02 August 2014

Conference: Funding for Startups

Today's conference was different in that the initial talk by the professor was restricted to 40 minutes and the panel discussion was planned for two hours, with many more panelists than usual. Professor G Sabarinathan moderated and gave the starting lecture.

The Panel
  • Sharda Balaji (Founder of NovoJuris, legal counselors)
  • Neelam Chhiber (Co-Founder, Mother Earth)
  • Sanjay Anandaram (mentor to CEO's of entrepreneurial companies on strategy and growth. Mentor to RedBus too)
  • Nagaraja (Naga) Prakasam (Angel investor)
  • Vivek Prabhakar (Founder of Chumbak and responsible for the good turnaround at Tanishq)
  • Srikanth (Head of Veda's Bangalore. Experienced in investment banking and private equity)
  • Parag Dhol (MD at Inventus Capital Partners, a venture firm)

Professor Sabarinathan began his talk saying the funding is about doing; not talking, which gave me the impression he'd be cutting short his lecture and conduct an exercise/game where we'd have to pretend to raise funds right there. That didn't happen though :) He also spoke of how you can't have canned solutions for a funding problem. Every situation is unique.

Funding alternatives
Some terms:
  • Equity: Most people think that equity funding is the only or best way to get funding. That's not necessarily true
  • Formal debt: The situation where you use your savings etc. for funding
  • Informal debt: When you're trying to run a business on a shoe-string budget
  • Spontaneous liability: A funding need that arises in the course of business and you have to pay for it even though you didn't forecast that it'd come up.
  • Grants: Money from government agencies. This is called social enterprising.
  • In-kind: For example, when you get to use cloud servers for free.
  • Service fee contract: As the name says.

Funding hierarchy
Funding, actually has a cost hierarchy. Depending on where you get your funds from, there's a cost you have to incur.
Normally, people have well articulated expenses. They're advised to raise money with the least cost. This cost is the direct cost which is very visible.
What entrepreneurs also have to be aware of is the cost of control. Popular literature says equity funding is free. It's actually the most costly way of raising funds. Once you receive funding, you lose a little control over the organization. You forgo many of the fundamental rights and control you have in your own company because of investors permissions, you can't appoint a CEO etc.

Money gives an investor the power to ask questions.

Personal money (anecdotally, your own funds are best unless the money belongs to your spouse or father-in-law) and OPM (Other People's Money ie: relatives/friends) are the least costly. Grants are also good, but you have to report to the person offering the grant, but that's more manageable than equity.

What the level of funding does
  • Too less funding: Saps the energy of a business, there are delays in capturing market space and affects early hiring.
  • Too much funding: Distracts the entrepreneur from the main area of focus, penury leads to parsimony, reduces sense of urgency to go to the customer early and there's a lack of market validation (Palm took it's device to the customer earlier than Apple and failed, but they got faster market validation and were able to quickly improve their product). Too much funding also dilutes equity and reduces the initiative of the investor to invest.
 The professor also introduced us to the approach of an MVP (Minimum Value Product), where we first slowly validate the product with users and then go big.

Planning for funding
Some pieces of advice for an entrepreneur planning for funding.
  • A funding plan is only as good as a business forecast
  • Meticulousness isn't risk aversion
  • Systematic thinking isn't rigidity
  • Know the difference between 'must-haves' and 'luxury'.
  • Revisit the funding plans once a month
  • Use specialist intermediaries because they carry market intelligence, know funders and the funding pitch. They know how to modulate the investment pitch and they do the followup for you.
Equity as a funding investment
Sources of equity funding can be from founders, friends, family, incubators, accelerators (Microsoft accelerator is one), angel networks (like the ones at Mumbai, Bangalore and Chennai), seed stage investors, early stage VC investors.
The ability to raise equity depends on location. Entrepreneurs in Bangalore are said to be very lucky in this respect (one of the panelists in the conference on analytics had also said the same. He spoke of how entrepreneurs stand to get a lot of free advice in Bangalore). People in Belgaum though, are said to have a tough time finding equity investors.

Considerations to be aware of for equity
  • How much funds to raise
  • Terms of funding
  • Dilution
  • Availability and time

  • There is no universal truth to funding. You have to figure it out yourself.
  • Anecdotally, funding choices can significantly affect sleep levels :) The professor narrated the case of a person who invested in a software services company (which is highly risky and takes two years to give a return) and had sleepless nights because he thought he was investing in a traditional business like the timber business.
  • Talking a lot can help avoid costly mistakes. The most successful people in fund-raising are those who talk to many people and gather opinions.
  • Also important, is to raise money from the right people. The professor spoke of a company with a Rs.4 crore turnover which was in danger of closing down in the next 48 hours because they took money from the wrong people.
  • Don't let down your guard during conversations. Don't reveal too much.
  • Define clearly what you want from your investor to avoid falling into a trap.

The panel discussion
Some of the important points that came forward when the audience posed questions to the panel.

What are the basic rules for equity funding?
  1. The team, balance, chemistry in the team, domain experience
  2. The size of the market and how fast it's growing
  3. The competitive advantage, ability to make good or extraordinary returns from the investment.
How do investors evaluate the market share/survey? Is there a standard referred to?
  • If it appears on the Gartners chart, it's already too late. It's more important to be directionally correct than precisely wrong. You should also have no idea of the market size and know it can scale.
  • Search for someone who wants to grow with you rather than think about the exit.
  • As per data Sharada had, a new startup which is around 6 months old is more likely to be funded than a 2 year old startup. Another panel member later said that it was not necessarily true.
  • Mr. Sanjay said that five years ago just an idea could get you money. Three years ago a proof of concept could. But now, you're asked about what have you yourself put into the game.
  • Mr.Srikanth advised that entrepreneurs spend the first stages of creating their company, in creating the business model instead of keeping the focus on capital. If they're just working for capital, investors won't fund them.
About accepting money from an investor?
You have to be ready to be answerable to them. Are you open to dilution? Such a situation also has some amount of good. It brings discipline and rigor. You know you're being watched and have to perform. As an entrepreneur, think about whether you want to be in 100% control of a 1 crore company or 1% in control of a 100 crore company?

If a similar company as mine got funded, are my chances bleak?
Don't look at what got funded. Look at the market need. Investors will understand. Eg: A person put forward a proposal quite simply with the fact that India requires 5 lakh welders. The supply is 1 lakh. The investor was convinced.
You need to have patience. Is your product going to be better, faster, cheaper? Look at whether the market can support another vendor? It doesn't really matter if a similar idea/company has already been funded. Another example is how new e-commerce businesses are being funded. It's because the market can support multiple vendors.
You should have the passion and conviction to go after it as the capital.

As an investor, how do you assess the team of entrepreneurs?
Investors don't look to see if you have an MBA. They don't look at educational qualifications. They see if you have the people who can deliver. Eg: If you're a technology person, you very likely don't know how to do sales. If you get a co-founder who is good at sales, then you're on the right track. Find the complimentary co-founder who has the skill necessary to take the business forward. The investors will see that and be more open to investing in your venture.

How to decide whether to go for debt funding or equity?
Mr. Srikanth answered this simply by saying: "If you prefer kabbaddi, go for debt. If poker, go for equity". The entire audience was in splits.

What does a Venture Capitalist (VC) invest in?
Just because you're generating orders/money, it doesn't mean a VC will fund you. VC's invest in fast growth. High knowledge intense businesses where there is fast growth. Spend time learning the different funds available. Each has different merits and demerits.

How important is your prior knowledge of the business?
Spend years getting experience. You should know your field. Showcase the business model and the profitability and ambition.

One common question posed by investors is "do you have any traction". What does it mean?
One panelist said that it's the polite term investors use, to say "we don't like you. Get out" :)
Mr. Parag tried answering it saying that traction also implies your connection with the market. Ask the VC what he means by traction.
Your business idea matters. People should say Wow! That's a fantastic idea. Go do it!

Is it more difficult for a sole proprietorship to get funding than a private limited company?
Yes. Because no institutional VC will invest in anything other than a private limited company. The Pvt. Ltd. tag gives the investor a small part of the ownership. You don't get that in a sole proprietorship.

How does a VC evaluate the team? Do they fund hiring too?
The team is very important. They look at the person. The vision and ability to execute the vision. Many tech people are bad sales people. They have a halo and refuse to bring in a co-founder. They don't get funding.
About the question on funding hiring, the job of the VC is not to run the business. Hiring is the job of the entrepreneur.

What kind of companies get funded?
Ms.Neelam said that it takes time to build a business without investors. They need to be deeply interested in you.
Mr. Srikanth added to that saying that in the history of Indian VC, service-based companies have been much more likely to be funded than product companies. Although rather than focus on that, the entrepreneur should focus on doing what is right for the market.

How do the VC's look at a companies revenue as a measure for investment?
Erratic revenues are scary to an investor. Zero revenues are still ok, because you may be building your business for a period of months without any revenue, and that's understandable; but erratic revenues are bad.

If I want to create a model which supports the surrounding ethnic community and uses tourism as revenue?
Ms.Neelam asked the person to refer the Dasara social impact program.

Misc points
  • Mr.Sanjay mentioned that many entrepreneurs, at the end of their presentation, have a slide on "exit valuation". He asked that people remove such a slide, because it's again the case of the entrepreneur doing the job of the VC. Let the VC decide the exit valuation.
  • Investors are very afraid of the single founder getting hit by a bus. It's better if there's at least one co-founder.
  • When preparing or receiving a term sheet, make sure you get a really good lawyer because the investors always have better lawyers on their side.

Most importantly, as a team, if the chemistry is not right, the arithmetic never works.

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