Negotiating Early Stage Financing: Getting Your Piece of Pie

The Growing VC Ecosystem in India

The burgeoning class of Indian entrepreneurs is making a beeline for VC funding to kick-start their ventures. It becomes an imperative to foray into the mindset of the venture capitalist to know what clicks with him. At a conference on private equity for IT/ITeS & Technology held by IVCJ in May, at the Hotel Leela Kempinski, Mumbai, some of the prominent figures of the VC community such as Srini Vudayagiri, MD, Lightspeed Venture Partner; Manik Arora, founder and MD, IDG Ventures India; Sandeep Singhal, Nexus India Capital Advisors Pvt Ltd; and Tejus Sawijani, partner, Singularity Ventures delved into what goes into procuring early stage financing.

The ramping up of the Indian economy has caught the attention of venture capital firms like Nexus, Lightspeed and other such US investors. Perceiving much greener pastures in India as compared to the US, the US investors are willing to pump in US$1 billion in approximately 140 companies in India.

Recent Trends

Observing a significant change in investment trend, Arora of IDG Ventures India points out to a decisive shift from services to products in the IT industry, for instance, software products, telecom products etc. This can be attributed to an increasing consumerism for IT products in India, which itself has been fuelled by NRIs having set up software product companies in India. VC funds are finding interesting mobile applications and niche businesses in the IT sector to be quite lucrative. On the other hand, the manufacturing segment is also attracting a lot of venture capital. Overall, the VC community finds a marked improvement in the quality of business plans submitted to them in recent years.

The Force of Negotiations

Cast the net as wide as possible and negotiate as aggressively as possible. Singhal of Nexus India Capital Advisors stated very pragmatically that the number of entrepreneurs far out-do the fund providers in India, hence the Darwinian principle prevails. An entrepreneur may be rejected irrespective of the quality of his business plan. Reinforcing this view point, Vudayagiri of Lightspeed Venture Partner spelt out the figures only – 8 out of 1000 proposals were sanctioned funds last year. In US, VCs are more forthcoming with funds.

Sawijani of Singularity Ventures dispelled the notions of any existing criteria for early stage valuation in PE. Driven by the sheer force of negotiations with the VC, chances of success at early stage funding can also be increased by approaching as many VCs as possible. The network of Indian angels must be connected to, such as Erasmic in Bangalore. The entrepreneurs must connect to incubators who in turn have links with many investors.

Scrutinising the VC's Mindset

The fund-seeker could be bowled over by the VC's scrutinising questions asked as an opening gambit for instance, the question about the kind of valuation numbers expected by the entrepreneur. If an entrepreneur gives very high numbers, it is perceived by the VC to be too risky to invest in. Instead, it is advisable to quote the previous investment and returns generated by the fund-seeker.

A high initial capital requirement is a de-motivator to a VC who himself is an early stage investor. Another insight into the psyche of the VCs is a preference for co-investment in a project for the purpose of de-risking it. Also, VCs consider more parameters than PE players while investing their money. Scalability of the company, in terms of magnitude of growth and time required for it, is one of the parameters. In an early stage business seeking funding, the quality of the managing team and the target market segment are the parameters for sanctioning funds. If a great market exists for the company, it increases the probability for receiving funds. The stake offered to the VC in the company too is a big decisive factor. A VC could consider the type of instruments of dividend being offered to him.

A VC becomes the entrepreneur's first link to network for procuring private equity later on. Also, the VC acts as the much needed sounding board to the CEO. Undoubtedly an association with a venture capitalist goes beyond mere fund procurement. Qualitatively, the VC brings in a great deal of value addition.

This article first appeared in IVCJ’s PE weekly Review (Week 20).