What are the differences between angel funding, venture funding and crowd funding? In what scenarios can they be exploited for maximum benefits?

(My response below, to the above question on Quora)

Different investors participate in different stages of a venture. Angel investors invest at the very early stages – when the founders only have an idea or when the idea is being or has been developed into a prototype. They provide enough capital for the idea to be tested and proven in the market, so that another set of investors can bring in more capital after the model is proven and when the venture needs more money to take the proven model to a wider base.

Continue reading “What are the differences between angel funding, venture funding and crowd funding? In what scenarios can they be exploited for maximum benefits?”

M&A: Why small exits matter? The big value of small exits (#iSPIRT-OEQ)

iSPIRT Open Ecosystem Questions(OEQ) Series. The conversation around this exciting session was lead by Sanat Rao (iSPIRT) and the speakers were Jay Pullur (Pramati Technologies), Sanjay Shah (Invensys Skelta), Pari Natarajan (Zinnov), Karthik Reddy (Blume Ventures) & Vijay Anand (The Startup Centre).

Sanat initiated the conversation with an observation that it was only the bigger exits that are picked up by the media. Smaller exits do not get any media attention at all. , We all hear about the big bang “home runs”: WhatsApp sold for 19 billion USD to Facebook, Google acquires Nest for 3.2 billion USD, etc. However, studies show that 65% of VC funded companies in the US return 0-1x to their investors. Even among the remaining 35%, the exit valuations are relatively small: since 2010, the average M&A deal size in the US/Israel is 100 million USD. Only a small 0.1% of VC-funded companies are home runs (50X returns). And not just in India. In Israel too, from 2010-14, out of the 88 exits, two deals on Viber and Waze accounted for a whopping 25% of the total M & A value.

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Given these statistics, why do we promote the myth of a multi-billon $$ exit? Why don’t we recognize the value of these smaller exits? Should we not be promoting and helping product startups to find an exit at an earlier point in their lifecycle, rather than treating these exits as a worst case scenario? Continue reading “M&A: Why small exits matter? The big value of small exits (#iSPIRT-OEQ)”

What parameters do investors use to decide on an investment?

Different investors will have different criteria for selection, and could vary by not just the amount of capital they invest but also the stage at which they invest and the kind of companies that they invest in.
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Most investor’s decisions are based on the following:

  • Quality of the team: This is our most important criterion. We are not looking for experienced entrepreneurs. But we certainly look for understanding of the domain, business concepts & operations management, and most certainly commitment to the venture.
  • Clarity of the concept/idea: How well has the team been able to articulate what they want to do. You cannot plan it well, if you cannot communicate it well.
  • Size of the potential: Concepts addressing large markets with large potential are obviously better.

If the above two are positive, then the following few areas would be discussed:

  • Scale of aspiration of the team: Does the team have the aspiration and hunger to be a market leader?
  • Business case: Is the business case strong enough? Remember, when pitching to an investor you are competing not just with direct competition from your domain but also with startups with interesting business plans
  • Exit potential: How are we going to get a good return on our investment. I.e. what is the exit option for us.

How to Structure the Business Plan of your Startup?

A business plan should essentially cover three aspects – what are you going to do, how are you going to do it and how will you make money. Watch as Prajakt Raut highlights the key components of a good business plan.

What do you need to have in place as a Startup in order to be able to successfully raise a seed round?

For raising a seed round, the startup should have laid the foundation to scale up, and validated most of the assumptions that would prove the business case around their concept.

Screen Shot 2013-05-27 at 1.02.39 AMOf course, the basics need to be in place – the product/service needs to be good and solving a relevant problem or addressing a meaningful opportunity, the market potential should be large, the core team needs to have covered between them the key functions of that business, etc. etc. In addition to the basics, the below are some of the things that need to be in place before a seed round.

Concept should have been proven: The startup’s product /service/concept should have been proven in the market. Some initial customers should have bought the product and found the value proposition meaningful. The product should have delivered on the promise. The price-point should have been proven. Also, the challenges that need to be addressed could have been identified in the pre-seed stage.

The ‘business’ around the concept should be clear: In most cases, the business model is tested and adjusted and retested in the pre-seed stage. Before seeking an institutional funding, it is ideal to have tested different revenue streams, honed on to a business model that would be pursued, the price-points should have been proven and the unit economics should be positive.

Validating the assumptions: Before raising a seed round, it is ideal to have tested the assumptions in the business plan (e.g. how many people will convert, cost of customer acquisition, average revenue per customer, repeat purchase rate, etc., etc.). In fact, this is the area in which startups should pay some solid attention to in the pre-seed stage of the venture.

Estimating people needs: Before raising a seed round, the venture should have got a good sense of what competencies are missing in the team, and clarity on how those will be filled in (in some cases, scaling up will require someone to be hired as the CEO too).

Future plans need to be in place: When you start up, you may not have the largeness of vision that will create a scale company. However, as the venture matures, and as you start thinking of an institutional round of funding, it is important for the founders to have a vision for the future and the ability to articulate this vision clearly to all stake holders (investors, employees, customers, partners, etc.).

In many cases, the founders start defining or redefining the addressable market and this usually means thinking of a far larger scale than they would originally have.

The team should have in place, or at the very least identified by now, the elements that they will need to put in play to manage the venture at scale. E.g. sourcing relationships or technology platform in a e-commerce venture.

Jugaad to processes: As the venture moves to secure seed funding, the founders need to recognize the need to shift from a ‘fix on the move’ mode to a process oriented approach. They need to recognize that as the team grows, they will need to rely on processes and matrices and the discipline to measure performance and progress on well-defined parameters.

Identify one among equals: When a few friends or acquaintances start a venture, the usually split equity equally and divide the responsibilities equally, and also designate themselves co-founders. All are therefore deemed equal, and it is possible that they are at the start. However, a ship needs ONE captain. The team has to identify a first among equals to lead the venture. Multiple power centres in a venture leads to confusion and chaos.

Ideally, before the seed round, the team should have decided who the CEO will be. (Most institutional investors will insist on knowing who the CEO will be, and it is not uncommon for founders to fight over this issue.)

Nett: the venture needs to be in a state where all (or at least most) the uncertainties have been dealt with (if not fully addressed) and the venture should seem like a good business case to pursue at scale. This is the time when seed-stage investors would be willing to bet on the founding team’s ability to take the initial learnings and reapply them at a much larger scale. In the process, there will be some new learnings and some new adjustments on the way. That’s the reason why the quality of the team, their passion, their ability to understand the innards of the business, etc. will be key deciding factors for seed-stage investors, even if the rest of the things mentioned above are all positive.

(Of course, this can never be a comprehensive list. I shall keep adding to it, and if you find have any points to suggest, do write to me at prajakt.raut@gmail.com)

 

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.

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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.

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.