Do You Have The Right Capital Mix?

One of my favourites from all the meetings I have, is my monthly morning coffee with Mr Narendra Karnavat. Mr Karnavat is one of the most active and passionate angel investors based out of India. Moreover, he is an entrepreneur turned investor, which gives him the privilege of looking at investment opportunities from the entrepreneur’s perspective. For obvious reasons, I also feel like this quality makes him more admirable and charismatic to me.  He quickly identifies if an entrepreneur understands the true meaning of dhanda and debunks the “wannabe” entrepreneur or as my favourite shark calls it, wantrepreneur.

His entrepreneurial zeal and energy are such that every meeting with him is a lesson in itself. We have invested in multiple companies together and he was also one of the first people to come onboard as an LP in Artha Venture Fund-I.

Yesterday, we met at my office to discuss some deals that AVF has in its pipeline. One of the topics that came up during our discussion was ‘how entrepreneurs usually make the mistake of misallocating venture capital’. Since the utilisation (and mis-utilisation) of venture capital has been a topic that I love to write about we ended up discussing this at length. 

Venture capital is expensive $$$ and can be measured from its high expectations of returns. It is (or should be) the first lesson in finance: one should deploy capital only when the returns from that deployment will exceed the cost of deployed capital. In simpler terms, it does not make sense to take a loan at a 10% interest rate to put it into a fixed deposit yielding 7% interest, does it? Similarly, a smart founder should not be deploying venture capital in areas that cannot provide disproportionate returns.

In my opinion the 2 worst places to deploy venture capital are:

  • Heavy capital expenditures like constructing a factory etc.
  • Working capital requirements

Capital for these requirements is best borrowed from banks and NBFCs and that too, only if the interest rate is below the ROI/IRR that the deployment is offering. This would be a prudent financial decision even if the interest rates were substantially higher than what is generally available but only until it is below the ROI/IRR that that capital deployment is offering.

It is imperative for founders with start-ups in execution/capex heavy spaces to do a crash course in finance and bring a finance professional onto the team early. This professional would help match the right type of capital to its deployment purposes and protect the erosion of the founder’s equity holding due to a mis-allocation.   

As for Narendraji, until next time! 😊                 

100/2018                     

Recommended Posts

5 Comments

  1. Well said Anirudh

  2. fab…
    after the founding team mix, the capital mix bears an impact on the potential exit multiples

  3. Well said. Putting a factory with venture fund is not the best use of the money. But it is very difficult for entrepreneurs to segregate the same, when under cash flow pressure. Hence must be planned earlier.

    • Absolutely right Abhishek! The proper prior planning on the use of funds ensures its best utilisation!

  4. Even visionary founders end up misallocating VC funds. How VCs are dealing with them?..
    Interesting to learn about wantrepreneur!


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.