What Startups Must Know Before Raising VC

The four years between 2010 and 2014 saw funds to startups increase from $13 million to $1,818 million, while angel investments grow eightfold in the same period from $4.2 million to $32.2 million. In 2015 risk capital worth USD 9 billion was pumped into the sector, across 1005 deals. So , in effect, between 2010 and 2015, the sector saw 18 billion USD of investments. A large proportion is in online and mobility applications, because that is where everyone is expecting enterprise to go (net users in India stand at 350 million, according to a study by the Internet and Mobile Association of India (IAMAI) and IMRB International). The Indian Unicorns- Flipkart, Snapdeal, Ola, InMobi, Paytm, Quikr, Zomato and MuSigma have taken up almost 33% of this funding.

It’s not surprising that e-commerce took the majority of the investment while consumer online retail and mobility apps took the close next spots.
But what do these VCs look for in funding? Essentially market presence, team, traction and the preparedness to fight competition. Though this is a very simplified list, essentially, these are the attributes that make a young company desirable for investment, experts at VCs say. Also an advantage is that a young entrepreneur brings in the ability to connect with the 60% of youth population that India enjoys – in their twenties and thirties.

The conviction and ability to learn, innovation and agility to transform speedily are some other things that attract investors. Essentially, the bottomline is- Show Me A Model That The Indian Middle Class Will Follow!
The example of a disruptive investment is that of K Ganesh in BigBasket in 2011, a venture most middle class Indians would not appreciate. No one buys veggies without checking for quality, or so they said. This was the precise nature of the business that attracted him. There was no competition! The playing field was blank, all that was needed was someone who could market it well. The scenario is unrecognizable today, with clamour for names, and almost USD 120 million raised by 5 other online grocery stores.

From the startups point of view, what are the things to be kept in mind before approaching a VC?

1. Do I need an investor?

Funding typically cuts your control over your company but gives you more money to play. What would you rather have? It is possible to run a midsized company with decent profits while retaining control- without any investor role. It’s all about the size you want to reach.
The first funding from yourself.You have to be committed enough to put your own money down. The next set of investors need to see that you have given the idea enough time and money yourself. After that comes the Angel round where you convince family and Friends or people who are acquainted to you, trusting your idea and giving you money to expand the scope or depth of the idea. Once all this is done, you will find the right Venture Capital team to pick up and support the idea. With your own money, you need to get a product developed and get some customers. The rest becomes easier then. The right funding comes from people and companies who are willing to support you beyond the money. They need to help you get customers, technology, or other sources of funds.

Not life partners before the dotted Line is signed:

Do not start spending in anticipation of the funding. Investors have been known to bow out at the last minute. Which brings us to the first point…also its best not share every single plan and detail about the company with the investor. If the marriage fails, keep some information with yourself.

2. You prepared for the stress?

Funding is an investment for the venture company. You will need to repay, and show profit. So be prepared for the controlling power, and complete objectivity. The investing partner will not ‘understand’ failure, it’s a question of money, and the start-up is an investment from which they expect returns. Funding is just a milestone and not the end. Funding means someone has found you and the proposition appealing enough to want to invest behind it. That is all. Having the right team, understanding the problem, figuring out a different scalable profitable way of providing the solution, showing that there are customers who are interested – are some of the issues to resolve.

Funding is a challenge, and then it will be a challenge to grow. How do you find a way…to solve the problem. How can you create a way where you can have sustainable growth of people- strong growth month on month? Your investors need to know that. People don’t want only money; they want to work on something that has a sense and purpose to it. It’s the same thing about funding, you need to convince investors that there is a problem, and convince them if anyone can do it, only we can.

VC Strategy

A VC firm isn’t investing its own money. It’s investing the money of its investors, Limited Partners (LPs). The LPs would like a return of at least 20% per year. This means that over a 10-year period, the VC needs to generate a 6x return.

Let’s say the VC invests in 10 companies per year, and each company needs 10 years to reach liquidity (some type of acquisition or IPO). One approach is to invest in 10 “modest” growth companies where each one grows in value by 6x over that 10-year period. That’s risky because if a few of them can’t hit the 6x mark in 10 years then the VC doesn’t get the return for the fund. Bad strategy.

Instead, many VCs look for home runs, companies that might generate a 100x return (the next Uber or Slack). If VCs invest in these high-growth, high-risk startups, they don’t have to worry about the strikeouts (i.e., companies that give them no return) because the few remaining companies will still yield huge returns.

You can see why it makes sense for VCs to encourage companies to spend on growth foregoing short-term profit or an early exit. Some companies might fail, some might have modest returns, and a few will be big. But those big ones, 60x or more, provide a return for the entire VC fund, and every other positive outcome is gravy. It’s a reasonable strategy for a VC, and if you raise big, you should be prepared to try to grow fast and not sell early.

Now, this all is an overly simplistic view of VC economics, and there’s a lot more nuance to it. If you plan to raise money, you should read Brad Feld’s Venture Deals cover to cover. And know that sound strategy for a VC might not be the best strategy for you. They have more “at bats” with other companies while founders only get one (or one every 5 or so years).

Moral of the Story

If you’re a first-time founder, consider what raising big VC money means before you go down that path. It’s not all sunshine and rainbows. But if you want to take a shot at hitting the next home run, by all means go for it—just know what you are getting into.