Startup Funding: For the entrepreneurs, from an investor’s lens!

By Gaurav Bansal, Principal, Fund Management, Alacrity India

A common topic today at most of the startup events is Startup Funding. No doubt, this is a topic of key interest as without capital a business will surely come to a halt. I have been fortunate to have been invited as a speaker to such sessions where the audience is full of young, energetic, first-time entrepreneurs looking to build the next unicorn. Most come with a technology background or have a domain expertise but very few have any background in finance or an understanding on aspects of fund-raising.

The most common question from the entrepreneurs is What do investors look for in a startup. Yes, this is an important question.
But there are some other fundamental questions that need to be addressed which many entrepreneurs need to be aware of. As an investor from the VC community, this article is an attempt to assist the young entrepreneurs in their journey.

  1. What are the different types of investors and the funding avenues available today?
  2. Is capital everything? What is the difference between commodity capital and smart capital?
  3. Who should be the Target investor?
  4. What precautions are to be undertaken while evaluating a VC / PE investor?
  5. How to find the Target investors and how to catch their attention?
  6. What does an investor look for in a startup?
  7. How much capital should a startup raise?

Let’s take a deep dive.

What are the different types of investors and the funding avenues available today?

Today, startups are fortunate to have Investors focusing at various stages in the life journey of a startup

The key is to know about the various stages and finding the right investor. Below are the different stages in startup journey:

  • Ideation – identifying the business pain point that needs to be addressed
  • Confirmation – discussing the paint point and commercialization aspects with a few potential customers
  • Creation – building the minimum viable product (MVP) in consultation with potential customers
  • Validation – running pilots / getting adoption amongst users / acquiring the initial set-of paying customers
  • Build-measure-learn feedback loop – incorporating customer feedback and improvising upon the product features, pen down the pricing strategy, sales funnel, etc.
  • Growth – repeatability (retaining existing customers), capturing a higher wallet share (upselling and cross-selling to existing customers), scalability (selling to a diverse customer base across geographies and / or sectors)

While the above stages are more from perspective of the life journey of a startup, from an investor parlance the journey can be categorized into various stages such as:

  • Angel / Seed / Pre-Series A: ideation, pre-revenue, early-stage post-revenue
  • Series A, B: acceleration stage
  • Series C and onwards: growth capital
  • Exit Stage: M&A, IPO

PS: The above stages are based upon my experience and can have different terminologies.

Capital can be in the form of equity or debt or hybrid (mix of debt and equity) or grants

  • Bootstrapping / Self-funding with one’s own savings
  • Friends and family
  • Crowd Funding platforms
  • Angels
  • Grants from Government bodies
  • Reward money from competitions such as Hackathons
  • Incubation / Acceleration programs by Corporates or institutions
  • Venture Capital – Equity
  • Venture Capital – Debt
  • Bank Loan or Private Equity (only at growth capital stage)

PS: The above forms of capital are available basis the stage of a startup and in different capital structures.

Is capital everything? What is the difference between commodity capital and smart capital?

Capital is important to keep the engine going, but is capital everything?

Time is the most priceless asset. Time, once gone, is irrecoverable.

Consider the following investment in TIME and think if these could add VALUE to a startup, in addition to the capital that an investor provides:

  • Insights on the value chain dynamics for a sector across different geographies
  • Technology relicensing from portfolio startups or through its network, thus reducing time for Go-to-market (GTM)
  • Access to channel partners, system integrators and potential clients across geographies via its presence or network
  • Inputs on company structure, board composition, ESOP pool, regulatory compliance requirements, etc.
  • Inputs on building a robust feasible business plan that is scalable and ensures capital efficiency
  • Inputs on best practices for sales funnel, customer on-boarding, pricing strategies
  • Assistance in building a strong team with equity-based compensation that ensures stickiness
  • Connects with mentors and domain experts across multiple sectors and geographies
  • Inputs on tracking and analysing the key performance metrics as applicable to the startup
  • Inputs on using the best tools for lead generation, marketing, SEO, client management, payments, etc.
  • Prepare for next round of funding via demo day feedback and provide connects to investors through its network

The above is a just a glimpse of what Smart Capital can offer in addition to just the capital to run the engine. Any investment without the above value-add is just Commodity capital.

Now, as a smart entrepreneur, one needs to decide which type of capital one should seek!

Who should be the Target investor?

An entrepreneur is investing his / her life’s time in building his startup. A significant amount of his / her bandwidth also goes in pitching to various investors. Often entrepreneurs don’t realize that it’s important to channel these activities towards the right investor set which is appropriate for their startup journey. This critical aspect can save a lot of time and capital which the entrepreneur can invest in building his business rather than pitching to the not the apt fit set of investors.

Each investor has his / her own risk profile and investment criteria. Following are the key parameters based upon which one can categorize the investors and approach the apt investor set that aligns with the startup journey:

Investment Criteria

  • Stage of startup – Is the startup at ideation or pre-revenue or post-revenue stage?
  • Sector / sub-sector focus – What sector is the startup focusing upon?
  • Ticket size and follow-on – How much capital does the startup require in this round and in subsequent rounds?
  • Stake – Minority / Majority – What quantum of stake does the Investor look for?
  • Investor role – Financial / Operational / Value-add – What role does the investor play apart from providing capital?
  • Geography focus – Which geography is the startup based out of and where all are its current / target clients?
  • Metrics such as minimum revenue, margins, stake, etc. – key performance metrics

An investor generally has his / her investment criteria or investment portfolio listed on the website. Else, one can track the investments via simple google search or by tracking investment news and understand the investment criteria.

What precautions are to be undertaken while evaluating a VC / PE investor?

As an entrepreneur one needs to be cautious about the following aspects while evaluating a VC / PE investor:

Fund scheme lifecycle and headroom
A VC / PE Fund typically has different investment schemes and each scheme has a lifecycle within which the Fund has to deploy all its capital and then exit its investments to return capital to its General and Limited Partners. Ensure that the Fund scheme is not in the later part of its lifecycle as then it would be under pressure to secure an exit in quick time-frame, unless the Fund is launching a new scheme which has a long lifecycle.

Another aspect to consider is the capability of the Fund to invest in subsequent rounds of funding. If the Fund has already deployed bulk of its capital (thus, no headroom) and it is not launching another scheme, then the startup may soon need to invest its own bandwidth in another round of funding once it is about run out of capital. Unless, the timeline for subsequent rounds of funding are planned well in advance and things go as per the business plan, it can be perilous to not have an existing investor who has the ability to pump in more capital at the time of need.

Competing investments
Ethics should form an integral part of any activity and most VC / PEs abide by the same. However, to be on the safer side, the entrepreneurs should check for investments already made by the Fund and ensure there are no similar investments made in the competitors. This will avoid a scenario where an investor is seeking information from the startup just to assist its own existing portfolio startups.

On the other hand, if similar investments have been made in different geographies, then such an investor maybe of great value-add in various aspects and may lead to cross-border business synergies. Thus, be cautious and tactfully evaluate this aspect.

Investment process and timelines
Time is money. Each VC / PE investor has its own investment process and speed of deal closure. Understand what’s the investment process and timeline for the particular VC / PE investor and consider the following:

  • Time-taken by the investor to revert with an initial query list / expression of interest, post the first pitch
  • Time-taken by the investor to conduct business due-diligence. Typically, for an early stage startup, there is not much existing data for an investor to look at, thus this process should be quick.
  • Time-taken by the investor to present the investment opportunity to its Investment Committee (IC)
  • Watch out if the investor’s Investment Committee (IC) is based overseas or is based locally
  • Investor also undertakes legal, financial and technical due-diligence (often outsourced to experts)

If the startup can comfortably manage its capital needs and survive the above timeline for the process, then it’s good to go. It’s a good practice to simultaneously indulge in talks with multiple investors (unless the startup has signed the term-sheet with an exclusivity clause) as it avoids over dependence on the investment decision taken by one investor. What if this investor decides not to invest after 2 months of due-diligence activity?

How to find the Target investors and how to catch their attention?

Most investors today have their own website where one can fill out some basic information and send the pitch for evaluation. One can also reach the investors over LinkedIn. Most investors prefer a referral via a mutual connect.

According to me, reaching an investor is not that difficult, the trickier part is getting an investor’s attention and getting that invite for the first round of pitching. Remember that TIME is the most critical asset.

Try and imagine the scenario from an investor’s lens. An investor is receiving pitch requests over LinkedIn, email, WhatsApp, mobile call, Facebook, Twitter, etc. Not that the investor is not interested in entertaining all the request, but like an entrepreneur, he / she has limited time to evaluate the requests and allocate time to those which make investment sense and match the investor’s investment criteria.

Some of the key pointers to keep in mind while reaching out to an investor are:

  • Before reaching out, do the research by going through the LinkedIn profile or website of the ‘Target investor’
  • Do not ask basic questions which are already highlighted on the website or profile. I often get LinkedIn messages with pitch books attached, even though in my LinkedIn profile I have provided a google form link for the startups to fill in. This simply shows how carefully the startup has read about its Target investor.
  • The pitch, no matter what the medium is, should be crisp (without fluff) and cover key aspects that an investor looks for
  • Avoid abuse of tech-heavy words such as AI, ML, DL, blockchain, etc. Remember, technology is only an enabler. A sound investor is keen to understand the business pain point that the startup is addressing.

What does an investor look for in a startup?

First and foremost, understand the investor mindset. A Fund manager is in the business of managing the money of its Limited Partners / General Partners (investors) and has to return the money to them by investing money and then securing profitable exits. Thus, an investor is basically seeking an investment opportunity to invest capital and generate returns via exit. Even before investing, the investor is already considering the possible exit opportunities in the near future. If the entrepreneur can showcase the possible exit avenues, then it really helps.

Below are some of the aspects an Investor looks at:

  • Management: How strong is the management team with the apt domain experience and complimentary skill-set
  • Vitamin or a pain-killer: Criticality of the pain-point the startup is addressing in the value chain in a particular sector
  • Market – product fit validation: Does the startup have a diverse set of free / paid pilot clients or paying clients
  • Market opportunity: How big is the market that the startup is providing a solution for
  • Business Model – pricing, revenue model, sales cycle, stakeholder alliances, marketing strategy, etc.
  • Unit economics – Is each transaction viable on unit level or does it require constant cash burn
  • Competitive landscape – Is there a healthy competition, deal traction by other investors, M&A activity, etc. Remember, ‘No competition’ implies no market, hence not of any interest to an Investor
  • Business positioning: Competitive positioning / USP / IP / customer retention strategy, etc.
  • Tech-enabled: Investors often prefer tech-enabled businesses that can be scaled using technology
  • Growth strategy – robust business plan to scale the operations, future rounds of funding required, team building, etc.
  • Investment Ask: Capital required, usage of capital, for how long will this capital keep the engine running (runway) before seeking the next round of funding and what business metrics / milestones does the startup aim to achieve
  • Exit: Exit possibilities and investor’s internal rate of return on exit (IRR)

PS: The above list is not exhaustive and different investors have their own parameters and investment criteria and indifferent priority sequence.

How much capital should a startup raise?

Equity is the most expensive form of capital. At pre-revenue / early -stage, one is in dire need of capital to invest in product, team-building, marketing, etc and the only asset available for exchange is equity (post one’s own capital and capital from friends and family). The process of fund-raising is not only time consuming but also uncertain. Additionally, the management’s bandwidth is significantly diverted from its core role of business / product development. At such a juncture, one is bound to think on the quantum of fund-raise and the timeline associated with the process.

Each fund-raise is associated with a set of milestones that the startup aims to achieve and it takes time to accomplish those. The quantum of fund-raise should not only allow the startup to achieve the milestones but also provide extra runway to account for the time consumed in the next fund-raising round. Hence, it is advisable to raise more than required capital to have a cushion to fund the working capital at tough times.

The time-gap between two successive fund-raise processes should be enough to allow the management to focus on core business targets.