Entrepreneurs should not divest over 30% in seed funding round; beware of ‘dumb money’

02 July, 2015

Today’s entrepreneurs, especially the ones in the technology space, are very progressive. However, sometimes they make basic mistakes when it comes to chasing ideas, raising funds, equity dilution and associating with the right kind of advisers.

Address a mass-market pain point with the right team

As a seed investor, I regularly keep evaluating young ventures. When an entrepreneur approaches me, I try to look for two things in their pitch. Firstly, will the startup solve a problem which is large enough. It could be a regional, country-specific or an international problem that they are trying to solve. The addressable market should be huge and the business model must be scalable. The startup’s product or services should have the ability to alter consumer behaviour. Secondly, I try to understand if the team has the ability to execute what they visualise. Several entrepreneurs have great plans, but are unable to give shape to their ideas.

When should I raise funds?

Some entrepreneurs want to be funded from day one. Not every business requires money upfront. First, try to bootstrap. The timing of raising funds is very important for success and longevity of the company. Raising lot of money too early is not ideal. While quick money gives instant gratification, the focus should be on building a company that would be around for another 20 years. There will be cycles when too much investor money becomes detrimental to the startup. Scale up the business first and only then raise money, if required. About 90 per cent of successful companies are built through the bootstrapped model.

Valuations and equity dilution

Valuations in the technology space have reached astronomical proportions and deals have dropped just because of this reason. The right formula is to raise capital that will sustain the firm till the next round. So, if a startup raises Rs 2 crore today, the money should help him raise Rs 10-15 crore in the next round. Or will the startup need Rs 5 crore to reach 15 crore in the next round? A thorough assessment on this front is necessary. In the angel funding round, do not dilute more than 30 per cent. Keep enough equity on the table for the future rounds. Too many entrepreneurs tell investors ‘give me 5 crore and take 50 per cent of my company’. As a rule of thumb, the founders should retain 70 per cent of the startup’s shares post the angel round.

Beware of fakes!

I see a lot of fakes claiming to be consultants, investment bankers and networking experts. They claim to open up doors for a fee. Fake advisers and mentors attach equity and monetary terms to mentoring. You don’t need external help for everything. The entrepreneur should be able to figure out a vision for the next few years on his own. Too many entrepreneurs are writing equity cheques in the name of mentoring and that’s a dangerous sign. There are enough mentoring forums out there that don’t charge you.

Investor due diligence

Resist from taking what I call ‘dumb money’. Only take funds that come from the perspective of helping the business grow. Today, several industrialists, family offices and individuals have started writing cheques. Many of them put in money only because they want to see ‘x’ per cent returns. They may not be aware of how a startup functions. It is very important to get the right investor on board. Your investor should be able to help you with contacts, assist in addressing customer problems and give value addition at every step.

Data-driven investments v/s intuitive investments

No idea is 100-per cent foolproof. An investor always relies on his gut feeling to decide whether a venture is bankable on not. Yes, you need a thorough assessment based on the available data points as you cant keep writing cheques. But once the assessment is done, the final decision comes from intuition. At the end of the day, you scout for the x-factor in the team you are investing into. If you do not see that enthusiasm or if there is no connect with the entrepreneurs, then you stay away. There are times when investors also misjudge. While entrepreneurs worry about failure at every juncture, investors too are cognizant of the probability of losing money.

Today’s entrepreneurs

Since 1993, I have seen drastic changes in the country’s entrepreneurial ecosystem. Today, entrepreneurs are really mature and way ahead of the curve. Their understanding of industry nuances is stellar. They interact with investors in a very professional and suave manner. One of my portfolio companies is on the verge of closing Series A funding. Its a real treat to see how the promoters are negotiating with the VC funds. The confidence that these young boys and girls have is really noteworthy.

(Sanjay Mehta is a serial entrepreneur turned investor. An early stage investor, Mehta has put money over 30 startups both individually and through angel networks. He is a member of Indian Angel Network, Mumbai Angels, Venture Nursery, B2B1K Ventures and CIO Angel Network. Mehta was profiled as the most active angel investor in 2014 by VCCircle. His portfolio includes names such as Zippr Smart Address, AllizHealth, Prettysecrets.com, Poncho (Box8.in) and others. As an entrepreneur, his most recent venture was MAIA Intelligence. Its business was recently sold to publicly-listed Datamatics Global Services.)

As told to our Senior Assistant Editor Adith Charlie


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Entrepreneurs should not divest over 30% in seed funding round; beware of ‘dumb money’

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