These are notes from an informative webinar hosted by Raj Joshi, Mitesh Desai, Vijaya Verma along with a Q&A moderated by Haresh Kumbhani. The webinar covered topics like Venture Capital, Fundamentals of Equity financing for Startups, Investing in Startups, Venture Investing in India, along with adding valuable nuggets to budding entrepreneurs from entrepreneurs with years of experience in the industry.
Raj, Mitesh, Vijaya & Haresh hosted a webinar session ahead of PitchFest of the MSU Vision2020 Incubator program where 5 chosen teams will showcase their MVP created during the past 6 months and ONE team will get further funding. Adjusting to global timings Raj, Mitesh & Haresh connected from the United States while Vijaya joined from Bengaluru, the startup capital of India.
Taking time off from their busy schedule, the speakers talked about Venture Capital structure, providing general information on Investments in startups, the perspective of investors, current venture capital scenario in India, etc. They also answered questions asked by participants of the webinar.
This blog is a transcript and structured text version of the Webinar as it was a great experience and I learned a lot from the session which I couldn't help but share with a broader audience. I encourage you to watch the whole Webinar by clicking here.
Contents,
Fundamental of Equity financing for Startups (Raj Joshi)
The Business of Venture Capital Investments (Mitesh Desai)
Venture Investing in India (Vijaya Verma)
Fundamental of Equity financing for Startups (Raj Joshi)
"Startup is where you build a different future"
- Peter Thiel
Funding Sources for Startups
Equity Financing
The market is moving fast and Innovation is happening at a faster rate. If you have an idea you should know that somebody else might be working on a similar idea. That's where funding your company becomes important so you can accelerate your product to the market.
VCs are firms set up to invest in Startups.
Startups in ideation or early growth stages can raise funds via Venture Capital firms also known as VCs.
VC's play a high-risk high-reward game by investing in many Startups.
2. Debt Financing
Established companies will typically look to borrow funds from financial institutions to drive growth and fulfill working capital requirements. In return, Financial institutions charge interest.
They require collateral before giving companies the money.
This being the case, early-stage startups don't typically raise funds via Debt financing because they are unlikely to have any collateral or stable cash flow to ensure that they will be able to pay back the debt with interest.
If start-ups can somehow get debt funding, it's a good way to raise money without diluting ownership of your startup.
The Business of Venture Capital
"The venture capital business is a 100% game of outliers (in every sense)."
- Marc Andreessen
VCs are incredibly smart people who invest in Startups using others (Investors) money in the process.
VCs and startups create a symbiotic relationship with each other and that relationship drives a tremendous amount of value-creating innovation in the world.
Where do VCs get money from?
→ VCs get money from Limited Partners. They're all kinds of entities that give money to VCs to get better returns than the Stock market or Banks.
→ Even banks give money to VCs.
→ Private equity firms usually buy out established companies but they rarely invest in start-ups.
What do VCs give to Startups?
→ Funding
→ Experience & Network
→ Strategic advice
What Startups give back to VCs?
→ Equity/Ownership in your Company
→ Board seats
→ Big returns upon the success
The language of VCs & Startups
If you are going to engage with VCs, you got to be comfortable with the language and terminology of the VCs.
When VCs listen to pitches from start-ups, they focus on key business metrics to evaluate the viability of the start-ups. Metrics such as Runway, Valuation, Burn rate, Cash flow, Revenue Growth, Gross Margin, and Fund Raise become important in negotiations with VCs. Term Sheets are important documents that facilitate the negotiation process with VCs.
Tracking different metrics is an important practice for startups. Metrics or KPIs are dependent upon the market you are in and the nature of your Startup. A few of the general metrics are Gross Margin, Monthly Recurring Revenue (MRR), Customer Acquisition Cost (CAC), Compounded Monthly Growth Rate (CMGR).
All of these terms are important in running a Startup and one will learn them along the way. Here is an example.
Runway
Runway is the cash you have on-hand that will allow you to be in business for x months. Understanding your (startups) numbers (financials) is very important. If you run out of runway, you run out of cash, and the startup will be at risk. Every VC will ask for numbers, so it’s critical to be aware of them.
Numbers (The founder - VC Dance)
Negotiation - VCs will want maximum equity for minimum funding while Startups would want maximum funding while giving away minimum equity and this Founder - VC Dance goes on until an agreement is reached.
Understanding this equation is important and for that, you need to understand the Cap table 👇
(Note: It's just a representative table just to give an example of how cap table looks)
Assume you launch your company with $1500, You hire an attorney and incorporate your company (startup) and issue shares. You take 8M (80 lakh) shares as Founders shares, you put 2M (20 lakh) shares in the Options pool to offer to employees to attract early employees as you don't have much to give at an initial stage.
Now after launch, you raise a seed round where you raise $100,000, then you have to issue more shares for the Investors, so you issue 2M (20 lakh) shares and dilute your ownership in the company which is reduced from 80% during the launch to 67% after Seed round. But with the Investment, the value of your company increases drastically. You lower your shares for a much bigger pie (valuation).
This exercise continues with further rounds of investments (Series A, B & C).
You can see from the above table that from Launch to Series-C the total Founders’ shares stay constant at $8M (80 Lack) and their ownership goes from 80% to 44% while the valuation of the company rises to $250M from $1500. So the net-worth of the Founders’ shares goes from 80% of $1500 = $1200 to 44% of $250M = $110M. This is all paper money meaning that these numbers are not realized until someone buys your company or stake in the company or it goes through an IPO.
These numbers are just for reference for the sake of understanding the Cap table.
These numbers are just for reference for the sake of understanding the Cap table.
Pre-money - Valuation of your startup before funding round
Post-money - Valuation of your startup after funding round.
The Business of Venture Capital Investments (Mitesh Desai)
Let's look at the Business of VCs from an Investors point of view and look through what VCs go through in their processes.
Think of VCs as Money managers. Generally, VCs return 30-40-50% returns on their portfolio. For big returns, they take big risks given the general perception that 9 out of 10 startups fail. So VCs rely on 1 big hit where that startup makes substantial profits to compensate and give phenomenal returns.
VCs make investments in areas that they understand. For example, VCs focus on areas such as FinTech, Social media, SaaS, EVs, etc. VCs generate specializations based on who their General partners are, Who their advisors are and build on the expertise from which they make their portfolio.
VCs are also classified based on the rounds they invest in or stages of investments. Earlier rounds are riskier than later rounds. Some VCs only invest in Growth rounds while others invest in Initial rounds so it's important to consider this to figure out which VCs to approach.
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Venture Capital Investors need Startups as much as Startups need VC Investments
The Venture Capital Funnel
Based on a study on US tech Investments on 1098 companies with seed rounds from 2008 to 2010 and Data on Returns till 2018 showed that the majority of companies fail with each round.
You can see from the figure above that after the seed round only 505 or 46% of companies go ahead while as the round increases more and more companies fail in the market or fail to raise money and a small number of companies get acquired by larger companies or tech giants. You can see that only 20 or 2% of the initial 1098 companies got to later rounds and became successful.
Meaning that only 1-2% of companies reach Unicorn status.
This is typical of any sector or area VCs invest in generally thus called The Venture Capital Funnel.
How do VCs evaluate an investment?
Looking at what VCs look for when investing in Startups in different rounds whether they're gonna invest or not is important.
Seed Round
What are the requirements for Startup?
→ May or may not have a Product or Minimum Viable Product (MVP)
→ Potential Idea that has Market changing potential
What do VCs look for?
→ Innovation
→ Team
→ Well defined Vision
→ A credible Business plan (To show them that Market exists or can be created for your product)
→ An ability to build the solution
VCs will give a small amount of money in Seed round, enough to build your product and check it can provide a customer validation.
Series A
If you're successful in delivering value in the seed round you go to the next round to ask for further investment to the same VC or different VCs.
What VCs are Investing in?
→ Market Validation
→ Customer acquisition (How are you gonna acquire customers and How quickly the market is gonna understand what is your vision)
→ Revenue growth
Requirements from Startup or Must-haves from the Startup
→ A working product
→ A detailed Business plan showing Cash flow projects (So that VCs can determine how much Runway you need to be Cash flow positive)
→ A credible Team
→ A detailed Customer Acquisition strategy
Series B, C, D,...
Upon successfully checking the term sheet for Series A, you further go for Series B, C, D,...
You prove to the VCs that there is a Market and there are Customers who are and will use your product further on.
What VCs are looking for?
→ How fast can you go?
→ Revenue Growth
→ Profitability
Other Investors than VCs
VCs are not the only type of investors investing in Startups.
Family-run Offices
High net-worth Individuals
→ They invest based on Values they're associated with. i.e. Bill Gates' fund invests in Startups involved in Social initiatives.
→ They're managed like a VC firm but take less risk than VCs & Gives more money.
→ They don't lead the investment, they're there for Economic, Social or Personal values.
Private Equity firms
→ Invests in Growth stage (Late-stage) startups that are profitable
→ Looking to do roll-up strategy, To acquire or merge with other bigger companies.
Corporate Investment funds
→ They've been very successful in the Technology industry.
→ For example, Companies like Intel, Google have very active investment funds investing in Technologies aligning with or around their business domains. If successful they might acquire the startup or keep funding till IPO.
→ Startups should approach these funds if it aligns with their product.
Typical Investment Term sheet Terms
Term sheet - The term sheet is an agreement between the investor and startup laying out the basic conditions under which an investment will be made.
They include and determine how a startup will get money from the Investors and how They will return money to Investors, How the founders will receive money, etc.
Thus, Understanding all these terms is important so that you're in a better position to negotiate with the VCs.
Venture Investing in India (Vijaya Verma)
Now, let's again see things from the Startup founders’ perspective and look at what Startups need from the VCs as they're on the action side.
We live in a fast-paced world where things need to be quick, which implies in business too. Thus, Startups should raise money from VCs to turn their idea and vision into reality and deliver to the market
Types of Investors in India
Angels - HNIs (High Net-worth Individuals)
→ People with more than 2 Cr. Rupees in Investable assets
Angel Networks
→ High net-worth individuals but rather than going solo they invest in networks or funds so the risk is mitigated.
→ The advantage is Networking as they're highly connected (Investors).
→ A good way to raise money for Startups.
Family Offices - Business Leaders/Celebrities
→ Investments are based on Values they're associated with.
→ Business leaders - Investing in startups aligning with or around their core of the business. i.e. Tata's are likely to invest in startups around EVs or Next-gen manufacturing tech.
→ Celebrities - Investments for personal and economical reasons. Investments are inclined with their philosophy. i.e. Yuvaraj Singh invests in startups and research around the topic of Cancer through YouWeCan Ventures.
India Arms of Overseas VCs
→ Silicon valley and Overseas based VCs hire Indian arms to invest in specific India-based companies.
→ They were most prominent before as they were pioneers for the VC business in India.
→ In 2021, amidst a debilitating Second Wave, India acquired 11 new unicorns, taking the total to 48, the third-largest number in the world, after the US and China.
Seed Funding (Sow the Seed)
Seed funding is really important for any startup as it's the inception to taking their product or service to the market.
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Your first money should be the right money
Mrs. Vijaya Verma recalls that she made a mistake while raising money for her Startup in 1991 when she gave up 50% of her company for her approx. $1M. Thus, she warns about taking care of that.
→ Angels are popular for funding the seed round but they may or may not participate in later rounds.
→ They're easy to approach & Quick to close the deal.
→ Make sure to check their background and especially their network which may benefit you as a startup leader.
→ Verify and ask yourself the question, Will they help you to get to the next level?
"Startup" VCs
→ Recent examples include Mindtree co-founder Mela Ventures led by Vani Kola who went on a funding spree recently, Idea Spring.
→ They've recently been founders themselves so they understand the dynamics and problems faced by you from a Founder's perspective.
→ They can be Good Partners because of their experience and expertise in the field.
→ They may not have enough funds to invest in the next rounds.
Next Funding Rounds (following Seed)
The critical stage for Startups is they have to expand, acquire more customers, get their product to a larger market, Increase the team.
Early Stage Funding
→ A very large presence in India. This group of VCs has sprung up over the past 10-15 years in India
→ Examples include Blume Kalaari started by Vani Kola Omidyar Network are some of the most prominent ones in India. They started small and became big. They have invested in over 50-100 ventures in the past couple of years.
→ Very important stage especially while choosing the VC.
→ Important to choose a VC with a presence in your Startups domain.
Series A Funding
→ Bigger Corpus (500 Cr+)
→ Business VCs like TATA's Tata Capital, Wipro's Wipro Ventures
→ Has the VC firm invested in your market earlier?
→ Do they make investments at the stage where your business is right now?
Choose a smaller VC when your requirements are small or you need a smaller amount.
→ Can the size of the fund meet your requirement?
Make sure you understand your financial requirements before pitching.
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Make your first pitch to the investor who is least likely to invest
→ Ask for feedback and incorporate it into the pitch.
→ Keep pitching till your pitch is phenomenal. Keep practicing your pitch both before and while pitching it to the VCs.
→ Pitch to the most likely investor last.
→ Choose your VC as carefully as you would choose your partner.
→ Whether you are nurturing a cat, lion, or unicorn, it is your baby.
→ You need a good partner to bring it up with good values.
A company with good Values is really important.
Q&A
Q: How to get funding for a Social venture? A startup with no cash inflow initially?
A: (Mitesh Desai) You'll be surprised how VCs decide to fund social ventures. You don't necessarily need to have the profitability to get funded. You need to have a Vision and you need to know that there's gonna be strong adoption of your vision. Let's take the example of Facebook, it didn't have any profits in its first several years, they just sold the Idea to the VCs that they'll make them money well and showed them the possibilities of future outcomes.
Find VCs that invest particularly for Social causes.
(Haresh Kumbhani) This is where Family offices come into play, Corporate sponsorships are another place to try, Celebrities can be a good option, you need to find celebrities that invest in Social causes related to your field.
Q: What is the right stage to go for Funding? When do you go for funding?
A: (Raj Joshi) It depends on the founders. If you are able to fund the company yourself (boot-strap), you should use that to go as long as possible and then look for funding via VCs. Typically if you don't have a product or service to showcase the possibility of getting funding is low but not 0.
Let me give you one example. One of my mentees got several million dollars in funding from a renowned VC based on a business plan. What helped is that he has a track record and has helped launch India-based subsidiaries for global Tech companies. But for students, you don't have that credibility or track record so the ideal situation is to get in the business for a few months, make sure you have a very good handle on your product and have a good financial forecast, and then approach (Angel) VCs for funding.
So give it a try and pitch a few VCs, what's the worst that could happen? You don't get funding, no big deal and you'll learn a lot in the process.
Q: Are there any dark secrets about Funding? Do you need to go about understanding those dark secrets before asking for funding?
A: (Vijaya Verma) Haha, hmm... There are no dark secrets as such for funding. I'll let you know when I find one.
(Haresh Kumbhani) The idea that you need to find the right level of support at right time (stage) is really important. This is where you start connecting and networking with people who've done it before, somebody who has done it before and thus can guide you. That's where you have the benefit of having us, we have experience in the whole process, I'm sure each of us has unique experiences and learning with which we can guide you. We know Venture Capitalists in India, we can connect you with them where you can ask for their feedback.
(Vijaya Verma) I want to add that, Angel networks have their websites where you can approach them easily, you don't even need recommendations to approach them so I just you can do that as well.
(Raj Joshi) I have a dark secret to share, well you can't call it a dark secret but generally, the person who has the money has the power. Just be aware that VCs know it too.
(Haresh Kumbhani) I have something to share too, some of the VCs have fancy offices here in Sandhill road, Silicon valley they will make you nervous and make you feel like you're in Dragon's den. One of my friends Carl Russo went to the VCs wearing shorts and flip-flops wearing a turned t-shirt. [In a humorous mood] The crazier the look the more chances you have to get funded in Dragon's den.
Q: We're a FinTech startup, which type of VC should we go to? Should we go with Angel, VCs, or Micro VCs? We also have the possibility to turn it into a Software product.
A: (Vijaya Verma) I think you should go for Startup VCs I described earlier. Because I know people in the zone who fund FinTech startups. You should go for smaller VCs, generally with a portfolio of around 20 companies as even the money you need won't be that much so it's better to go for those kinds of VCs.
Q: As a Startup, our valuation depends upon how much risk we've reduced right? So suppose our company's net worth is 5 lakhs and if we need to raise 25 lakhs won't we need to give up a big chunk of our company?
A: (Raj Joshi) Yes, if you want that money based on that valuation you need to give up equity. Whether it's a big chunk or the size of the chunk depends upon your idea, the product, and the founders as well. Remember, it’s always a negotiated process, you don't have to accept what VC is offering. Typically successful entrepreneurs will get multiple term sheets meaning multiple VCs will give you multiple offers and then you have to calculate the Valuation and figure out Pre-money, Post money, etc. all those good things. But if you have a good idea and your team is strong, the money will chase you and that's where you need to be. It is all dependent on the idea.
(Vijaya Verma) Don't give away >50% of your company, I made that mistake. You may feel overwhelmed by the money coming in but don't give away too much of your company.
(Mitesh Desai) Another thing to remember is that it's not the current valuation that you have that determines what % of the company you'll give away. It depends on how big your idea is and what your growth potential is. VCs will look at that and offer you a term sheet that determines what % of the company they want.
(Haresh Kumbhani) Remember that term sheets are not final so you can go back and negotiate.
Q: Is there a way to increase the company's valuation? Like proving the sales potential for the future? Besides financials, how do you increase company financials?
A: (Mitesh Desai) There are more factors than just financials that go into Valuation. The team itself holds significant value. So if you have an experienced team or a team that is complete meaning you have all the people based on your needs as a startup to be successful drives a lot of value to your company. The idea itself has great value. Sales are an indicator of how successful you will be. So it's important to focus on present revenue and factors like having a team, having well-defined roles within the team, and showing the confidence that you will deliver based on what you're pitching for.
Q: Investors are potentially quite disruptive, whenever investors get on the founding team's responsibility is to make the investor happy and It can change the priority of the business, what to do about it?
A: (Vijaya Verma) Yes, for my first startup the first VCs were good but we had problems with the second VCs. They were keener on getting to a point and selling the startup while I was a founder was more focused on taking it further with my vision. It was quite hard for me to convince them because every now & then they'd say things like your revenues aren't growing, let's just sell the company and so on while I would say just give us some time, there was this tug of war situation. That is where the Team plays an important part because if you have an equally strong and supportive team that is aligned with your vision then you can fight the VCs to lead your idea forward. So it happens all the time and that's why you should be confident about your idea and move ahead with your vision.
Q: Are VCs primarily looking for returns on Investments and put pressure on founders or Are the VCs really like Partners?
A: (Raj Joshi) It depends on the Investors and the Founders. Of course, the Investors have only one objective, They want to maximize their returns. If they feel Founders are going in the wrong direction they will try and influence them. Investors also help open new doors. It's great if the relationship between Investors and Founders is open, good, constructive, and positive, both sides must respect each other, when that happens it can be very additive.
(Haresh Kumbhani) I would say from my experience that the relationship between Investors and Founder is a Love-Hate relationship. Often, investors will tell you what are you doing? You're stupid! You're thinking too small, they may throw obscenity at you, etc. They're the kind of VCs you need, they're the ones who care about you. We as founders get quite emotional at times saying I got yelled at, I got sliced and shredded, etc. but the next morning you wake up and you're ready to bounce. VCs are the proxies of the real world out there, they train you. So VCs are your Coach at any level but they're not your friends.
Q: How to identify VCs? How to approach Venture Funding?
A: (Haresh Kumbhani) Generally all the prominent VCs are approachable especially for Seed funding they have their websites and contact info and even have the option to send them your Pitch.
You need to understand your size, like how much money do you need? What stage are you in? etc. to get to the right type of VCs based on your needs. Some of us who are available will help you in this case.
Q: What does an Investor look for in you except the Pitch?
A: (Vijaya Verma) VCs definitely ** look at you as a person, in your vision and the way you project your vision, your team. So the leader and your team are the important
(Mitesh Desai) The person, the passion, and the ability to bring the team together are what counts. The pitch has to be solid but it’s the people which are your biggest assets.
(Raj Joshi) They will look at your Passion and at the Vision you have for your company. Are you wanting to change the world? Are you looking to become the next big thing? They will also look into your Soul to see if you're humble, serious, and genuine? These attributes are subjective and soft but make a huge difference.
(Mitesh Desai) A good VC friend of mine told me while I was preparing to pitch, "Look, what we (Investors) look for while investing is a schizophrenic founder. You have to be confident that you're gonna rule the world and you'll be scared that you'll be wanting to fail."
(Haresh Kumbhani) I want to add a few things. One is Language, a lot of people stress about the language as a lot of people think that just because they are not fluent in English it will affect the pitch. A lot of founders in Silicon Valley are not Native English speakers. It's your Idea and Vision that speaks for you and you just need to focus on communicating that confidently to the investors. Language doesn't matter that much. The second thing is the comment that 90% of Startups fail is the general statistics, so many founders ask the question, Why even bother? I want to ask this to others on the panel as well because I've seen people who like to fail and they fail and keep coming.
(Raj Joshi) There is a reason why Entrepreneurs tend to be Serial Entrepreneurs. You shouldn't fear failure. Most successful founders hit success in their second or third try. When I look back at my own life, I've had failures early on but they only helped and inspired me to try and go on.
(Mitesh Desai) Failure is what drives most entrepreneurs. They want to do better next time. They want to learn from it, they wanna be successful and that constant drive of being successful is what makes them successful in the end.
(Vijaya Verma) You said 90% of startups fail which means 9 out of 10 startups will fail but when I started I just thought I'll be that 1 startup that will succeed. That's the confidence you need to be an entrepreneur and that's how you should approach it when starting. Later on, you will develop the trait of learning from failure.
I want to end this article or notes from the webinar with a very popular Silicon Valley saying,
