Selecting your investors

Startups are usually not in a position to be choosy about whom they can accept funding from, and quite often after a number of rejections end up taking money from whoever willing to fund them.

However, while signing up your investors, it is critical to check the following:

Will you enjoy working with them? While this is a difficult one to take an objective view on when you really, really need their money, it is a critical question to ask. Attitudes to investee companies, style of working, matching of personalities are critical components in ensuring that investor & investees enjoy working with each other. In startups, in my view, it is ideal that the founders and investors can have a friendly relationship. And this does not mean not being professional… but an easy going, non-formal style of working is helpful in a startup stage when things are not going to be as predictable as they are in a growth stage company. 

Is the personality, ethics, value system, aggression, compassion, etc. of the investors in line with the personality of what I want to build. Different people have different styles of operating and if these styles are in conflict, it may lead to disagreements in how you handle the business, especially how you tough situations.

What’s their outlook to your business and are they willing to wait out the difficult times? While your investors and you may agree with the potential, some investors have a ‘spray and pray’ approach. I.e. they invest in many companies, especially in emerging sectors, and see which ones quickly show signs of success. They are quite happy then to disengage with the slow movers and back the early-successes. In such situations, if your startups does not really take off as expected, and most don’t, you may be left in a corner.

Do they have experience of working with startups at your stage. There are clearly different investor groups who specialize in different stages of the company. Angel investors will invest in the concept stage, early-stage VCs will invest in the post proof-of-concept stage and VCs/PEs will participate in the scaling-up stage. Different stages of a company require different competencies and therefore different interventions from the investors. Investors who usually deal with growth stage companies may not have the patience or experience in dealing with the nimbleness and direction changes that a startup may have.

Of course, it helps to connect with companies that the investors have funded and understand about their experiences with the investors. 

Managing investor relationships

Companies with a healthy relationship with their investors are happier companies. Unhealthy relationship between investors and founders can be quite stressful. That’s why it is critical for startups and their investors to work as a team and be on one side of the table.

While some responsibility of ensuring a healthy relationship is obviously with the investors, founders have a critical role to play in this process.

Clarity on goals and objectives

The starting point of course is to ensure that your investors and founders are aligned on the goals & milestones and objectives of the company, and the parameters on which progress is to be measured.

Agree on the communication and intervention processes

Getting investor agreements on the periodicity and format of reporting and engagement is helpful in ensuring that the intervention is structured and planned. A monthly review is suggested for startups, though in concept stage companies founders may benefit from the experience and the business relationships of investors and hence may engage more frequently.

Communicate early on challenges and issues

No one expects to have a smooth journey and challenges and roadblocks are part of the journey. Your investors are critical stakeholders in your progress. Hence, if there are challenges and issues, often investors can assist with solutions. Communicate early and be transparent.

Reporting and templates

Investors and founders should agree on the format for reporting progress. A template that captures the key parameters should be drawn and presented every month to investors.

Have formal board meetings, including structured meetings with your advisory board members

Apart from it being mandatory governance requirements, quarterly board meetings are a good forum to engage with a wider group of stakeholders where progress, challenges, issues and direction changes, if any, can be discussed.

The process of pitching to investors

Often first-time entrepreneurs underestimate the time it may take to raise funds for your startup. 

Unless you get seriously lucky or have easy access to a number of investors, it is prudent to estimate anywhere between 3 – 6 months to get funded. And that is if you have a good plan and a great team.

Well, its relatively easier with angel investors and much easier with angel groups like the Angel Investors Consortium. That’s primarily because they invest smaller amounts in a wider range of companies but also because individuals are making decisions and hence do not have to go through more complex processes of VC funds.

Here are a few steps that are involved and approximate time it could take with angel investors:

Step 1	Identifying the right investors	2 weeks
Step 2	Getting the first meeting, including time taken for trying to reach someone to get meetings set up	1 - 2 weeks
Step 3	Meetings with the evaluation team	1 week
Step 4	Presentation to Investment committee	2 weeks
Step 5	Term sheet	1 week
Step 6	Term sheet agreements	1 week
Step 7	Due diligence and signing of documents	1 – 2 weeks
Step 8	Funds hit your bank
Total time		9 - 12 weeks

Here are a few steps that are involved and approximate time it could take with institutional investors:

Step 1	Identifying the right investors	2 weeks
Step 2	Getting the first meeting, including time taken for trying to reach someone to get meetings set up	2 – 4 weeks
Step 3	Meetings with the first layer of filtering	2 weeks
Step 4	Meetings with the senior layer	2 weeks
Step 5	Internal presentation to Investment committee	2 – 4 weeks
Step 6	Term sheet	1 week
Step 7	Term sheet agreements	2 weeks
Step 8	Due diligence	2- 4 weeks
Step 9	Signing of documents	1 week
Step 10	Funds hit your bank
Total time		16 – 20 weeks

And these are fairly optimistic timelines with the investors who finally fund you. There will be several you would meet who may, out of genuine interest to invest, progress the discussions but may not conclude the deal for several reasons. And there will also be many who may decline to invest in the first meeting itself but still it will have taken 4 – 8 weeks to get the “No” as an answer.

Given the lengthy process, the entrepreneur should try to be selective about which investors they should approach. Investors, especially VC funds are clear about the kind of companies, the stage and the domains they would invest in, and that information is usually available on their websites.

One of the first things that entrepreneurs need to do is make a shortlist of who the ‘right’ investors would be.

• To begin with, you need to decide if you are ready for angel investors or for VCs. Click here to know more between VCs and Angel Investors.

• When applying to investors, check their websites and see if they have invested in businesses similar to yours and if your domain is within their interest areas. E.g. if you are a life-sciences company, there is no point in approaching investors whose focus areas are Mobile & Internet and Consumer Businesses. 

• Check if there are synergies between any of their portfolio companies and your business, and if there are, then evaluate highlighting the same during your presentation.

• From among the many people at the VC, identify who in their team is more likely to be excited about your idea. This is easy to find because most VCs will have profiles of their team members, including details of which companies or domains that person is involved with.

Once you have identified the investor, and the person who you are going to connect with, try seeking an appointment by making a call to the office. Most likely, you will be asked to send the presentation to a generic mail id used for receiving business plans. Well, this is not something that you can always avoid. The truth is that investors get so many calls and mails requesting for meetings that it is almost impossible to accept all requests.

In most VC offices, business plans received will be reviewed with some level of seriousness, though most probably by the junior most executives who may not necessarily be experienced at taking a gut feel call on what seems like a good business case. If you are lucky to get past this stage, you will be asked to come and meet an associate. And that’s just fine. This is the first line of filter in a VC fund and an associate is expected to do a thorough evaluation based on their internal criteria, and then if and found suitable, are expected to move the deal up to a partner who can decide if the deal is to be presented to the investment committee.

If you pass the first line of filter in a VC fund, and this can take a few meetings, you would have to present to the next level. This round, depending on the interest of the fund, could take a few meetings with revisions and discussions on strategy, scale, funding needs, etc.

Once there is broad agreement on key areas, and if the deal fits into the internal criteria of the fund, the deal will be discussed at the investment committee meeting where the terms of the term sheet will be outlined.

After presenting the term sheet, the entrepreneur is expected to run it past someone who knows the legal stuff around term sheets…. And when you ask someone’s opinion, the person feels it obligatory to suggest a few changes. It then takes a few meetings and discussions to finalize the term sheet and sign off.

NOTE: some VCs would discuss the terms of the term sheet offline over meetings and dinners, and therefore the draft presented to the entrepreneur on which there is an informal agreement on key points like valuations, control, vesting, rights and downside protection. However, the time taken would still be approximately be the same.

Once the term sheet is signed off, the due-diligence will start. Also, the startup may have to complete some tasks as part of the ‘conditions precedent’ and that could be things like filing for patents, getting an independent director on board, getting customer contracts signed, etc.

After all this is done, the final signing of the documents and receiving the cheque are the logical next steps.

Understanding valuations

Simply put, valuation is about how much the shares of your company are valued at.

In a private limited company, ownership is decided on the basis of equity shares. The % of shares you own defines the % of your ownership of the company.

Let us understand with an example. I am of course over simplifying for the purpose of ease of explaining and understanding.

Ramesh and Suresh start a company. They both own 50% each of the company.

A few months later, Ramesh and Suresh approach an angel investor who decides to invest Rs.50,00,000 [INR 50 lacs / USD 100,000] in their company for which he takes 20% of the company. In this scenario, the post-money valuation of the company would be Rs.250,00,000 or Rs.2.5 cr [USD 500,000]. This is because Rs.50 lacs got the investor 20% equity, so the value of 100% is Rs.250 lacs or Rs.2.5 cr.

Stated differently, the company got a pre-money valuation of Rs200,00,000 or Rs.2cr [USD 300,000]. In this scenario, Ramesh and Suresh now own 40% each in the company, with 20% being owned by the investor.

Later, the company decides to raise Rs.10 cr [USD 2 mn] from a VC who takes 20% of the company. In this scenario, the post money valuation of the company is Rs.50cr [USD 10 mn]. Stated differently, the company raised Rs 10 cr at a pre-money valuation of Rs.40 cr [USD 8 mn]. With this round, Ramesh, Suresh and the angel investor each get diluted by 20% and hence the capital structure or cap table stands as follows:

            Ramesh                       32%

Suresh                                    32%

Angel Investor             16%

VC                               20%

In both the rounds, the money invested by the angel investor and the VC has gone into the company and not to Ramesh and Suresh.

Going further, the company does well and the VC decides to increase their holding to 26% and offers to buy 6% of the shares held by the angel investor for Rs. 10 cr. [USD 2 mn]. Now, the valuation of the company is Rs.166 cr or USD 33mn. Even at this stage, when the valuation of the company is Rs 166 cr, Ramesh and Suresh have not made any money. However, the angel investor has had a successful exit with a 20x return on his original investment, and still retains 10% in the company.

At this stage, the capital table will look like this:

Ramesh                       32%

Suresh                                    32%

Angel Investor             10%

VC                               26%

At a later stage, Ramesh and Suresh decide to dilute their holding and decide to sell 5% equity each to another VC for which each get Rs.20 cr [USD 4mn]. At this stage, the 2^nd VC decides to also buy the 10% held by the angel investor for Rs.20 cr. Hence, now the valuation of the company therefore is Rs.200cr or USD 40mn, and the cap table will look as follows:

Ramesh                       27%

Suresh                                    27%%

Angel Investor             ----%

VC                               26%

VC 2                            20%

This of course is a rather simplified version of reality, but done only to illustrate the concept.