Opinion

Useful tips on financing startups

| Updated on January 16, 2018 Published on October 16, 2016

Title: Entrepreneurship Simplified: From Idea to IPO Authors: Ashok Soota & SR Gopalan Publisher: Penguin Random House India Price: ₹499

It makes more sense for start-up entrepreneurs to seek angel or VC funding than use up their own money

The area on which we get the most questions from new or potential entrepreneurs is invariably related to funding the venture. The ambit of questions includes the desirability of bootstrapping, angel investing versus venture capitalist (VC) investments, the right amount to raise, and approaching new investors like private equity (PE) players for subsequent rounds. The final stage for fundraising is the IPO, but since our conversations are mostly with potential or early-stage entrepreneurs, the IPO seldom arises for discussion.

However, we do advise that entrepreneurs should have an approximate understanding on the time to IPO as this will determine the exit strategy for investors. If the thought process is to avoid an IPO and seek a strategic investor to monetise the wealth created, entrepreneurs should also be clear whether this is an option or a Plan B.

In his two entrepreneurial experiences (MindTree and Happiest Minds), Ashok was always clear that he was building businesses which he would take public. This was clearly communicated to the investors (VCs in both cases) upfront and the period indicated as six or seven years, so that the right expectations were set from the word go.

Bootstrapping

The one big argument for bootstrapping (a situation in which an entrepreneur builds a company with personal capital, generally a small amount), even if external investors are available, is when deferring the induction of investors might ensure a significantly higher valuation. However, as we will show later in this chapter, there are multiple approaches to increasing valuation. In essence, we are mostly in favour of seeking external investors from the start.

The reasons for this approach are multiple. Firstly, good investors not only validate your idea but also help you to modify and adapt it. They also add value in multiple ways, such as adapting your business model, sharing your risk, identifying talent, introducing you to their partner ecosystem and so on. To be fair, there are many bootstrapped ventures that have grown to become profitable... These examples include SignEasy, Zoho and Fusioncharts. While the founders in these cases seem happy with their decision to bootstrap, the issue is how much larger or more valuable the company could have become with external funding.

If the founders do have funds to invest in the venture, we see it as preferable to put these in as part of the first round. The external investors will see it as a positive that the founders are putting their own neck on the line. Also, the founders’ money comes in on equal terms with the investors’ money with respect to valuation. In a sense you become your own VC with such an approach.

On the other hand, if the founders put in all their investible funds into bootstrapping, there is a big danger that they will run short of cash by the time they are negotiating with VCs. There is nothing worse than handling such negotiations with your back to the wall.

The prospect of dwindling cash and unpaid salaries creates anxieties and may lead to accepting the very first offer which comes the founders’ way.

You will come across entrepreneurs who took the bootstrapping path and are happy with the results. More often, though, it’s an invitation to years of skimping and personal sacrifice while you watch others sail by you in scale and profitability.

Also, once in the market, ventures should be ramped up quickly to avoid others getting into the game. Adequate money is one of the fuels for such acceleration. A combination of investor funds and founder funds increases the pool size.

Finally, the main reason we are against bootstrapping is that we’ve seen too many founders blow up their life savings trying to get a venture off the ground and then failing.

Angels or VCs?

Odds are that there will be as many views on whether to seek angel or VC funding as there are entrepreneurs.

Prajakt Raut, entrepreneur and entrepreneurship evangelist, sees many advantages (and some disadvantages) in starting with angel investors over VCs.

Ashok’s view is somewhat different. Angel investors will typically invest only up to $1 million in your venture and the way cash gets burned while creating a business, you will soon be knocking on the door of VCs anyway.

In a majority of cases, the bulk of the organisation’s pre-IPO life will be spent with them as your investors. Since every round involves some dilution, you may as well go straight to the VCs if you can get them interested in your venture.

Prajakt’s view is that VCs and angel investors give different kinds of advice and that angel investors would be more likely to help you with the ‘fundamentals of the business at the starting point and guide you through the setting-up stage’. Our view is that a good VC will provide valuable assistance at this stage as well...

We have noted that the Angel ecosystem has of late been very active and hence should not be underestimated. Kris Gopalakrishnan, Infosys co-founder and a member of the Indian Angel Network, says that... ‘ All kinds of models can coexist today because there is a need of early-stage capital’.

Since 2015, the entrepreneurial boom has also seen increased activity in the angel investing space. Investors like Sharad Sharma, Mohandas Pai, Rajan Anandan and many others are contributing to creating hundreds of start-ups every year...

The good news for entrepreneurs is that there is a wide choice of angel investors and VCs available. And the choice is not limited to angels and VCs; today, we have a wide variety of options available, including online dealmaking platforms and crowdsourcing for funds.

A comprehensive article on crowdfunding by Venkatesh Babu in Business Today lists the major crowdfunding platforms as LetsVenture, termsheet. io, Investopad and Catapooolt. Many of the crowdsourcing platforms have a preference for social sector projects.

These include Ketto, Fueladream and BitGiving. The indicative amounts raised by crowdsourced projects are similar or somewhat higher than those available from angel investors.

If you are seeking entities which can provide funds of say $3 million or more, like VCs, the alternatives are large companies which are now making strategic investments in start-ups. These include Alibaba from China and the large IT companies like Infosys and Wipro.

Investors for even bigger ticket spends of $25 million and more are the PE players like KKR, Apollo, Carlyle and the sovereign funds of the Middle East countries.

Since we feel that the single largest vehicle for early stage investment is VC firms, we will now focus on negotiating with and ‘living’ with VCs — many of the points will also be applicable to handling other categories of investors...

Extracted from the Chapter, ‘Funding Your Venture’. With permission from Penguin Random House India

MEET THE AUTHORS

Ashok Soota is the founding chairman of Happiest Minds Technologies and was the founding chairman of MindTree. Prior to MindTree, he led Wipro’s IT business for 15 years.

SR Gopalan is the founder of Dawn Consulting and Bizworth India. Gopalan was president of TiE Bangalore. He has workedwith Union Carbide and Wipro.

Published on October 16, 2016
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