Start-up Investor Ecosystem: Decoded!!!
Everything You Need To Know About Investors In The Start-Up Ecosystem
What are the types of investors in the current Indian start-up ecosystem!
The two major types of investors backing the whole show are – Angels and Venture Capital Firms!
Unlike otherwise – in Angel and Venture Capital; you start with people, and then figure out what numbers you can make!
Even though, both come with different mindsets, goals, preferences and investment strategies, but what brings them on the same page is that, their primary motto is to provide working capital.
Most of the deals that take place in the current market are in against of Private Equity. These investments are often also called as private capital, which is used to support a long-term illiquid investment strategy. Simply put – supporting a company that won’t be making any profits for a while!
To give you brief insights about the length and breadth of the current Indian start-up ecosystem from investments point of view – the year of 2015 saw an infusion of $9 Billion across 1,005+ deals, which quite surprisingly, accounted for more than 50% of the total deal value of the past 5 years. The Q3 (Third Quarter of 2015) itself, saw an infusion of around $3.8 Billion spread across 259 deals.
To put that figure into perspective – there was an investment happening in some start-up, in some part of the country, every 8 hours! And what is even more interesting is that, nearly 2/3 of these investments were made by angel and seed investors!
Let’s look at each type of investor very briefly, more like an elaborated definition!
An angel investor is an individual with sizable net worth, and offers capital for a business start-up, in exchange for convertible debt (capital offered as debt for a certain period, after which it converts into equity) or ownership equity.
They are also popularly known as – angel, business angel, informal investor, angel funder, private investor, and seed investor.
In the US – an individual with $1 million of net worth, $200,000 of individual income, or $300,000 of joint income (with spouse) for two documented years, are qualified as accredited investors.
Angel capital is most required to fill in the gap in seed funding between “friends and family” and “Venture Capital”, since it is difficult to raise more than a few hundred thousand dollars from the former, and VC’s cannot go below $1-2 Million.
Unlike others, Angels Investors characteristically invest money from their own pockets, which ideally takes place through equity crowdfunding (such as: AngelList) or as a part of an organized angel groups / angel network, to share their research and pool their investment capital. These investments can range anything between $10k and $1 Million, sometimes maybe a bit more too.
Their due diligence could include having coffee or lunch with the entrepreneur or performing thorough expert background checks and research, which of course, differs from case to case.
They typically demand extremely high rate of returns, which is usually anything between 10-30% stake in your company and approximately 10x – 20x ROI (Return on Investment), within three-five years roughly.
This is because, Angels are the ones who hold the highest amount of risk as compared to other types of investors, given the high chances of failure, and also since they invest their own money and have limited resources of due diligence available.
And they are also the ones who are hurt the most when it comes to dilution as well. Their investments are usually gets diluted dramatically in the rounds of funding that take place after theirs, and are completely wiped out if the start-up fails.
Given their bottle-necks, Angel investors also have a set pattern of functioning. You would often come across Angels investing in groups, most referred to as Angel Groups or Angel Networks, or in the projects that come through trusted references. This not only reduces their risk financially, but also helps them to get better research, guidance and understanding of the market.
Other than that – Angels often avoid investing in companies that are beyond their area of expertise / interest and geographical location (their city limits).
Talking about their exits – the ideal exit an Angel Investor looks at is mostly a buyout in the future rounds, by a VC, or further ahead, depending on the growth of the company, they also extend upto a Merger or an Acquisition.
Some of the most prominent and active Angel Investors or Angel Networks in India include: Indian Angel Network, Mumbai Angels, Powai Lake Ventures, I3N, Sanjay Mehta, Sunil Kalra, Anupam Mittal, Kunal Bahl, Sachin and Binny Bansal, Vijay Shekhar Sharma, Vishal Gondal, etc..
To begin with – there are four main players: Entrepreneurs, Investors, Investment Bankers and Venture Capitalists. Entrepreneurs need funding, Investors want high returns, Investment Bankers need companies to sell, and Venture Capitalists make money for themselves by making a market for the first THREE.
Technically speaking – a firm that manages and invests funds of third-party investors are known as Venture Capital Firms.
Unlike Angels, a Venture Capital Firm is an institution whose business is to invest money into enterprises that are considered risky by the standard lenders such as capital markets or bank loans.
The main difference is – it’s not their money!
VC’s invest at different stages, stages that arrive post the Angel Round (seed funding round), which typically are required to fund the growth of the company (also referred to as Series A, B, C rounds, and so on…), and preferably in companies that offer qualities such as innovative and well-developed business model, potential for rapid growth, and an impressive management team.
Their investments are usually anything beyond $2-3 Million with a Return on Investment (ROI) that largely depends on the growth and profitability of the business, which is earned when they Exit (typically 3–7 years) the company.
Potential Exit Strategies that VCs prefer include: Mergers, Acquisitions and IPO (Initial Public Offering). Some VCs also prefer to exit at different (early or later) rounds, through Buyout options (by other investors).
Just like the Angels – VC firms too, prefer to co-invest with other firms, in a format wherein, there is one “lead” investor and several “followers”.
But unlike Angels, VC’s have a mandate to perform thorough Due Diligence. In fact, they may even spend as much as $50,000 to do so. VC firms have an Investment Committee that helps the firm in making decisions on potential investments, and are not swayed by individual opinions.
In exchange for the investment they make and for the high risk, the VC firms gain a significant measure of control over the company, a seat on the company’s board and the company’s decision-making process. This may range from the power to replace the management completely, to even forcing a sale of the company.
But beyond that, VC’s also turn out to be of great value to the start-ups as well. VC firms, ideally come with a package including – technology backgrounds, finance, technical expertise, marketing know-how, business acumen, deep industry experience, access to their deep industry-relevant contacts, assistance in the recruitment process, strategic advisory, etc…
One of the biggest myths most of the people live in, is that VC’s invest in good people and / or ideas. Yes of course they do, but as a whole and in reality, most of them follow the current market demand and trend, and invest in good industries / sectors! Industries and Sectors that are more competitive and in demand by the consumers!
For instance: In 1980, Energy sector accounted for more than 20% of Venture Capital Investments, which over the period of time, magically shifted from Genetic Engineering, Specialty Retailing to the Technology sector. That was because the demand for these industries / sectors increased.
Anyway, this is how a Venture Capital Firm’s structure looks like: -
- Limited Partners: – Investors in venture capital funds that comprise of HNI’s (high net worth individuals), institutions, etc., are known as limited partners.
- General Partners: – They are the ones who run the VC firm and are the decision makers of the Investments.
- Venture Partners: – They source potential investment opportunities.
- Principal: – They are mid-level investment professionals.
- Associate: – This is typically the junior-most trainee position in the firm.
- Entrepreneur-In-Residence: – They generally are experts in a particular domain and help the firm perform due diligence on potential deals.
Some of the most prominent and active Venture Capital Firms in India include: Sequoia Capital, Accel Partners, Blume Ventures, Nexus Venture Partners, Kalaari Capital, SAIF Partners, Ah Ventures, Kae Capital, Matrix Partners, Seed Fund, Ojas Venture Partners, etc…
So the next most obvious question that comes to mind is….
When is the best time to approach Angels and VC’s?
Now that we have established that both of them have a common mission and goal, let’s give you a better idea about who to go to, and when!
So this is how an entrepreneur’s journey starts.
- IDEA: They begin either first begin by converting the Business idea / Plan to an executable business model evolution. During this stage, they start by investing either their own money or by raising finance from their family or friends. With that amount, they turn the idea into reality!
In certain cases, an Angel Investor may even invest in such a proposal, making him the founding member of the company. With of course, various terms and conditions!
- SEED ROUND: Only, after the newly born product has gained some MVP (Minimum Viable Product) or has been validated by an (X) number of early adopters / customers, the entrepreneur is a suitable candidate to an Angel Investor (in general cases, of course!).
This is the stage where you would require working capital, and is the perfect time to pitch your product to Angel Investors who seem ideal for the company. This can be judged by their industry expertise, their interest (from an investment point-of-view) towards your sector, what they bring in on the table, etc… This is technical development or the Seed Stage.
- VENTURE CAPITAL: This is the growth phase of a company wherein, the business model is fundamentally proved and needs expansion in different ways. That is where when Venture Capitalists come in to the picture, with a “Series A” investment (again, in general cases, of course!) and help the company to grow (in every way) until it is ready to go public or be acquired.
Post this round, in all other future rounds, funds are raised from Venture Capitalist Firms, and sometimes from Private Equity or Hedge funds as well. This goes on, till the time your need for more funds end, or when you launch an IPO.
Other than that, in certain cases, you may even hear start-ups raising Bridge Financing: when a start-up is in between full VC rounds, and needs funding, so to fulfil its purpose, it raises a smaller amount of money instead of a full round; or Debt Financing also known as Venture Debt (like a loan), between this whole journey to avoid dilution of equity.
Lastly – What is the process of raising capital?
To begin with – if you are thinking of getting an Investor sign an NDA (non-disclosure agreement), then drop the idea. They won’t! Because if they did so, they would be in direct and constant violation, since they review 3-4+ companies in every market that they operate.
Before anything else – the first step for any entrepreneur would be to create a Pitch Deck! It is the visual PowerPoint presentation that acts as a backdrop to your oral presentation. However, there might be times, when you may not be presenting in person, and would be asked to send across an eMail. In such a case, the slides must be self explanatory, with only the information you are comfortable revealing. Piece of Advice: Create two Decks!
Below mentioned includes all the information that a Pitch Deck must contain: – (the sequence may change in different cases)
- Business Idea
- Bio of top 3 people in the company. ( Must be Short, Crisp and Precise)
- Problem definition (with your targeted market segment and the size of your market)
- Solution along with details and demo
- Revenue Model and options
- Progress of your company till date
- 1000 day plan
- Future exit options
- Lastly – amount of capital required and how long will it last
To impress these investors, you must be prepared, in every aspect possible. Think of it this way – you are there to convince them that you are the person they want to work with for the next 3 – 7 years.
The process of raising investment generally goes something like this. A few steps may get skipped or even change in the order, depending on the stage you’re at, your experience and reputation, and connections.
- The Introduction ideally happens through a reference
- The Initial Review by an associate in the firm
- The First Call with that same associate, if they like your project
- The Partner Discussion happens when that associate likes the overall offering and takes the deal ahead to the partner of the VC firm
- The First Meeting happens when the partner also likes what they see, and call you for a meeting.
- The Valuation Discussion happens if they still like what they see, and want to move ahead
- The Partner Presentation happens after both the parties come to common grounds about the valuation, and are then invited to present to the whole Partner team
- The Initial Due Diligence is the next step that takes place.
- The Term Sheet are the terms of the investor which includes: valuation, option pool size, liquidation preferences, veto rights, type of preferred stocks, number of board seats, etc
After the success of these rounds, come the Attorney Review, Term Sheet Negotiations, Term Sheet Signing, Full Due Diligence, Final Investment Documents and then finally, the Deal Signing!