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storytelling (funding your startup ep 1
THE BASICS OF FUNDING #startup
All set? Okay, let's look at some of the headlines that have been hitting the media over the past couple of years:
'Tiger Global invests $200 million in BYJU's; valuation jumps
to $8 billion" 'Walmart completes deal to buy Flipkart for $16 billion"
'India Startup Oyo Raises $1.5 Billion at $10 Billion Valuation"
Nandita Mathur and Salman SH, Tiger Global invests $200 million in BYJU's; valuation jumps to $8 billion', Livemint, 10 January 2020, https:// www.livemint.com/companies/start-ups/tiger-global-invests-200-million-in byju-s-11578570528442.html
Anirban Sen, 'Walmart completes deal to buy Flipkart for $16 billion'. Livemint, 18 August 2018, https://www.livemint.com/Companies/ qOBduC30BVpKTv9CpCYayH/Walmart-completes-16billion-buyout-of Flipkart.html
Saritha Rai, 'India Startup Oyo Raises $1.5 Billion at $10 Billion Valuation', Bloomberg, 7 October 2019, https://www.bloomberg.com/ news/articles/2019-10-07/india-startup-oyo-raises-1-5-billion-at-10-billion
'Warren Buffett's Berkshire Hathaway closes $300-million investment in Paytm"*
'Chinese investors are suddenly in love with Indian startups't
Sounds mouth-watering, doesn't it? Now here are some more:
India emerges 3rd largest ecosystems for successful startups # 'Indian startups raised about $14.5 Bn equity funding in 2019"
Yes sir, this is boom time in India's start-up world. And everyone seems to be getting massive rounds of funding. From angel investors, from VCs, from the US, China, Japan and, of course, India. Everyone is getting funding. And, therefore, so can you.
However, you must remember that the companies we have just spoken about raised this kind of funding after years and years of growth. And your own start-up is perhaps still in its early stages. You may get there, but you need to start small. So let's take it one step at a time, and examine how you will start raising money. Beginning with the first step-namely the family and friends' round.
Alnoor Peermohamed, Warren Buffett's Berkshire Hathaway closes $300-million investment in Paytm', Business Standard, 28 September 2018, https://www.business-standard.com/article/companies/warren paytm-118092700876_1.html
1T.E. Narasimhan, 'Chinese investors are suddenly in love with Indian startups, Rediff.com, 2 January 2020, https://www.rediff.com/business/report/tech chinese-investors-are-in-love-with-indian-startups/20200102.htm
* PTI, 'India emerges 3rd largest ecosystems for successful startups'. The Economic Times, 17 October 2019, https://economictimes.indiatimes.com/ small-biz/startups/newsbuzz/india-emerges-3rd-largest-ecosystems-for successful-startups/articleshow/71636451.cms?from=mdr
Jitendra Singh, "Indian startups raised about $14.5 Bn equity funding in 2019', Entrackr, 27 December 2019, https://entrackr.com/2019/12/startups raised-about-14-5-bn-equity-funding-in-2019/
The Family and Friends' Round
When you create a start-up, you obviously need money. For hiring people, for marketing your product or service, for developing and hosting your website, for operations such as managing inventory and deliveries, for the call centre that will handle calls to and from customers, and for just about anything else that your business requires. And the first place you'll check for money is your own savings. Hopefully, you still have some left after all the mandatory partying that life requires. Having done that, you'll probably go to your father, or your chacha or mama, and beg for money (begging is perhaps an exaggeration, but you get the idea). If you've maintained decent relations with your chacha or mama, there is a reasonable chance that you'll get something out of them. Even the reason is as simple as, 'Chal beti (or beta), zindagi mein kuchh toh kaam kar le (At least get something done in life).' And then, of course, there are your friends the ones who are not already neck-deep in debt because of their own start-ups. So that's the first round of funding the 'family and friends' round.
Now there are a couple of important issues that you must note here. First of all, all these people know you-or, at least, they think they do. You are not an unknown outsider who cannot be trusted (we will ignore the distinct possibility that you are a known person and therefore cannot be trusted). And, therefore, they might be willing to take a risk with you. Something that an external investor will not do. Maybe, just maybe, they also see some promise in you. Yes, they will probably look at your business, but they may not want to see the balance sheet of your company. In fact, they might even be willing to fund your idea even before it has taken off, because they know you. On the flip side, however, the amount they put in is likely to be small. To summarize, at this early stage you may be able to raise small amounts from your friends and family, without too many questions being asked. And then, of course, you start your venture-and soon discover
that
you
need far more funding. By now, of course, your chacha ormama say no, and, most likely, so do your friends. But you do need the money, so where do you go?
To angel investors, of course!
Angel Investors
Angel investors are the first external investors in your business. Those who do not know you. Why are they willing to invest in your business? Very simply because they want to make money. They have tried fixed deposits and debt funds, and have learnt that they don't make more than 7 per cent or so-and, of course, they pay tax on this interest. Some of them have tried out the stock market and made money, but they have realized that stock markets can at best give you around 15 per cent returns over the long term. That's it. Real estate is a good option, but the amounts involved are very large and the investments are illiquid. And anyway, real estate seems to be stagnating, at least in the foreseeable future...
And therefore, investors are constantly on the lookout for new avenues of investment. Something that can potentially get them much higher returns than these traditional investment options. Where they can park a small part of their investments, even if the risks are substantially higher. And what better place for this than start-ups?
Look at it this way. What are our unicorns such as Flipkart, Oyo Rooms and Ola Cabs valued at? Over a billion dollars each, isn't it? And in some cases, several billion dollars-Flipkart, for instance, was valued at $21 billion when Walmart bought it. Now, can you buy shares in any of these companies at this valuation? Unless you are a direct descendant of some royal family and have inherited pots of gold, certainly not. But-and this is a very important but could you have bought shares in these companies when they were toddlers and just about starting off? Aha! Sure you could have. And that, ladies and gentlemen, is the concept of the angel investor. QED.
Angel investors sometimes simply called angels are people who are either rich or at least comfortably off, and are looking at investing in companies at an early stage. In the hope that they will become the next Flipkartor Naukri.com. And since they have invested an early stage, they own a large chunk of the company's shares. whose value could increase dramatically when these companies grow ever so rapidly. So the word 'angel' is probably a bit of a misnomer they are very, very keen to make money. But they are also willing to ke a risk. They are, therefore, willing to help you out with funding when your business has not really stabilized and no one else is willing to fund you. And that is how they came to be called 'angel' investors. After all, angels are those who help you when you're in trouble, isn't it? However, to get back to earth, we know that all start-ups will not become unicorns. Many will simply die out. Some will plod along. But there will be those few success stories that will either become unicorns, or will be bought out by those that do. And that is what angels hope for. To invest in several companies in the hope that at least one of them grows rapidly and becomes a unicorn. Or is bought out by someone, who in turn is bought out by someone... till one of these 'someones becomes a unicorn. The other start-up investments may be worthless, but that doesn't matter-the angel is looking for those one or two start-ups that will make so much money for him that they take care of the losses of all the others put together. Now can you see the lure of angel-investing?
Most angels operate in groups, rather like a pack of wolves although, hopefully, the similarity ends there. We call these groups. angel networks. Each of these networks have several angels as members, and organize regular meetings-typically monthly or quarterly ones. If you are looking for funding, you would need to apply to one or more of these networks. Subsequently, the network goes through a process of shortlisting, based on which a few the start-ups are selected. These shortlisted start-ups are then asked to come to the next angel meeting and make a presentation which we also called a 'pitch session'. Here, the
For the moment, however, we'd just like to emphasize a couple of points. First, while angels operate in groups, their investment decisions are taken individually. The network might help its members in evaluating businesses and doing the necessary due diligence, but investing in each start-up is solely the decision of the individual angel. Secondly, the kind of money raised at this stage is typically between Rs 50 lakh and Rs 2 crore, with each angel putting in anything from Rs 5 lakh upwards. Indian Angel Network, Lead Angels Network and Mumbai Angels are a few of the well-known angel networks in operation when we were writing this book. By the way, many cities have their own networks, such as Chennai Angels, Hyderabad Angels, Jaipur Angels, Chandigarh Angels, etc. Interestingly, given the small amounts that each angel needs to invest, namely Rs 5 lakh, many of these angels are what we call 'aam aadmi angels'-those who are not super rich but still invest in start-ups. And then, of course. we have the real heavyweights-the super angels, such as the Infosys founders, Ratan Tata, Azim Premji, Sachin and Binny Bansal and Vijay Shekhar Sharma. Unlike aam aadmi angels, these super angels do not need networks. Once they decide on a start-up, they often decide to invest the entire amount in the start-up themselves.
Now let's assume you have raised your angel round. And hopefully you grow. And grow. And at some stage you need more money for more growth. Probably more money and at a higher valuation. Perhaps a million dollars, or the equivalent in rupees. Now that is typically beyond the reach of most angels. But you still need the money, so who do you go to?
Venture capitalists, of course!
Venture Capitalists
As you are aware, a venture capitalist, or a VC, manages a fund that takes in investments from either HNIs-high networth individuals or even organizations. These funds then invest the money in start ups, but usually at a later stage compared to angels. Now what we are about to say is extremely important, so please pay attention. No drowsing or nodding off. Angels invest their own money, whereas VCs typically invest other
people's money. How does that make a difference? Simple. If you are an angel investor and you happen to like a great but risky idea, you might be willing to put in a bit of your money. But if you are a VC, would you take the same level of risk with someone else's money? Clearly not (of course, if you do, you can never become a VC. Or, more likely, you will not remain a VC!). Which is one of the reasons why angels make early-stage investments and VCs make later-stage investments. Because at an early stage, the business is not proven and, therefore, risky. At a later stage, the business has stabilized, at least to some extent, the dud companies have been weeded out and, hopefully, investments carry lower risks. And that, ladies and gentlemen, is why VCs invest at a later stage, when a start-up has proved itself.
The other difference is that VCs invest larger amounts, which ties in very well with the fact that at later stages, start-ups do need much more funding. Typically around Rs 5-7 crore and above. Or if you find dollars more exciting, a million dollars and above. The flip side, of course, is, with the business having stabilized to some extent, valuations are also higher.
Don't get us wrong. Nowhere are we saying that VC investments are guaranteed to succeed. Of course not. But the business is more proven and, therefore, the risks are lower. And so, today we have lots of VCs around, looking for those juicy investments, Sequoia Capital, SAIF Partners, Bessemer Venture Partners, Tiger Global Management, SoftBank and Lightspeed Venture Partners are just some of them. And then there are the so-called micro VCs such as Blume Ventures, India Quotient and YourNest Venture Capital. These VCs typically get in at earlier stages and invest amounts that are somewhere between angels and conventional VCs.
And now for some yummy terms. Every industry has its own fancy terms, which people in that industry love to bandy around. So the computer guys talk about blockchain, Hadoop, augmented reality and so on. The bankers talk about bond yields, spreads, NIMS (net interest margins), etc. The auto industry brags about electric vehicles, hybrids and Bharat Stage VI. So what about our VC industry? Shouldn't it have its own unique terms that VCs can throw around at parties? Sure they do. And their terms are Series A, Series B, Series C... all through the letters of the alphabet. And sometimes, just to confuse you, there is also a Pre-Series A...
Sounds like fun? You bet it is. These are simply stages of investment. So a Series A investment typically raises $1-3 million. a Series B raises $3-5 million, a Series C raises $5-10 million, and so on. You get the idea, don't you? Series A is typically the first investment by a VC fund, Series B is the next one, and so on. And each stage gets a larger quantum of funding than the previous one. Of course, you must remember that these are only ballpark figures. So you could have a Series A investment that raises less than $1 million. or more than $3 million. There is no law against it. Just remember that Series A precedes Series B, which, in turn, precedes Series C and so on. And that also tells you what a Pre-Series A investment is. Something that is significantly less than a million dollars, but comes only after an angel round.
Dear reader, do you realize how important this section is? Because you are now armed with just the right set of terms with which to impress people at your next party. And if you drop these terms somewhat nonchalantly, as though you deal with such boring things every day, we can assure you that the effect on your listeners will be quite powerful.
IPO
If you have just about launched your start-up, you don't need to worry about IPOs, or initial public offerings simply because it's likely to be very, very far into the future. If at all. Essentially, you have to worry about it when getting your shares listed on the stock exchange, through an IPO. Now why would you raise an IPO? Well, there are many reasons. First of all, it gives all the investors including the employees who may have got ESOPs (Employee Stock Option Plans) an easy exit through the stock market. Valuations become clearly defined. And, of course, the special powers of the VC that the shareholder agreement provides (see Chapter 20) are gone. By the way, most start-ups never reach this stage. Biggies such as Ola Cabs, Paytm, Flipkart and Oyo Rooms never had an IPO. They simply kept raising larger and larger rounds of funding from VC's. On the other hand, you have Info Edge (the owners of Naukri.com) and IndiaMART, which have both floated IPOs,
Why Raise External Funding?
Good question. The first reason is obvious and we've mentioned it earlier-friends and family can only help up to a point, and whe you need larger amounts of money to scale up rapidly, you need to go to outsiders. That much is clear.
But that's not the only reason. Remember investors-whether angels or VCs-are typically highly experienced. And therefore they can add tremendous value to your start-up through mentorship. Because they now own part of your company and are therefore interested in seeing it grow and succeed. Also, they bring solid contacts, which your start-up can use. For instance, if you have a B2B start-up, just imagine the senior-level contacts and therefore potential clients your investors could ger you. And then, of course, the company gets credibility-so if a biggie such as Sequoia Capital or SoftBank were to invest in you, well, your customers would start respecting you, wouldn't they? To summarize, money, experience, contacts and credibility are all key reasons to look at investors for funding.
But hang on. Does every start-up need funding? Let's just step
back for a moment. Look at successful businesses around you. Look
at that highly popular photo studio in your neighbourhood. Is that business? Yes. Is that a successful business? Of course it is. Did they raise any rounds of funding? Most likely not-except perhaps from their family. And what about the highly rated nursing home just two streets away? Once again, highly successful, but which probably never raised any funding, except maybe a bank loan. In fact, you will see successful businesses all around you that are doing great work and perhaps minting money-just look at the Jaguars parked outside their homes. But most of them would never have raised external funding. In fact, we are fairly certain that only a small percentage of ventures actually take funding from outside.
So why has funding become so essential? The answer is media. parties and peers! 'I just raised a Series A round,' brags a founder at a get-together with friends. Of course, he forgets to mention that his venture is loss-making and is likely to remain so for a long, long time. But that's irrelevant. He's raised a Series A round-that's what matters. And the poor guy listening to him, who is actually running a profitable business without needing funding, feels left out. Maybe I'm wrong. Maybe I do need money,' he thinks. Or take the media. Every channel and its uncle blares out, XYZ company raises a Series B round. Or, 'PQR valued at over 100 million dollars. And the poor chap watching feels left out once again. You see? The environment is abuzz with valuations-Series A, B, C, bridge rounds, VCs and the like. And whether you like it or not, peer pressure forces you to act. Tune abbi tak Series A raise nahin kara? Koi problem hai kya? (You mean you haven't raised a Series A yet? Is there a problem?)' And so on.
Does that mean you do not require funding? Of course not! If you are building a solid product, you would most likely need money to build it. If you are in a business where rapid growth is the only way to stay ahead of competition, yes, you would definitely need funding perhaps lots of it. If you are trying to build a consumer brand, you have no choice you must raise money. But please remember, funding is not something you raise because it is fashionable. It is not something you do when your girlfriend (or boyfriend) starts, drifting towards Mr (or Ms) Series B. It is something to be raised if and when you need it. Remember, funding is not an end in itself-funding is a means to an end. and that end ix to run a successful, profitable business. Yes, if you do need it, there is no option and you must raise it.
Also, even if you do need to raise money, funding and valuations should not be your focus. Focus on building your business. If you can do that, the funding will come. Don't chase funding. Build a successful business, and let funding chase you.
The Impact of the Coronavirus or Any Other Crisis
Dear founder, that's a huge question. And at least part of the answer is obvious: Businesses have slowed down, even if temporarily, People have lost money. Most of them are not willing to take risks at the moment and are happy to park their money in a fixed deposit with their friendly neighbourhood bank. So what happens to angels? They are also people, aren't they? Quite naturally, they have also become risk-averse. That doesn't mean they will not invest, but they will perhaps be far more choosy. And that brings us back to our favourite theme-ensure that your start-up is PERSISTENT, and you stand at better chance of getting angel funds. By the way, this is true for any crisis, and not just COVID-19.
When funds are in short supply, PERSISTENT is the way to go. But what about VCs! Well, that's a slightly different story. Remember that angels have a choice they can park their money in bank fixed deposits. But the VC cannot. VCs have raised funds for a limited period, and they need to give returns to their investors. And so they will go ahead and invest. What's the message for you, dear founder? Well, if your start-up is at a later stage and you need VC money, you will probably find it a bit easier. But, of course, you still need to be PERSISTENT.
And with that, we come to the end of this chapter, We have looked at different kinds of investors, and we have also looked different stages of investment. We've seen why you need to raise funding. And why you don't. And now, assuming you do, wouldn't you like to look at the real thing? Wouldn't you like to meet start. ups that have actually gone through these stages? Including those that managed to raise funding? And even more important, those that could not and fell by the wayside? Wouldn't you like to understand the PERSISTENT approach? We're sure you would. And for that, there is one simple thing you need to do.
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