Investment and Finance in India

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Four Questions Entrepreneurs should ask any Angel Investor in India

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Note: Angel investment generally refers to any small investment (may be up to Rs. 2-3 Cr.) in an early stage (pre-revenue) company. The people making these investments are called “Angel Investors”.

Yes. You can ask them questions. Angel investors are not doing any charity or favor to you. They are investing in your business with the expectations of high returns and you have all the rights to ask them questions. In fact, if you ask them right questions, it can save you lots of time, energy and resources.

Please ask the following four questions to them before you start discussing your idea. If they are reluctant in answering these questions, then it is advisable to stay away from them.

  1. Have they made any investment in last 12/18/24 months? An angel investor is a person who has made any investment in an early stage company in return for equity. An angel investor is NOT someone who is claiming that he would make an investment in a company. Any one can make this claim. Please ask the person what investments he has made in last 12/18/24 months and if he has not made any investment at all then what are your chances of getting investment from that person? It is highly unlikely that yours would be the first company that he liked and felt confident enough to put his money into it. May be he is disguising himself as an angel investor for some other ulterior motive. So, please ask this question and, if the answer is “ZERO” or “I am evaluating a few proposals” or “any other vague answer” then you should stay away from these investors.
  2. What are his specific investment criteria? You should ask this question in the beginning and if you get a very vague answer, you should be very cautious. A very common way for any investor to get himself out of the deal, once he has acquired all information/research/knowledge/money he wanted, is to ask for significant majority or put up some irrational conditions in front of entrepreneurs. If you ask this question early, you can save yourself lot of time in educating the investor and avoid any frustration at the end of this process. Ask for his investment criteria especially about the stage of business. At what stage he is going to invest – Idea, Product Prototype, Stable Product, First Trial Customer or First Paying Customer. If your requirements do not match with his criteria then you should not spend any time on this.
  3. Are they charging money for listening to your pitch? If the answer happens to be YES, please stay away. Simple. The investor who can not even afford the expenses to listen to entrepreneurs’ pitch, what are the chances that he can afford to make any investment in the business?!
  4. Do they have any other business? Yeah, while it is understood that most angel investors will have some other business but entrepreneurs should be wary of these two kinds of angel investors’ businesses:
    • In India, many “investment bankers” are disguising themselves as “angel investors”. Their main intent is to get these entrepreneurs as clients for their investment banking business. They have absolutely no intent or desire to invest in your business. This is a marketing exercise for them to create pipeline for their business. You should clearly stay away from any angel investor who has investment banking as his other business.
    • Also, many technology business owners portray themselves as angel investors to keep a check on technology happenings in the market. In some cases, they do invest in other businesses especially if they see some synergy with their own business. While there is nothing wrong with it but if any such angel investor has not made any investment in recent past, then he may only be interested in listening to ideas and getting it implemented by his team. I would not recommend you to stay away from them but you should definitely be cautious in sharing information with them.

Exit Options

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Exit Options are one of the most discussed aspects of a venture capital fund-raising process. The promoters and the investors make money if and only if the company is able to provide a decent exit to the investors. Exit Options are important for all concerned parties (promoters, investors) as a good return on investment consummates the hard work, efforts put in by the promoters and the risk taken by the investors.

When it comes to exiting from the company (i.e. selling the common shares) the equity holders mostly exercise one of the following three options-

  1. Initial Public Offering (IPO)
  2. Mergers and Acquisition (M&A)
  3. Company/Promoters Buy Back

Initial Public Offering (IPO): IPO is the process to selling the company’s shares to public. After the IPO, the shares are traded in a stock exchange and people can buy and sell shares by paying a small brokerage. This is one exit option that all investors love. IPO provides the investors time, price and quantity flexibility. Investors can choose to sell any quantity at anytime and at any price once the company’s shares are listed on a stock exchange.

Mergers and Acquisition (M&A): M&A is the process of selling the company’s shares, partially or completely, to another company. This is the second preferred option by the investor as it does not provide them the flexibility to exit at their chosen time and they have to sell all their shares in one go. In most cases of an M&A, the pricing, timing and quanta is specified simultaneously and investors do not have the flexibility in their exit.

Company/Promoters Buy Back: This is the least preferred option by the investor. In company/promoters buyback arrangement, the company or the promoters agree to buy the investors’ shares at a certain price if company is not able to provide any other exit either through the IPO or M&A. This option is least preferred because here investors’ returns are capped and there is no upside beyond that. However, investors like to put this in the shareholders’ agreement so that at least their capital and minimum returns are protected even if company does not do as well as projected.

Also, please feel free to leave your comments/feedback.

You can follow me on twitter @wowfinance.

Sweat Equity and ESOs (Employee Stock Options)

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Sweat Equity is fundamentally the equity provided against the “sweat” (in contrast to money) while ESOs are stock options giving the employees the “option/choice” to buy the company’s equity at a predetermined price. ESOs are actually a sub set of sweat equity as exercise of ESOs results in employees getting equity at a discounted price.

Sweat Equity and ESOs are used by the start-ups and early stage companies to acquire talent when they cannot offer them their market price due to cash constraint. Sweat Equity and ESOs are also used to retain talent as these come with certain constraints like lock-in, vesting and non-transferability that make sure that sweat equity owners can benefit from it if and only if they have been with the company for a definite time. Sweat Equity is also used to motivate talent to perform better as company’s equity value increases with its performance, which in turns benefit the employees holding the company’s equity.

The following terms are often used in conjunction with sweat equity and ESOs-

Lock-in: Lock-in period is the time before which the sweat equity or the ESOs owners cannot monetize their equity. This time is generally three to five years for a start-up company.

Vesting: Vesting is the mechanism specific to ESOs that describes the time and number of ESOs the employee can convert into equity. Generally, start-ups allow 25% of ESOs to be converted into equity at the end of each year.

Non-transferability: As the name implies, non-transferability clause does not allow the transfer of sweat equity or ESOs from the original holders to anyone else. This means that either the ESOs can either be converted to equity or be expired after the vesting period.

Employee Stock Option Plans (ESOPs): ESOP is a plan through which company allocates ESOs to its employees based on their performance.

Also, please feel free to leave your comments/feedback.

You can follow me on twitter @wowfinance.

Written by Neeraj Jain

April 24, 2010 at 10:21 AM

Term Sheet Series – No Shop Agreement

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No Shop Agreement is not such an important term for a venture capital deal however it is an integral part of all non-binding term sheets signed between the Company and the investors. In fact, this term does not affect the final agreement between the Company and investor and it remains effective only for a certain time before signing of binding agreements.

No Shop Agreement simply means that the Company would stop “shopping around” for better deals till the time company’s discussion with this investor is logically complete. Through this clause, the Company agrees that it will work only with this investor for a definite period to close the deal. If for whatever reason, the deal is not close within that specified time frame then the Company can start talking to other investors.

Generally, the time specified in this clause is 30-45 days which is the time taken by the investor to perform due diligence on the company. The investors do not want to see that while they are performing due diligence on the company, the company is involved in discussion with other investors who can now offer better terms to the company.

One important thing to remember about No Shop Agreement is that if the company is found to violate this particular term then the deal with the current investor is definitely off as the investors lose faith in company’s management integrity.

Written by Neeraj Jain

April 13, 2010 at 10:30 PM

Case Study Series: Analysis of a successful venture capital fund raising exercise

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Over the last few years of my career as a venture capital consultant, I’ve worked on a number of fund-raising assignments for small and mid size companies. Some of these transactions were successful while others failed at some stage of the fund-raising process. This case series is started with the analysis of a successful transaction. The future articles in this series would talk about not so successful transactions as well. This series should provide a huge opportunity for entrepreneurs to understand as to what actually works with VCs when it comes to fund-raising for their companies.

Introduction to the Company: The Company in this case is a Delhi based small logistic services provider. The company’s business is to provide third-party logistics (3PL) service like warehousing, packing, unpacking etc for a number of large FMCG, Auto, Electronics companies.

Things that were working for the Company:

Team: The owner of the Company is a first generation entrepreneur who has built a good team by hiring two senior industry professionals to manage the future proposed growth of the company. Along with the promoter, these two provided enough expertise and credentials to the team. The team was a good combination of entrepreneurship skills of the promoter and professional experience of the other team members.

Clients: The Company had some of the best names in their industry as its clients to boast of though the revenue from each client was quite small. The company was providing its services to large and reputed clients in FMCG, Auto, Electronics and Beverages industry. This proved to the investor that the company has the ability to acquire, deliver and retain the best clients in their field.

Hot Growing Industry: Logistics has been a huge area of interest in the venture capital community in India for quite some time now. There have been a number of transactions in this industry already and most investors are still looking for good projects. Unfortunately, most Indian players who call themselves logistics companies are essentially transport companies but this Company was a good mix of warehousing, cold storage and transport business.

Things that were NOT working for the company:

Small size of operations: Though the company had some of the blue chip clients however the Company’s profits were very low. At the time of fund-raising process, the company was making net profits of close to Rs. 10 lacs. The proposed investment was quite large in comparison to the Company’s current scale of operations and it took some skill on the promoter’s part to convince the investors that the company can manage a comparatively large operations.

No experience of some proposed businesses like Cold Storage: Some of the businesses proposed by the Company were completely new. No member of company’s current team had any expertise in those businesses. However, inclusion of those businesses made tremendous strategic sense and that’s why they were able to convince investors about inclusion of new businesses.

Valuation: Since the required investment was significantly large in comparison to the Company’s current operations, the valuation became quite a challenge. Any standard valuation technique was leading to a very small stake for the promoters. The problem was solved by a performance linked valuation structure where promoters were rewarded by equity every time they met a performance benchmark.

Please send me an email at neeraj AT metalogosindia DOT com if you are interested in looking at a sample financial model for the above mentioned company.

Also, please feel free to leave your comments/feedback.

You can follow me on twitter @wowfinance.

Written by Neeraj Jain

April 7, 2010 at 11:06 AM

Private Equity and Venture Capital Deals in India in March 2010

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The following deals were announced by Indian private equity and venture capital investors in the month of March.

private equity and venture capital deals, March 2010, India

Please feel free to let me know that if I’ve missed on any major deal which was announced this month.

You can follow me on twitter @wowfinance.

Written by Neeraj Jain

April 1, 2010 at 6:46 PM

Term Sheet Series – Board of Directors

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This is one of the most important clauses of the Term Sheet. I believe that it is as important as the valuation/price clause but somehow entrepreneurs do not realize its importance to the same extent. To understand the significance of board of directors in any company, please read on.

In any business, two of the most important parameters that are of interest to any VC investor are:

  • Profit Sharing
  • Control Sharing

While profit-sharing is determined by the respective shareholdings of all the shareholders, control-sharing is largely dependent on participation in the board of the company i.e. by nominating your own directors on the board.

Board of Directors are the people who approve all the major decisions proposed by the company’s management and they effectively run the company from a control perspective. These individuals are selected by the shareholders of the company to manage the company. Every major decision taken by the company like annual budgeting, fund-raising, changing key positions in the company, public listing, and major investments needs their approval. The Chief Executive Officer (CEO) or Managing Director (MD) of the company is answerable to the shareholders and to the board of directors. Board of directors exercises immense power on the company. So much so that these are the people, who decide the appointment of the CEO and they have the power to remove him as well.

When VCs invest in a company, they ask for a certain number of seats in the board of the company. This clause generally reads like “ of the total 5 directors in the company, at least 2 directors will be appointed by the VC investor”. Generally, percentage of board ownership is similar to the percentage shareholdings but this need not be necessarily true. Sometimes, VCs like to have majority in the board of directors even if they have only a minority stake in the company. Also, the board of directors appointed by the VCs are always a lot more active than the other board of directors.

When negotiating this particular clause with the VC investors, entrepreneurs need to take extra care of what all powers are vested in the board of the company and whether entrepreneurs have enough say in the major decisions of the company. Generally, VC investors give most of the operational control (day-to-day working) to the entrepreneurs while trying to keep all the major decisions making to themselves through majority in the board.

You can now follow me on twitter @wowfinance.

Written by Neeraj Jain

March 30, 2010 at 11:05 PM

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