First time Venture Capital investing

In case of First time Venture capital investment, while any Startup will provide key metrics like:

1. P&L statement
2. Balance sheet with equity already invested, Cash Flow and projections (linked to assumptions – as to how the business will pan out)

It should also provide valuation done basis:

1. Current Multiples
2. Forward Multiples
3. DCF (Discounted Cash Flow – which also gives the IRR (Internal rate of return) which the investor will make on his investment) and
4. Comparable Multiples.

Technical aspect of valuation aside, in case the investee is seeking its first investment from a VC/ PE Fund – more important aspects are:

1. Macro-economic factors
2. Industry dynamics in which the Startup is operating
3. Proven capabilities of Promoters and their academic background
4. Whether Promoters are from same field as their Startup
5. Whether Promoters have a clear thinking of what, why, how they want to do
6. Proof of concept established already or not
7. Barriers to entry – if they are low, any other company with huge hoard of cash will quickly enter and out compete
8. Patentable technology
9. Returns expected on the investment in terms of IRR – Should be minimum 20%
10. Exit – How will the investor get an Exit. So there are clauses in any Term Sheet to secure exits:

a. IPO
b. Sale to 3rd party investor
c. Buyback by Company
d. Buyback by Promoter

 

First time VC

First time VC

Then there are clauses in Term sheets to protect the investor, like:

i. Tag along clause – In case promoter is selling shares to a 3rd party investor, the initial investor has right to sell his shares along with in that transaction
ii. Drag along clause – In case investor finds a 3rd party investor but new investor asks for bulk of shareholding, the initial investor has right to drag along promoters shares with him
iii. Ratchet clause – This is the clause most responsible for ballooning valuations of startups. This essentially means that a new investor coming in has 2 protections – one, he has right of refusal in case any subsequent investor will come in. Second, his the valuation at which he came in, will be protected and any new investment will be at valuation upwards of valuation at which he came in

But this is the risky part. Most first time investors take at least 26% equity with seat on Board, so that they can have a say in the business

11. Lastly – always keep in mind – when its a first time funding – its pure vegetable market negotiation. So Promoters say 100 – Investor says 20. And then one settles on 35-40. Its like bargaining for vegetables in the market, but investor has an upper hand since he’s the first one investing and taking a big risk.

Promoters will site example of other peer Startup funding and how much % it dissolved and got how much investment in return. So, one has to see the differences in timing and business plan of those Startups with the one in which you are investing.

12. Investment depends sometimes also on mandate of Fund on which it raised its investment and so many other Factors

Then there are many types of investment models – Plain Vanilla equity or Mezzanine Finance of nature of quasi-equity, quasi-debt (Convertible Preference shares, Warrants, Bonds etc)

Author: Tushar Kansal

Tushar has been associated with the Project Assessment, Fund-raising & Financial Advisory realm in India for 2 decades. He has straddled multiple roles in Financial Advisory in Deloitte Touche Tohmatsu, PE Deal-maker in Times of India’s Brand Capital, in Corporate Finance roles in Aircel, as an Entrepreneur in Education field and as a CFO (Chief Financial Officer) till 2014. Prior to that, he was the Head of Debt for MTS India, where he was instrumental in raising $2.5 billion structured debt. Tushar has been involved in $6 Billion of transactions in Debt/ PE/ M&A across all asset classes. He has major experience in Education domain – From 2001 to 2006, Tushar led his Education entrepreneurship venture which provided Entrance examination training for Engineering colleges in India. The venture grew to 800 students and then was bought out by a marquee pan-India player in this space, as a strategic sale. Tushar is a panel member at CNN-News18. He is also a Columnist @ Business World, Indian Defence News, Business & Economy, Indian Economist, Digital Market Asia, OpIndia & Growing India.

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