industry is no indicator of the size of the opportunity you are addressing.

You should focus on your plans and what you intend to get to in the next few years.

Be prepared with answers to questions

It is critical for entrepreneurs to know your business better than anyone else in the room. Be prepared with answers to questions, especially around assumptions about your business.

Know your business inside out. Know who the competitors are, know their business models, know the size of markets, know why consumers buy, know what the problems are with what your consumers are solving their problems currently with.

Explain why you are qualified to do this business

Investors are keen to know what you and the founding team brings to the table. So, a listing of your resume and career graph is not relevant. What is relevant within that is what you have done to make you a good candidate to pursue this venture. E.g. for an online retailing company, that “you have 11 years of professional experience in blue chip companies” is not as relevant as “I have handled supply chain and established relationships with vendors across the country” is important for investors to hear.

Be passionate. Early-stage investors, angels as well as VCs, invest in people

At the startup phase, investors are largely taking a bet on YOU and your team. They are betting on your ability to create a large company around the concept you are presenting. Hence, it is critical for them to see your deep commitment to the domain and your passion for the space.

Be clear about what you expect

Tell the investors clearly about how much money you need and what you intend doing with the money and what milestones you will achieve with the money that you are asking for.

End with a recap – end strong

Don’t end the presentation with slides of excel sheet numbers. End with a strong recap of what you have told them. Summarize what your concept is and say why this is a good business case.

Remember all the basics of good presentation skills

  • Few words per slide
  • Good looking slides attract attention – put some effort in designing the presentation well… at least it has to be clean and well-structured
  • Speak clearly and speak slowly
  • Be confident and passionate
  • Let one person present while the other handles the computers – don’t try to do all things together
  • Decide who will answer what questions
  • One person should present – don’t try to distribute the presentation among 2-3 co-founders – remember, the first meeting will be only 20 minutes or so. Others should participate in the post-presentation discussion.
  • Don’t go with an army of people if the others are not going to participate in the discussions – but ideally all co-founders should be present

Understanding term sheets

A Term Sheet is a document that defines the terms of the transaction between the investor and the company. It outlines terms for the following broad categories:
  • Valuations
  • Control
  • Exit options
  • Downside protection

 

While most first-time entrepreneurs are more focused on the valuations, the terms and conditions that cover the valuations are as critical. E.g. a company raising USD 100,000 at a pre-money valuation of USD 400,000 may not necessarily have a better deal than a company raising USD 100,000 at a pre-money valuation of USD 300,000 if the terms of the second company are more favorable than the first.

 

While there are several terms that will require understanding, here we have outlined a few that are of importance to entrepreneurs. Disclaimer: Please consult your lawyer when dealing with a term sheet. If you need any information, write to us at startup@applyifi.com and we will try to provide you answers.

 

 

 

Term Meaning
Liquidation preference Liquidation preference defines how monies received on liquidation are going to be split between different classes of shares. [Just like different categories of creditors will have different rights in terms of liquidation.]

The term sheet will specify what ‘preference’ the investor will get over ‘common stock’ owned by the entrepreneur/founders/existing share holders. E.g. the term sheet may suggest that, in the case of a liquidation, the investor will get 2x their investment before the balance, if any, is split between common share holders.

A liquidation preference may also allow the investor to instead convert their holding into the proportionate % of common shares and sell, if it is higher than the money they would get on selling at the price they would get if sold at the preference value.

In some cases, if the term clarifies, the existing investor may be allowed to convert to common stock and hold their holding. They would do this if they believe that the new buyers of the company will increase the value of their holdings.

 

Liquidation is not necessarily only if the company fails. It could be merger or a strategic sale or whatever. In these situation, what level of preference multiple is offered will decide what is left for the entrepreneur [and other common share holders] in case of liquidation.

In case where the investor is allowed the option of converting to common shares AND holding on to their shares, it may cause issues with the acquirer if they do not see value in the investor holding on or if there is a strategic interest clash.

As with every other term, the negotiating power of an entrepreneur with a proven track record [professional career record or previous successful entrepreneurship experiences] wil be higher than the negotiating power of a relatively newer entrepreneur. In bad times, the preference multiples asked could be ridiculous.

 
Drag Along This term requires the minority share holders to sell their equity to an acquirer if a majority of the shareholders agree to a sale.

To illustrate with an example, if an entrepreneur owns 40% of the company with 2 VC firms holding the balance 60%, if they decide to sell their stake, this clause will force the entrepreneur to also offload his/her shares, even if he/she did not want to exit.

 

Implications are obvious. If the company does not do well and if the investors decide to bail out with whatever value they can realize, the entrepreneur would be forced to sell his/her stake even if they believe that there is merit in continuing with the venture.

Sometimes an investor may want to exit because the venture [or the domain] does not fit into their strategic thinking any more. In this case, if the investor wants to exit, even if the going is good, the entrepreneur may have to sell his/her stake.

 
Preference shares Preference shares are shares that enjoy more privileges than common shares. These could be in availing dividends before common share  or preference share holders may also have greater rights to the company’s assets and proceeds in the event of liquidation.

 

Here too, the implications on the entrepreneur are based on multiple factors including the multiple of liquidation preference, if it is included, etc.

In most cases, simple preference shares which give an investor rights over assets in case of liquidation and dividends before common share holders are not considered unfair by entrepreneurs as it represents only a fair demand that the investor is seeking to protect his/her capital and the entrepreneurs acceptance indicates a high level of confidence in the venture to allow an investor to protect his/her capital.

 
Indemnity Well, this is a pretty straight forward one in which the investor who sits on your board seeks an insurance cover to as an indemnity cover should there be a legal case and the investor needs to protect himself/herself.

 

Depends on how much protection is sought and how much the insurance premium is, and how that amount is in relation to the amount that is raised.

I.e. the investor and entrepreneur need to evaluate if and if yes, how much, indemnity insurance makes sense. Especially if it is going to cost a lot and if the amount of capital raised is little.

Also, if the capital is raised for, say, concept testing where the exposure to liability is nil or limited, then it may not make sense to invest in insurance premium [again, if the capital raised is limited]

 
Anti- Dilution Protection Anti dilution protects the investor’s capital in case the entrepreneur decides to, for reasons of market conditions or strategic relevance or whatever, to accept capital from a new investor at a valuation that is lower than that at which the investor had invested.

In a situation where a subsequent round is raised at a lower valuation, anti dilution right allows the company to revalue the original valuation and thus issue additional shares to the investor.

 

This, in my view, is a fair clause and entrepreneurs should be confident enough and accept it. Fighting this clause would necessarily mean lack of confidence in estimating a higher value for the equity in subsequent rounds.

 
Right of First Refusal

Or ROFR

ROFR allows investors the right but not the obligation to invest in the subsequent round of fund raising. With this clause, in the next round(s) of funding all things being the same i.e. as long as the existing investor too is offering the same value, the company will have to accept investment from the existing investor.
 
Vesting Vesting means that the stock will be available to the person after a pre-determined time or on reaching a pre-determined milestones.

 

Often used for stocks offered to employees e.g. ‘xx’ number of shares will vest on completing 24 months of employment.

 

Vesting is also common in the case of early-stage companies to protect the investors from one or all founders quitting the company after the funding. In the case of vesting for employees, the term sheet may specify a ‘cliff of a year’ followed by monthly vesting thereafter. This means that if the entrepreneur leaves within the first 12 months, he/she would get no equity. However, on completing 12 months, the entrepreneur would get a significant portion of his/her equity and the balance will vest monthly over a period of the next 2-3 years.

 

In the case of vesting though, there will be clauses which protect the entrepreneur in case of events like next round of funding, acquisition or even firing by the board.

 

While it seems unfair, it also provides protection to the entrepreneurs. For example, if one of the founders leaves or does not perform as expected and is asked to leave, then vesting ensures that he/she does not get the full benefit of the equity due and gets only as much is vested till leaving or being asked to leave.

 

Webinar by The Hatch Institute on MVP – Manish Singhal

According to Start up Genome report‚ almost half the start–ups do not celebrate their first birthdays. Once they are past that hurdle‚ almost 90% of the ventures fail while scaling up!

As an entrepreneur, with limited time & resources at your hand‚ you feel like a pilot trying to take off before you outrun the runway! You have to find who you are as a business & who your customer is quickly and with minimal investments. That is what will give you a significant advantage in the marketplace.

This webinar explores how to use MVP (Minimum Viable Products) as a strategy to ensure your venture’s smooth and safe take–off!

Take aways from the workshop :
1. Concept of MVPs
2. How to apply MVP strategy on your business
3. Fine Tune your MVPs

 

 

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