A fund-raising start-up team has to make a plethora of choices, many of which may not be on their volition. Nevertheless, it is important to understand the potential ramifications of some of these choices.

Two important non-financial strategies in venture fund-raising is staging and syndication. Staging refers to raising the needed capital in multiple rounds rather than raising in a single round. Syndication refers to the number of investors that participate in a round. If the number of investors is higher, the degree of syndication is said to be higher. So the question is, what should the start-up team go after: Staging? Syndication? Both?

Staging

Arguments can be made on both ways on the basis of practical considerations. Proponents of staging would claim that by raising funding in tranches, one is able to demonstrate the progress made by the venture, which would help to get a higher valuation in subsequent rounds. If all the money is raised at one go (provided such an option exists!), then the founders have to dilute their shareholding significantly. The cons to staging is that multiple fund raising exercises could affect the time that the founder needs to spend on the venture.

To settle the issue, we looked at the impact of staging on venture returns. The results, as Holmes would have said, were instructive. Returns could be seen as a manifestation of various performance indicators. Returns are higher when neither the quantum of funding nor the rounds of funding is high. However, when the quantum of funding increases, returns reduce irrespective of the number of rounds of funding indicating that excess investment or easy availability of capital does more good than harm.

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All things being the same, an optimum number of rounds of funding has a positive impact on returns. A possible explanation is that only when the start-ups are able to demonstrate performance, they can successfully raise the next round of funding. Thus raising capital in multiple rounds acts as an incentive for better performance. On the other hand, if the funding rounds are many, it would lead to significant consumption of top management bandwidth, thus affecting business. Additionally, managing the expectations of multiple investors in several rounds would not be easy for the founders.

Syndication

The founder often has very little direct say on the degree of syndication in today’s era of investor networks. But can influence it in indirect ways. When do investors syndicate? Theory says that, predominantly when they are not sure about the prospects of the venture. In such cases, investors tend to minimise the risk by taking smaller positions and sharing the investment opportunity among a larger group of investors. However, a positive element of syndication is that investors bring different strengths to the table.

Having a group of investors can thus bring immense benefits to the venture. In Hindu mythology, Surya drives a chariot driven by seven horses, whereas in the Gita Krishna ’s chariot has four horses. More the number of horses, more majestic and powerful is the chariot. However, more the number of horses, more skilled should be the charioteer . Entrepreneurs are like charioteers. They need to know that it is not easy to manage the diverse expectations of multiple investors.

The magnitude of returns vis-à-vis quantum of funding and number of investors indicate that the highest returns are seen when the number of investors are not high. The negative relationship between returns and number of investors could be due to the heterogeneous expectations between different investors, which often leads to potential conflicts that can even threaten the existence of a start-up.

While the number of investors increase returns up to a point, the transaction costs of managing multiple investors overshadow the value addition that could accrue from having more number of investors. Our analysis suggested that having between four to six investors worked best for start-ups and generated higher returns.

Summary

Frugality remains an important asset to the entrepreneur. Seemingly endless access to capital can do more harm to the venture in the long run as overambitious entrepreneurs engage in inefficient spending on marketing, acquisitions and rapid expansion. Staging acts as an incentive for founders to focus more on business performance rather than needless bling. The results on syndication confirm that too many cooks do spoil the broth. Having a small group of convinced investors with skin in the game is more beneficial than having a dozen who are looking only for a share in the pie.

The writer is a Professor at IIT Madras, an Associate at Harvard Kennedy School, Harvard University and co-founder of YNOS.in

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