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Deepak Bhawnani

VCs must do their homework before investing, and stay alert to hazards

11 July, 2018

With the advent of startup culture, India has seen fresh tech and management graduates from top domestic and international institutions foraying into business as entrepreneurs. Success stories of Indian startups like Zomato (restaurant search and food delivery service), Paytm (digital payments firm), and MakeMyTrip (online travel portal) have not only raked in millions of dollars for the founders but have also inspired many others. Given that niche business models have started gaining more traction, many want a slice of the action.

The entrepreneurial ecosystem has never been better, with millions flowing in from angel investors, venture capitalists, crowd funding, and investment funds. Over the decades, family investment offices have also taken a keen interest in supporting this space.

It is important to identify entrepreneurs who can create value, rather than an overpriced valuation. Poor returns and high-gestation periods create unrest for investors.

Even a strong business proposition takes a long time to transform from an idea to a sustainable and scalable business model. Though these young entrepreneurs bring with them an influx of new ideas and stellar academic credentials, they are a risk!

Though ideation and setting up may seem like big risks for budding entrepreneurs, the real challenge is the struggle to scale up and putting raised capital to good use. An early-stage funding or trenched investment and shifting trends pose a risk to the vast startup market. Missteps and oversights are an integral part of entrepreneurship. “Non-corporate” founders need significant mentoring to build a business while adding to the technical knowledge they possess.

Investments in startups are often speculative and their success depends on whether the new product or service finds a market. While there is an inherent risk of a longer-than-expected gestation period, there is also a possibility of a burn rate that exhausts cash resources, which then creates a need for additional funding and further dilution of equity.

Because venture capitalists ensure that entrepreneurs with high-potential enterprises are not starved of funds, these business incubators are exposed to inherent risks associated with investing in early-stage companies. Even after adopting a guarded and cautiously optimistic approach, early-stage and seed investments can be risky.

An early-stage company shares its business plan and finances with potential investors, and the lack of a veritable history is evident. Therefore, inferring from the professional career of such entrepreneurs may not be helpful considering their relative newness to the corporate world, and limited track record of work.

However, risks can be ascertained by reviewing the reputation of the key driver, their activities, lifestyle and personal interests, along with profiles of their extended family and key connections.

It becomes imperative to understand their involvement in other businesses, activities or potential conflict issues. Additional checks can uncover hidden ownership interests, court cases, defaults, and allegations of malfeasance.

Research is required via media sources; corporate filings; litigation checks; as well as social profiles and blogs. A process which includes regulatory compliance, enforcement, litigation, terrorist lists, sanctions, and blacklists, is critical.

With today’s dynamic and complex terms of conducting business, prudence and caution are desirable qualities that help separate world-class leaders from novices. After review of all relevant data, one can proceed to create a substantial bond with the other party.

Deepak Bhawnani is founder and CEO of Alea Consulting, a risk mitigation and reputation management consultancy. Views are personal.

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VCs must do their homework before investing, and stay alert to hazards

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