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  • Writer's pictureJyoti Pande

Plethora of investors: As negotiating power of startups gets stronger, overvaluations can be a chall

Sep 6, 2015, 10.48AM IST By: Jyoti Pande Lavakare

Anyone who has been tracking the Indian entrepreneurial ecosystem closely, couldn't have missed noticing the explosive growth and exponential interest by investors in every sort of startup, online or offline, in the past 18 months. Since January 2015, that interest seems to have reached a climax. According to some analysts, it almost seems like there is more money sloshing around than there areentrepreneurs and ideas. Investors and entrepreneurs alike seem equally bemused by the number of deals on offer and the rapid pace at which they are going through.

"Both, in terms of quantum and quality of entrepreneurship, the ecosystem is much more active. Our own deal flow has more than doubled. We are seeing better quality of ideas, the number of entrepreneurs have increased sharply," says Ritesh Banglani, partner, Helion Ventures. Paula Mariwala, executive director, Seedfund (and part of its founding team since 2006) and president of the recently formed India chapter of Stanford Angels & Entrepreneurs, is more vocal.

"There are many more good quality deals. In the past, what was missing was the early adoption data. No one had a role model. Those companies were the pioneers. Today, the quality of entrepreneurs has changed. They are much more confident — they do their homework and have thought their business plans through. Another difference is that they now also have familial support," she says.

Even among the most conservative of Indian families, it is now "cool" to be an entrepreneur. Seedfund has invested in Carwale, an automotive website, and RedBus, an online inter-city bus route aggregator, inventory manager and ticketing platform, as an early stage investor.Entrepreneurs have their own stories about being in the enviable position of choosing their investors and the colour and character of their money. "Investors have been approaching us even before we are fully ready to receive funding," says Tithi Tiwari, cofounder of virtual reality startup SmartVizX.

The product design virtual reality tech company came into existence only in January 2015, and has already been sounded out by several big investors. These include exporters, high net-worth individuals and businesses, and even an Ernst &Young partner (telecommunications), in his personal capacity.

"I was surprised; even the amounts were quite large — over `50 lakh of personal wealth," says Tiwari. "However, we are being circumspect about where we get our funding from because we want to partner with the right profile of investors, someone who will bring in intellectual capital and domain expertise, apart from just money. We want investors who can help us grow and add value to the team."

Even a brick-and-mortar startup like Ducere Technologies, which manufactures a physical product like its tech-embedded haptic shoe — enabling it to measure itself on more tangible metrics — faces a similar dilemma.

"Whose money do I take — that is the more challenging task for me today," says Ducere founder Krispian Lawrence. His company makes bluetooth-enabled haptic shoes called Lechal, originally meant for the visually impaired but reinvented as wearable technology for all. Lechal shoes will begin selling globally on Amazon (and in India on Flipkart) in 17 different styles from his factory in Secunderabad by November 2015. "What is the additional value I can get from an investor? I want to build a company that is value-driven, not valuation driven. I should be able to justify the valuation of my company," says Lawrence.

For entrepreneurs, this seems to be the time that any idea worth its salt can be assured of funding, which is quite a change from a couple of years ago, when young founders were lamenting the lack of adequate funding, be it of the angel variety or venture capital (VC). Today, the balance of power seems to have shifted in the other direction and founders are spoilt for choice. In some cases, they are turning away investors or renegotiating almost-done deals.

Mariwala mentions several cases where entrepreneurs negotiating with her early-stage funds have walked away at the last minute because another investor offered them a higher valuation. "We are losing deals because of a mismatch of perceived valuations," she says. With the negotiating power of startups getting stronger and their "term sheets" increasingly ending up more and more on their terms (a process that used to be dominated by the investor) overvaluations can become a very real challenge.

While some entrepreneurs are using the relatively easier capital to drive up valuations, others are using the multiple choices they have of ready investors for obtaining more intangible value. They want to pick their investors as much for their rolodex (networks and contacts) and their minds (mentoring and handholding) as for the money they can bring to the table.

"The entire way of doing deals has changed," says Mariwala, warning that the easier money could dilute some of the discipline of building out a strong company slowly, from the ground up, bootstrapping for longer. "India is still a tough place to execute and do business," she says. "It is also important to see how much money is being burnt in early stages."

TiE Reverse Pitch A recent event by The Indus Entrepreneurs (TiE), a not-for-profit global network of entrepreneurs and professionals, actually had a session in New Delhi called "Reverse Pitch — Show Me Your Money" with investors pitching to entrepreneurs, rather than the other way. At least 10 early-stage investors, individual angels and funds introduced themselves to a roomful of entrepreneurs in the education space last month, exhorting entrepreneurs to take their money. "Investors have seen value in entrepreneurship in terms of people making money. They have seen the exits, so more (people) are encouraged to come in and invest," says Upasana Sharma, director, TiE Delhi-NCR. "The balance of power has really shifted in favour of entrepreneurs. Every week there is a new fund, an accelerator, an incubator. It is never-ending," adds Sharma, backing up her anecdotal evidence with a long list of new funds and investors that have entered the Indian startup space in recent months. "It feels almost like a bubble," she admits. But it's not just new angels and VCs that are entering the fray. "I'm seeing several HNIs and old money ready to invest in startups," says Mariwala. When asked why, she points to the ads playing on prime time television. "Everyone is seeing ads for Flipkartor Quikr or Snapdeal or some other startup. The writing is on the wall — this is where the growth is. The old economy seems almost passe." Sharma agrees. "There is an absolutely new breed of people out there. The purpose of our Reverse Pitch session was also to introduce these (newer investors) to entrepreneurs, to introduce some of the newer players to the system." The session saw a handful investors introducing themselves who had no links with the original ecosystem.

A New Breed of Investors And then there are the entrepreneurs turned angels. These include employees of successful companies who made money from their stock as early joiners and serial entrepreneurs who may even have exited a company or two. "It isn't just a need to diversify their risk by diversifying their portfolio. It is a real desire to pay forward. To help younger entrepreneurs, give them a leg up," says Banglani. That idealistic view may well be true, but there are enough herd investors who want to tag along for the ride as they see value being created in new companies — basically everyone with some cash to spare and an eye on where the growth is coming from. "Which is not a bad thing," says Banglani, pointing out that co-investing and open syndication are globally accepted practices.

"The inflexion point was when the Flipkart-Myntra deal happened (in May 2014). That shook up the system. Everyone sat up and took notice. Even the old money - the ultra-rich HNIs - sat up and took notice. It was like the whole paradigm had shifted," says Mariwala. What added fuel to the fire was the enthusiasm of what Mariwala calls the "Chinese dragon" effect from overseas funds like Tiger Global, Soft-Bank and others which are very bullish on south-east Asian and Chinese markets.

For example, Tiger Global, although headquartered in New York, has offices in Beijing and Mumbai and its investments in Indian startups have risen exponentially. In just five months of 2015, it disclosed investments in around 17 companies and participated in rounds that total about $1 billion. Soft-Bank's overall investment in Indian e-commerce stands at about $1 billion, spread between, Snapdeal and Ola Cabs and, despite some hiccups, it has publicly stated it wants to invest almost ten times more. Having such heavyweights around not only gives early-stage investors a chance to exit their investments, but also a validation for their confidence in Indian startups.

"The good news is that it (easier capital access) gives entrepreneurs more opportunities to take their ideas to proof-of-concept. The only downside is that with so much money in the system, some entrepreneurs hold out for higher and higher valuations, which may not necessarily yield the returns expected," says Sharma.

"If the intention of entrepreneurs is just to negotiate up the valuation, then this is shortsighted and won't last. Intelligent entrepreneurs who don't just want money but also want to leverage a relationship with a highquality investor are getting to know multiple investors before committing. It reflects that the entrepreneurial ecosystem is becoming more mature," says Rahul Khanna, managing partner, Trifecta Capital, one of India's first venture debt funds. Venture debt is a form of speciality debt financing that helps minimise dilution, so founders get to keep a higher share of equity.

According to Mariwala, the lines between seed, series A, B, C and venture funds are blurring, as more and more investors try to enter at earlier stages of a startup's life. "The late-stage people want to get involved in early stages, and early stage in seed rounds. The cheques are also getting larger," she adds. Khanna agrees. "I hear of pre-seed rounds these days" he says, only half jokingly. Trifecta works with founders to help solve the typical concerns of excessive dilution, inadequate runway, and aggressive milestones that affect valuations when raising capital. Analysts agree that it is early-stage investments that are seeing the maximum activity. "More and more investors want to move upstream, to earlier stages. Everyone is trying to catch valuations before they become unaffordable," says one Delhi-based angel investor. "But Series C rounds are still taking their time to close," he says, referring to later rounds. Banglani is more cautious in his view.

"These terms — seed, venture capital, series A, B, C — were always fungible. We (at Helion) are predominantly players in early-stage entrepreneurial activity. But overall India is still by and large capital-starved. Relative to the amount of activity we are seeing, the ecosystem can absorb more capital," he says.

Banglani makes an important distinction between smart money — well-informed professional investors who track startups and have their ear to the ground, focussing on longerterm value — and the tag-along, herd investor looking for a quick buck and quicker exits who end up crowding "popular" niches.

"By and large, most of the money coming into tech startups is still smart money," he says. It is the overcrowded and somewhat overvalued niches like hyperlocal delivery startups that are already hyperinvested that are beginning to see signs of a slowdown of interest, say analysts.

The recent volatility in global markets may have a cascading effect on the Indian startup ecosystem and investors may become less generous with their chequebooks. "The overall broader stock market volatility could begin to translate into a decline," says one analyst. Which means entrepreneurs could soon be back at working harder to fetch higher valuations and building value. Another business cycle, another day.

(The writer is an independent columnist and writer)

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