An entrepreneur’s journey starts with an idea. But when his small business gets off the ground, capital is required to fuel the growth. Earlier, I had written about 10 funding options for startups in India. Raising venture capital is one of those option. In this article, we’ll discuss VC funding in detail.
What is Venture Capital Funding ?
As per Wikipedia, Venture capital (VC) is a type of private equity. Its a form of financing that is provided by firms or funds to small, early-stage, emerging startups that are deemed to have high growth potential, or which have demonstrated high growth (in terms of number of employees, annual revenue, or both). Venture capital firms or funds invest in these early-stage companies in exchange for equity–an ownership stake–in the companies they invest in. Venture capitalists take on the risk of financing risky startups in the hopes that some of the firms they support will become successful in future and in this process VC firm will get multiple times return on their investment.
Venture funding is not meant to be long term funding. The central idea in such funding is to insert investment in an organization’s balance sheet and also infrastructure till a predetermined size and market credibility is reached so that is can be sold to a larger corporation and public-equity markets can get into the action and generate liquidity. Essentially, a venture Capitalist would purchase a stake in an entrepreneurial idea and nurture it for a short duration ending in an exit with the aid of an investment banker. Putting things simply, the big challenge here remains to progressively earn a superior return on investments in what are inherently risky business ventures.
How VC Funding Works?
It is a widely held belief that VC firms tend to invest in what they find to be great people and great ideas. But in practice it all comes down to VC firms investing in great industries which do well irrespective of existing competition and the current market.
VC firms and capitalists tend to focus on the central part of the traditional industry S-curve. They tend to stay away from the early stages, when the technologies haven’t been perfected and the market needs are still developing. They also stay away from later stages when competitive phases in the market arise and growth rates slow down without much that can be done to change things. Consider the disk drive industry. In 1983, more than 40 venture-funded companies and more than 80 others existed. By late 1984, the industry market value had plunged from $5.4 billion to $1.4 billion. Today only five major players remain.
The adolescent period of accelerating growth characterized by especially high growth, referring to the initial growth phase of the company, it becomes a major challenge to set apart the eventual gainers from the losers because initially both types of enterprise will have their growth curves and also financial performance look the same. At the initial stage such as this, companies are trying to deliver products as best as possible to a market which has displayed a need for the said product. At this stage the VC has the challenge to identifying management which can successfully execute tasks to meet market demand.
Even though selecting the wrong industry or betting on a technology risk in an unproven market segment is something VCs avoid, there are exceptions to this rule which tend to involve “concept” stocks. These are companies that hold great potential but take a really long time to succeed. A great example for this occurrence is, genetic engineering companies which act as a case study, proving this concept. In this particular case, the VC firm’s challenge is to recognize entrepreneurs who can advance key technologies to a certain stage such as approval from national and international health agencies that certify the process or product that has been invented.
Here comes the key part of the VC funding process. Once the VC firm has funded the portfolio company and time has elapsed, the VC’s will have to exit the company and the industry possibly before it reaches its peak, which will ensure the VC’s can harvest the highest profit or ROI at a relatively lower risk. Smart, and experienced VC’s work in a secure niche where conventional and low-cost financing is mostly unavailable. Provided things work out, high rewards can be paid to management teams which are successful and also institutional investment will be accessible to provide liquidity in a comparatively short time period.
Logic behind the VC Deal
There are many variations of the basic deal structure in VC fundraising styles, but irrespective of specifics, the logic of the deal doesn’t change: to provide investors in the venture capital fund both sufficient downside protection and aso favorable position for additional investment if the company proves to be a winner.
Venture Capital Industry Works like this – it has four main players: entrepreneurs needing funds; investors wanting high returns; investment bankers needing companies to sell; and finally the venture capitalists who generate money for themselves by making a market for the other three players
VC firms also need protection from investment risks which is gained in the form of an effort to co-invest with other VC firms. Usually the organizational structure in such as co-investing effort is a lead investor and follower investors. It is actually very rare to see a sole VC firm funding an individual company completely. It is considered common practice however for VC firms to have around three or two groups involved in all stages of financing. These act as media for diversification for VC firms leading the VC firms to invest in more deals for the same amount of cash. What they also do is reduce workloads of the VC partners by dividing risk assessment tasks amongst themselves during the due diligence period and also helps in managing the deal overall.
Another positive effect of having several VC firms collaborating on funding for a particular company, is that the credibility of the funding itself along with the company goes up. It has often been suggested by market observers that really top notch funds always will be a follower of top tier firms.
Expectation of higher returns in the VC deal
In return for financing one to two years of a company’s start-up, venture capitalists expect a ten times return of capital over five years. Combined with the preferred position, this is very high-cost capital: a loan with a 58% annual compound interest rate that cannot be prepaid. But that rate is necessary to deliver average fund returns above 20%. Funds are structured to guarantee partners a comfortable income while they work to generate those returns.
Great examples for such VC deals would be the ones done with Flipkart as well as Ola Cabs, where the ROI was tremendous for the VC firms involved. Since these firms were pioneers of sorts, and played the market right whist meeting the current demand without any shortage in supply, they have emerged as market leaders in the country with other VC firms queuing up to fund them and be a part of the huge bottom line.
Things to Consider Before Raising VC Funding:
Given below are the questions that every startup founder should ask before going for raising VC funding:
Whats the current size of the organization?
The first step is to analyse the future growth of your company and come up with realistic projections for the coming years. Based on the size of your company in the coming years you can decide whether to go in for VC funding or not.
Should I consider venture debt?
Venture debt means an assortment of debt financing products for companies that are looking for backing from VC firms. Usually venture debt is handed out by dedicated Venture debt funds (VC firms) or banks. This will act as a complement to equity financing. It represents a viable way to finance a business from far fewer sources than would otherwise be required.
It can present a way to finance business with lesser dilution then equity and also does not typically require a valuation to be set for the business. Also VC firm investments don’t require giving up board seats and have fewer governance requirements. But it also has to be kept in mind that like any other loan, venture debt should also be paid back with interest.
When should I raise venture debt?
This is a question for which the answer really depends on the founder seeking funds. The founder will have to customize his approach to answer this question. Here are a few situations where it appropriate to raise VC funding:
- To replenish Cash reserves of an enterprise to reach the next organizational milestone. For example if you have raised 50 crore rupees and need 20 crore more to hit the next major milestone.
- Funding Capital expenses which are significantly and unavoidably larger, for example in case of acquisitions.
- Reserve funds to act as a buffer in case it is predicted to take longer to hit the next organizational milestone.
When should I avoid venture debt?
In some situations the founder should seriously reconsider or totally steer clear of venture debt. Here are a few examples
- It isn’t realistic to expect debt repayment
- The conditions levied by the VC firm are too cumbersome and tedious.
Here are the key things to consider when raising venture debt:
- The size of the loan
- The time period of the loan (when does it need to be repaid?)
- The price of the loan (what are the fees and interest rate?)
- The covenants (what are the financial and non-financial covenants?)
- Timing of the amortization (when do we start repaying the loan?)
What’s the best way to run a venture debt fundraising process?
To get a better understanding of the entire process it is best to interact with various banks and Venture Debt funds to analyse the capital currently existing in the organization. It is also recommended to hire a venture lawyer who has worked extensively on venture debt deals since the lawyer will be able give the soundest advice on clinching the best possible terms.
List of active VCs in India
Here is a list of top venture capital firms in India
1) Helion Ventures
One of the biggest and most successful Venture capital firms in the country is Helion Ventures and which has invested in over 75 start-ups while making 110 deals until now. It runs a company worth $605 (US) which is roughly equal to 4021 crore INR. This is an India focused company which invests in outsourcing, Internet, mobile, healthcare, financial services and education sectors and domains. When it comes to exits, its biggest portfolio companies include Makemytrip, along with taxi booking service TaxiForSure and bus booking service RedBus which were later acquired by Ola the cab service and Naspers Group respectively.
This VC firm was launched in December 2105 with a $30 million (US) (approximately to 201 crores rupees) fund and has gone on to invest in 83 start-ups and 105 deals so far. Its investment portfolio is diverse and is filled with portfolio companies like event booking platform Explara, warehouse automation player GreyOrange, and also hyperlocal delivery service Roadrunnr. Blume has had around a dozen exits so far for example IndianStage which was acquired by Explara, 1Click which was acquired by FreshDesk and Promptec which was acquired by Havells.
Indian Angel Network is a platform (not a VC) which has a network of over 400 angel investors in the country, and has made 92 deals so far across the globe, investing in 88 companies since its inception in 2006. Since this is a network platform for angel investors as opposed to a single VC firm, this has a wide spectrum of portfolio companies and angel investors alike. Styledotme the fashion wear enterprise, rankjunction the online education firm, hashcube, the gaming enterprise are just some of the portfolio companies which have benefitted from this platform.
This is a Bengaluru-based VC firm that has funds amounting to a total of $650 million (US) (~4,732 crore rupees). Its high priority portfolio companies include e-commerce giants Snapdeal, and Urban Ladder along with e-learning company Simplilearn and personal assistant app Haptik. Its most notable exits in India are Myntra which was acquired by Flipkart, and the mobile video delivery platform Apalya acquired by Arre, a digital media brand.
Sequoia capital has the unicorns of IT industry under it’s portfolio. This firm has invested in companies like Dropbox, Truecaller, Freecharge, BYJU’s, JustDial, Zomato and many more.
Top 5 Indian companies that have raised VC money
The most respected name in cab service in India today has crossed well over $500 million (VC funding) or Rs. 3,299 crores putting it into one of the highest funded Indian companies today. Handling over one million cab booking requests per day, Ola quoted a growth rate of almost 30 times over its previous year. Headquartered in Bangalore and funded by a barrage of VC firms from Matrix Partners to Sequoia Capital and Accel Partners, this company is bound to go places.
One of the best mobile wallets in the business in India, Paytm is valued around $3-4 billion and has a staggering user base of 100 million. Paytm provides its users apps for shopping on most mobile platforms, and has earned a license from the RBI to set up a payments bank, empowering it to give current and savings account deposits. Headquartered in Noida VC firms such as Intel Capital and Reliance Capital have dabbled in this company.
Well known as the go to brand for e-commerce in India, Flipkart is definitely highly capitalized being valued at almost over $15 Billion. The company has given preference to its mobile model seeing enormous potential in the same. It has its Headquarters in Bangalore and has sold over 8 million items during its Big Billion day sale alone!. Major acquisitions this year include FX Mart, Appiterate, and AdIQuity. Accel Partners, Morgan Stanley and a row of others have invested in this company.
This comes close on the heels of Flipkart and is valued at half of Flipkart’s value of $6.5 billion. Snapdeal has acquired Letsgomo Labs, RupeePower and Reduce Data amongst others. Bessemer Venture Partners, Intel Capital, Saama Capital have invested in this company.
This is a popular Hyperlocal delivery platform. Grofers was in the news late November for reportedly raising $120 million (roughly Rs. 800 crores) in its series D round. The two-year-old startup acquired MyGreenBox, Spoonjoy, and Townrush, all this year. Sequoia Capital, Tiger Global, SoftBank have funded this company.
The Final Word on Venture Capital Funding
Venture Capitalism is a new breed of industry that is gaining momentum all throughout the world. The motto of this industry is to heavily invest in initial growth phases of companies and reap high profits in the short run as the company grows rapidly. This unique business model has the potential to create employment on a global scale by supporting the employers themselves leading to an all-around win-win situation. If you are a start-up and looking for VC money, now is the right time to spring into action!