In my attempts to engage in angel financing, I have seen the typical concerns that potential angel investors have. Many of these have to do with the investment parameters, and figuring out how investors can get their money back (or returns) – especially given the inherent immaturity of these businesses in being able to outline an exit potential. Investment then gets limited to businesses where investors perceive a high probability of creating a breakout business. Many other diamonds remain in the rough. I have been thinking of ways of addressing this issue so that seed financing is available to a larger base of startups. This should allow for great businesses to “emerge” rather than being “envisioned”.
To start, I am sharing some thoughts on a potential investment structure that should allow this to happen. There are several other elements to making this successful, besides the investment structure, and I will talk about some of those over next few weeks. In the meanwhile, comments and critiques are welcome on this – both from entrepreneurs and angel investors!
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Alok, thanks for that
1) If valuation is not an issue why not just let it be equity with the standard clause of 1x liquidation preference? Much easier and stamp duty is lesser and is not classified as debt for ROC and all that.
3) 27% comparison to credit card rates: interesting though the debt isn’t as unsecured and there are warrants/board provisions/lien on company assets to cover it (banks give lower for working cap lending even when unsecured) But I doubt this is vanilla debt – any figure will work when the entrepreneur is really desperate, and if they’re not, loans will be forthcoming from other sources. And as you said, figures are malleable…
Prashant – The interest rate will get determined by the market. The intent is not to make this cheaper than friends and family, but to provide a fundraising mechanism where friends and family can not step in. The issue with pure convertible is that startups in India seem to be taking longer than in the west to get to their institutional rounds, and many may survive as cash flow companies which will never raise another round.
Krish – welcome your thoughts on the other aspects. In spite of the carnivals, I think we are far away from problems of plenty 🙂 I like the thought on feeling up (no really!) – i think the constraint is that of time. I agree with you that the “control” that angel investors have can not be huge.
Shantanu – please explain why – this is not debt with an external/personal collateral.
Vivek – the structure I am proposing here is not convertible debt. Its debt with an option to put equity capital over a longer period of time. Somewhat different.
Suresh – My view (and somewhat counter-intuitive perhaps) is that if its a cash flow business with little chances of exit, keeping the valuation high might be ok. Returns are largely expected from debt returns and thats great. If the upside kicks in, it doesnt have to be huge since most of the return expectations are based on debt. If the business is the opposite (no cash flow for a while, potential for high upside) then I would reduce the debt rate, and increase equity upside (by decreasing valuation) – kinda falls back to conventional angel/vc model.
Alok:
I think this is excellent. Personally, it helps me put fwd a proposal to a few HNIs that we are talking to for funding.
Point 4 refers to pre agreed valuation level. How will one decide the valuation of a company like ours, which is a good cash flow business but might not scale into an exitable company in its current form. We realize this and we are making attempts to build larger revenue streams thru allied products and that is changing the complexion of our company on a daily basis. I am sure every entrepreneur is making similar attempts.
So my question is how will decide how much to give away for a x INR when I am not sure how much my company is worth. This might put the brakes on the investment process as it is too much of a grey area for the angel…
By the *more immersive way* referred in my previous post, I meant –
a) allowing the potential angels (as are domain experts) to feel up the team `on the shop floor’ for say, a 3 month term on each occasion, in return for a tiny lumpsum (not as investment, more as an `earnest money’) that could cover a portion of the actual fixed costs of the startup during the length of the stay of angel (say 50% of monthly rent, utility bills and consumables) – in a non-binding arrangement (NDA/Fixed Term Non Compete’s are in order);
This will eliminate shallow pitchers and hollow domain experts from wasting each others’ time. It will also help channel the resources to productive purposes only.
In case if there is a strategic difference of opinion between the team and the angel, the angel just refuses to foot that portion of the bill but has no right to stymie the effort. He just stops at airing his dissent so that it doesn’t stun the progression of disruptive innovation that invariably begins with a few random throws of dart.
[The angels can be domain experts themselves (let’s say *proprietory*) / those sponsored by investors that warm up to the opportunity. To ensure continuity, the sponsored domain expert will serve on the Board till the exit of the sponsor investor, if the investor commits to the venture relying upon his feedback]
If this warm-up initiative proves useful, early attainable milestones can be set for the team that now includes the angel as well.
Non-binding arrangement continues together with earnest money clauses, upto say 12-18 months beyond which the angel + team will have to bind themselves with definitive agreements with investment commitment from the former and consensus on defined exit strategies from the latter.
I believe this structure (optionally convertible debt) has been tried by TDICI (earlier avtaar of ICICI Venture) in early 90s when it was still operating in venture capital mode (VECAUS-I). If I recollect correctly, this was their preferred instrument of choice. It will be good to get some feedback from ex-TDICI folks on this model.