Starting Up The Right Way.
It’s the theme song from Jaws that they’re playing for venture capitalists (VCs) these days. Ask Sangeeta Murthi Sahgal of Lumis Partners, who was recently welcomed at a dinner party to the predatory chords of the 1975 movie, played especially for her benefit.
Even now, at The Indus Entrepreneurs (TiE) seminar in July, Sahgal is busy soothing suspicion away. “We’re not here to take your baby away,” Sahgal assures a room full of young entrepreneurs asking wary questions about venture capital funding for their start-ups. “VCs don’t just want to extract — we want to support growth. We’re on the same side,” Sahgal tells them reassuringly — a far cry from the days founders assiduously wooed venture capitalists, usually after they had exhausted the three Fs, friends, families and fools, for funding their start-ups
Then the pendulum swung over the other way and waves of funding made paper millionaires out of computer programmers and first-time entrepreneurs, raising millions in financing at steep valuations – too much money chasing too few real deals, contributing to the dotcom bust. Today, both founders and funders are better evolved and more circumspect – and more evenly matched – when it comes to start-up funding.
No one’s arguing that today’s founders have much easier access to funds – more plentifully available – than ever before. But what is striking is how little control increasingly assertive entrepreneurs are willing to give up today in return for capital compared to before and how savvier they’ve become in evaluating the quality of funds available, especially in terms of their non-monetary and intangible value. Today, venture capital is the most expensive source of funding, with fund managers expecting 30-40 per cent return on capital. If there is still demand for such funds, compared to the more patient and less demanding traditional sources of funds like bank loans at less than half that cost, it is because of non-financial (and non-obvious) benefits like the networking, mentoring and social and professional validation that VCs can provide.
“Business doesn’t happen on excel sheets. I’m looking for constructive engagement,” says Rajat Chauhan, a sports-exercise medicine & musculoskeletal physician, explaining why he would still prefer more expensive venture capital to cheaper bank loans to scale up Back 2 Fitness (B2F), his rehabilitation and sports physiotherapy clinic, to a chain of six within the national capital region (NCR). (Disclosure: I’m a full-paying client)
Chauhan is not just looking for funds, but networked and mentored funds — intellectual capital combined with venture capital.
“With a bank loan, I need to mortgage an existing asset. My experience has zero value. VCs don’t need a tangible collateral — you can leverage your future earnings or business, and they are your partners in risk,” Chauhan says. So in addition to the inherent Indian middle-class unwillingness to stake more than a certain portion of one’s own funds (Valley entrepreneurs are usually willing to risk larger proportions of their personal fortunes), first-time entrepreneurs like Chauhan actively seek the invaluable early-stage advice offered by experienced VCs.
But although venture capital funds may be the most visible part of the spectrum, there are several others. To better understand the start-up funding ecosystem (the last of my three-part series on painting the entrepreneurial landscape) think of a spectrum that begins with the founder’s personal credit, whether bank or 3F loans, and spans across to venture capital firms. Fitting between the two ends of this spectrum are seed funds and angel money.
Angels are independently wealthy individuals, singly or banded together like Bay Area’s Angel’s Forum, the Mumbai Angels or the Indian Angel Network. Any city that has vibrant entrepreneurial activity, is sure to have angel syndicates. (AngeslSoft and the Angel Capital Association can connect you to angels in North America, Canada and Mexico — and a really cool connector is Angel List, a site that matches entrepreneurs with investors, making financing hugely more independently accessible.)
Seed firms are like angels in that they invest relatively small amounts at early stages, but like VCs in that they’re companies that do it as a business, rather than individuals making occasional investments. Seed funds can also serve a dual role of incubators, like the Valley-based Y-Combinator or its Indian avatar The Morpheus that “engages with start-ups in the most crucial phase of their existence, the first 12-18 months, the...valley of death,” phase says its website.)
Managing investors is one of the most important skills founders need to learn — and they’re learning quickly. Today’s entrepreneurs aren’t rushing blindly to take money wherever they can get it. Instead, they are evaluating the quality of the money on offer, biding their time and more often than not, saying no, or not now. According to a recent New York Times story, founders in the Valley have gone a step ahead and learnt the art of taking the money as well as keeping the control.
“Entrepreneurs are right in being wary of taking venture capital,” says Ritesh Banglani, vice-president at Helion Ventures, which manages funds worth $350 million in India. It’s not just the expense, but that all venture capital funds are, by definition, finite-time funds and come with an inbuilt assumption of an exit, linked to the life of the fund. If a business cannot provide an exit to the investor within that time-frame, that venture capital may not be the right kind of financing for that company - at least at that stage.
Entrepreneurs also need to understand that the timing of accessing funds over their venture’s life cycle is as critical to the success of their venture as their reasons for choosing one source of capital over another. Especially because a start-up may need several rounds of funding before it matures and different sources depending on which stage of its life cycle it is in — seed funding in the early stage and venture capital funding at a more mature stage may work better.
Banglani looks for an ability to scale the company up very rapidly “from zero to an IPO-able valuation in about seven years.” And this is precisely why technology ventures score high with VCs since by their very nature, they are non-linear businesses. So if your business model is consumer-oriented, highly profitable and replicable, process-dependent and rapidly scalable, it is a sure pick for a VC, especially if you have a good management team in place.
Meanwhile, angel money is gaining popularity because it is more patient and less demanding – with lower expected returns and fewer restrictions – it gives founders the freedom to take it slow and stay in control. Angels may not necessarily even be looking for an exit and could be happy merely with dividends.
The trick, however, is to look for professional angels who understand the business and can evaluate the risk involved, not cash-rich individuals who only provide hot money.