While some investors may favor service startups, in general most VCs would rather invest in a product startup. This is because unlike a service startup where the revenue potential is linear and headcount dependant, a product startup has the potential for non-linear growth
How does the deal work out whenCo-investment or syndication is normally done if the amount of funding required by the startup is too large for the appetite of a single investor or an investor wants to spread the risks associated with an early stage startup or there is expectation that the other investors bring in significant strategic business value.
two or three investors come together to fund one startup?
In a co-investment scenario, typically one investor takes the lead and is called a "lead investor." In general, the lead investor is the one who sources the deal and sets the deal terms (for example deal structure, valuation etc). However, in some cases, co-investors may jointly negotiate the deal with the founders and share the investment amount and responsibilities equally. Depending on the structure of the co-investment model and number of participants in the round, board representation and certain other investor rights such as information rights etc would be negotiated with the startup. Again depending on the model, there may be board representation only for the lead investor with observer status to other investors. In such a case, the lead investor on the board will be representing all the investors in that round. For the co-investment model to work, it is important to ensure that all investors speak a common language and share the overall vision and direction of the company.
How does a VC make money by investing in a new business?
VCs who invest in early stage businesses normally make money by unlocking the value built in the business over a period of time. During an early-stage investment, risks are fairly high and therefore the valuation at which the VC enters the business is low. Businesses who take in VC money are expected to build/create value in the business over a defined period of time. This value built in the business over a period of time is unlocked through an exit event whether in the form of IPO or sale of business or buyback of shares. VCs make money through this exit mechanism by selling their shares at a higher price compared to their initial purchase price. This is the reason why exit or potential of exit becomes very critical for a VC.
What legal agreements does one have to sign with the VC?
Legal documents that need to be executed with VC can be split into two stages, i.e. pre-investment stage and investment stage. During the pre-investment stage, VCs normally execute a term sheet with the startup. Post investment, VCs enter into a share-purchase-cum-shareholders agreement. The nature of agreements also depends on the practices followed by each investor. While some enter into a single-share-purchase-cum-shareholder agreement, some may split the agreements into multiple agreements such as share subscription agreement, investor rights agreement, voting rights agreement etc.
What are some tips for a business plan presentation to a VC?
Communicating the right message is very critical and at a minimum any business plan to a VC should talk about/provide evidence about the following:
- Pain or need is felt by a large number of customers and the market timing is right.
- Enabling mechanism/ecosystem in place. Product does not require multiple influencers or does not have multiple path dependencies.
- Macro trends/customer confidence is positive.
- Potential to reach out to a large number of customers/users.
- Absence of large, established, well-funded incumbents in the space and consequently the startup operates in a competitive vacuum.
- Product/service provides real and measurable value and is not trivial.
- There are identified budgets/buying cycles for the product.
- Product is well differentiated from the competition and competitive advantage can be sustained for at least 18 to 24 months.
- If the product is very easy to build and technically not challenging and is a pure execution play, and the team has demonstrated execution capabilities and has the right ecosystem relationships
in place. - If the company’s product is solving a well-defined problem in a mature industry, it has significant cost/performance benefits and has found a unique way of solving the problem as compared to existing established players.
- Business is capital efficient and does not require significant infusions of capital.
- Business has the potential to create value and wealth for all stakeholders.
Pavan Krishnamurthy
Pavan has over 15 years experience across various industries such as early stage investing, consulting, venture advisory, research etc. In the recent past, he has worked with Nadathur Holdings and Investments (an early stage venture capital firm focused on technology and life sciences ventures), SRW Advisors (an advisory and mentor capital firm that worked with entrepreneurial ventures in areas such as strategy, business model/plan development, finance, mentoring etc) and Syndicated Research Group (a US-based research advisory firm that provided research advisory services to senior executives of Fortune 500 companies in the domains of human capital strategies and corporate finance strategies).
To write to the author, please send an email to dare@cybermedia.co.in with the subject line 'Ask the Investor'.
Disclaimer: The views expressed here are that of the author and do not represent the magazine's.
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