Advertisements

Tag Archive : angel investing

The Taxman cannot solve Angel Tax

It has only been a week since I wrote a post on the need to change the investment narrative in India and just 3 days after that, I received a slew of notices from the income tax department asking for ludicrous details on the investments made by Artha India Ventures. Furthermore, a couple of our founders warned us that more notices were on their way since they had gotten them too. This witch hunt is nothing but a death knell for angel investors. Former-IAS Venkatesh Shukla said it best “civil services officers were the “worst” people to decide policies for start-ups.

In one of the notices that we received, we were asked for proof for 20+ points that included literally everything but my medical records (although I should submit them too, just in case). One of the items of the information sought included personal bank account statements of the director of the entity that we had invested through. Since the current directors are all family members, getting this information was not a problem, but can you imagine the embarrassment we would have had to face if we had prominent people as our independent directors? To sum it up, the evidence being sought is nothing but a ruse in forcing us to settle with the officer.

I would love to challenge this harassment in a court of law, but our legal system is already creaking under the weight of crores of cases, adding another one would hardly serve any purpose. The Prime Minister and the Finance Minister need to be cognizant of the difficulties of doing business in India as well as raising seed and angel funding for Indian start-ups. Such fact-finding missions will certainly drive away the much-needed financial support for the start-up industry in India.

Thankfully these notices (as of now) are not being sent to VC/PE funds, so the investors putting in money through funds are safe from this kind of harassment. However, I do continue to believe that we require a robust angel investment ecosystem to start producing 3,000-4,000 seed funded start-ups that will expand out of India by 2030. One of the solutions would be SEBI or a competent authority providing accreditation to certain individuals/entities to be angel investors, a topic I have been discussing on various forums for the past 2-3 years.

This accreditation would put an angel investor on par with VC/PE funds that are allowed to assess the risks of investing in unlisted companies and decide the value they are willing to pay to buy a stake in them. Start-ups that would raise money from accredited investors would only be required to submit the investor’s accreditation certificates (which SEBI can also list on their website) to the income tax officer during the enquiry. If any of the investors on the list do not have accreditation, it would open the start-up and that whole round’s investors to income tax enquiries. The message would be loud and clear i.e. no accreditation is equal to IT investigation. Therefore, this would form a self-policing system wherein start-ups would avoid raising money from non-accredited investors and investors would not like to invest alongside non-accredited investors, thereby pushing every angel investor to get themselves accredited.

The PMO and FMO offices need to step in to stop the mess being created by the income tax department’s officers, from spreading further, or (I shudder to say) we will be an India of 1990 and not 2020.

98/2018

Advertisements

Video of the Week: AIWMI Family Summit 2018

Yesterday, Aditya Ghadge sent me a link to a recording of the panel I had participated on with Siddharth Ladsariya, Abhijeet Pai, Aniket Bharadia and Sandeep Jethwani (he played moderator) on Inside Perspectives from the Next Generation Business Leaders at the AIWMI’s Family Office 2018 Summit. I thoroughly enjoyed this interaction because each panelist came from a different vantage point. Sandeep investigated each person’s viewpoint deeply as is expected from the Head of IIFL’s Wealth Advisory Group. I really enjoyed this view and I hope you do too!    

Since I missed out on the video of the week last Saturday I am also sharing the interview of Atul Nishar that took place right before the panel above. It was an awesome opportunity for me to hear a successful entrepreneur like Mr Nishar candidly take me through his journey, the ups and downs, the exits and how the entrepreneur in him is kept alive by backing start-ups. This interaction is pure gold!  

93/2018

High Valuations are a Thorny Issue!

Yesterday at a luncheon, a fellow angel investor and I were discussing deal flow when the senior editor of a respectable news house introduced herself to us. As many journalists do, she brought up the “high” valuations that are accorded to Indian start-ups and inquired as to whether they are “sustainable”. My fellow angel investor immediately asked if the journalist had ever read the agreements that founders sign to qualify for lofty valuations? Just as he had correctly anticipated she hadn’t, and therein lies the reason that befuddles the most astute investors.

What most people do not realize is that any money raised by a start-up could be considered debt on the company. All investors need to do is, decipher the clauses that will protect their investment. In fact, if founders insist on obnoxious valuations, there will be clauses that will not only guarantee the preservation of capital but also promise a return on the investment! Be rest assured that there are stern punishments for the founder’s equity value if things go pear-shaped.

How stern a punishment can be, is best demonstrated by liquidation events, for example, take the cases of CaratLane in 2016 or Tapzo in 2018. In both exits, the proceeds are nearly equal to the amount of money invested, which definitely means that the investors invoked their capital and ROI protection clauses. This ensures that founders, ESOP holders and even the earliest investors will be left with nothing but a story to reminisce with friends in the years to come.

Therefore I strongly advocate reigning in valuations and giving founders the freedom to experiment and make their own mistakes, so they can develop robust businesses. The founder that finds solace in lofty valuations will find that the higher the valuation chair, the sharper the thorns that could cut the butt that sits on it.

77/2018

The Paripassu is Killing Investor Interest

A marked increase in the number of angel investors joining the ecosystem has led to a problem of plenty for many angel networks. Most of them boast of having hundreds if not thousands of investors spread across the globe. The problem of too much capital chasing too few deals led to a drop in the quality of deals that were/are getting funded by the networks. I wrote about the ills of investments bankers mongering around as angel networks in a post earlier this year called “Angel Investor Networks in India are Dead”. The other major issues that this problem of too much capital in a single angel network have led to are – oversubscription, pro-ration and low investor participation post-investment.  

I strongly believe that founders that have made a deal with a large group of passive angel investors have made a terrible… terrible mistake. This defeats the entire purpose of raising an angel round, which is to get the “value adds” that the angel investor group will provide i.e. help in business development, recruiting, guidance, sales & marketing and so on. A significant factor that motivates investors to pitch in this help is ensuring that each angel investor has enough “skin in the game” to be obliged to invest their time in addition to the money they’ve put in.   

However, due to a large number of angel investors in the ecosystem and lack of good deals, there are situations where active angel investors have to reduce their commitments to accommodate the neuvo angelsWhile I am sure that this is important for the ecosystem, it is truly detrimental for the startup because a lower investment amount reduces the excitement of the active angel investors to work with the entrepreneur.  

A personal example from my angel investment days is a company where I had committed 15 lakhs (~$25,000) in the seed round but got paripassu’d down to the awesome figure of Rs. 95,000 (~$1500) to accommodate 50 odd other investors that were all committing sub 5 lakh amounts. Since I usually calculate a 3x multiple in the follow-on round, the company should be worth at least 45 lakhs in the new round for me to be interested in putting in my time to work with them. In this case, the startup would have to deliver a 45x return in the next round itself to keep me interested, a figure that just isn’t plausible. Therefore, it was a struggle to convince me and my team to help this startup, because a competing investment where we could invest 15 lakhs would just make a better return for our time.  

I am not in any way endorsing that founders reject passive angel money as long as it is a decent amount per angel, but it is extremely important that the founders set aside a large chunk of equity to be taken up by active & prominent angels with decent sized checks that will keep them motivated them to stay engaged.  

Otherwise, founders might realize that along with their company’s equity they have diluted their investor’s interest in it.  

64/2018

Book Review: The Entreprenurial Bible

Book summary

This book is a collection of lessons from some of the top venture capitalists and angel investors in the United States. Through the chapters, VCs share their experiences on how to build value in a startup by describing important aspects of how to pitch to VCs, when to pitch to VC’s, how to negotiate with VCs, etc. In addition, the book talks about practices that align founder’s interests with the growth of their company and consequently the growth of the VC investment. Not only does this strategy give the founder more liquidity preferences but also lowers the risk of investing for an investor.

The book is written in the form of short essays contributed by various members of the VC ecosystem, with the author’s continuous narrative connecting the stories to his own anecdotes. Although ordered haphazardly, this book is a page turner due to the wisely penned stories and examples from such exemplary contributors.

About the author

Andrew Romans is the GP at Rubicon Venture Capital which is an early stage VC with offices in New York and San Francisco

Who should read it

  1. Entrepreneurs that
    • Are thinking about raising venture capital
    • Have raised venture capital
    • Are thinking about raising a new round
    • Are thinking about an exit
  2. Angel investors that
    • Are interested in investing in early-stage companies
    • Have invested in early-stage companies but want to do it better
    • Want to ensure that their investments are set up for success
  3. Venture Capitalists
    • You just should read it if you haven’t already

Why you should read it

This book is unique in that, it is the first book that I have read which offers a view from the different vantage points i.e. from the perspective of the entrepreneur, angels, venture capitalists (early and growth stage), private equity guys and lawyers on issues that invariably come up whenever any two of the parties engage on a deal. This smashes the enigma that some members of this ecosystem create (or maintain) and provides tips on how to have the upper hand on a negotiation table. It teaches the reader how to question, negotiate and close a negotiation successfully.

3 things I learned from this book

  1. The importance of providing founders (and early investors) with liquidity at various points in the life cycle of a venture to
    • Secure the commitment of the founders in the venture
    • Provide money to early-stage investors & founders to back early-stage companies thereby creating deal flow for the VC as well as grow the ecosystem

(The AVF team and I have started working on the viability of a structure described in the book along with our CA & Lawyers – more on this in a later post)

  1. The difference between patient capital and impatient capital and why it is important to match the start-up with the right kind of capital
  2. The preparation required by an entrepreneur (or even a VC) when pitching to investors
    • This was a big, big learning
  3. The difference between fundraising and raising a round of funding (very important!)

Where is it available

  1. This book is available on Amazon.
  2. It will be the first book for 2018 that I will be shipping out (physically or digitally) to all Artha investee founders (the team will reach out to you soon on this!)

B3/2018

47/2018

Angel Networks in India Are Dead

Angel networks have played an important role in developing a robust investment ecosystem for start-ups in India. While the initial networks were small, they were composed of individuals who had known each other for a while, so there was a web of trust that continued to hold the members together. Then as the initial investments of these networks started to pay off and start-ups started becoming an obsession for mainstream media, the networks grew rapidly from a city or regional networks to India-wide or even global networks. What looked like an amazing business was the slow poison of death being gleefully ingested by the network’s administrators. Today, many of these angel networks are dead if not in the terminal stages of death.

What I meant by ‘dead’ is that these networks have morphed into investment banking businesses under the garb of angel networks. Therefore, most of these networks comprise of passive investors that rarely bring in deal flow or can provide time to investees – both important tenets of a successful angel network. Instead of ensuring that the investors know each other and form robust bonds for the future of the investees, the network is gauged by the number of people that have paid the “annual fee”. The value that each angel adds isn’t a metric that is considered– therein lies the problem.

The net result is that the entrepreneurs that approach these networks for funding are treated as “leads” that need to be closed. There aren’t any minimum investment thresholds (eg. size of the cheque, etc) for the investors putting in money which means that the sheer size of these networks coupled with angel’s abilities to write multiple small cheques, almost guarantees that any leads that come to the network won’t go unfunded. The size of the network also causes a hike in the number of investments in order to keep every angel interested. This leads to either relaxing investment standards, investing in rounds that do not conform with network’s objective or most worryingly, investing at valuations that do not make sense thereby killing an entrepreneur’s future chances of raising funds.

A large angel network is harmful to the ecosystem because it lacks the focus and objectivity required of this type of investment group. A smaller, more close-knit angel network that revolves around one investment theme or comprises of individuals from one specific geographic location or investors who only invest in a particular geographic location are all better for the startup ecosystem but not the “angel network business”. Otherwise, this celebrated size of the growing angel network will soon become the tombstone under which the angels’ network will be buried.

39/2018

Beware of This Type of Angel Investor!

Exactly a year ago, I wrote about a growing malaise in the angel investment ecosystem in the post You are NOT an angel investor. It is serendipity that I am writing about sub 5-lakh ($7500) investments from angel investors that are starting to cloud the cap table.

Founders that are raising multiple small cheques from many different angel investors are only shooting themselves in the foot. They should take a moment and ask themselves (and hopefully the investor) why the investors aren’t willing to put in a respectable investment of at least Rs. 5 lakhs?

Do they

  • Lack conviction in the venture?
  • Are hedging their bets by spraying and praying?
  • Are they testing this new investment class?
  • Do they not have the liquidity required to invest more?

If the answer to any of these questions is a “yes”, the founder has reason to be gravely concerned. Investors that lack conviction in your venture are coming along for a ride only if it is smooth, the moment your ship starts swaying in rough waters, they will be the first ones to jump off. The scenario isn’t any better for the spray and pray investor. Both these investor types will create havoc for the founders not only by paying late on the investment but also reneging on their commitments if the company goes through stormy weather. If the cheque size is Rs. 5 lakhs or more, it is still worth getting these passive investors albeit they pay on time. However, to raise a small cheque from an unreliable investor are two variables that can be best avoided.

The investor that doesn’t understand angel investing or doesn’t have to wherewithal to invest a respectable sum of money into your start-up, is only making you the petri dish to understand a new investment class. Why should your venture be that experiment? Why don’t these investors just pay for executive education programmes on angel investing in India or abroad? This will only set them back about the same amount of money that they are willing to invest in your venture. Let them learn investment lessons on their own dime (and time) and not use your bandwidth to do so. In addition, you can avoid the mess that these rookie investors will, later on, create by needling on non-issues or holding up later rounds because they didn’t get the upside that they envisioned.

A second thing that the founder should be wary of is an investor who has a limited net worth and is investing it in a highly risky investment class like startups. What will they do if the investment goes south, like a majority of startup investments do? (it’s the truth, whether we like it or not) Can these small investors gang up and sue you for selling them an investment opportunity that they did not understand? In most western countries, only accredited investors who have the money and understanding of sophisticated investing are allowed to invest in startups. Despite petitioning different government organizations to bring in this type of accreditation, I have seen no action. Why should your startup become the case study to create that accreditation in India?

I have personally been in investments where these small cheque investors were invited with much fanfare. They were responsible for ruining good opportunities for exits, acquisitions and even raising new rounds of finance. The reward you will get from this small investor is just not worth effort. Avoid this investor at all costs.

 18/2018

 

 

 

The math of early stage venture capital

Today I met with an entrepreneur in the travel space that kept reiterating that they wanted to grow organically and without burning money. The “startup” wanted to take it’s a offline business model of booking air tickets, where it earned a respectable profit – online. 

Coming from a strong referral I spent a couple of hours understanding what they did. I concluded that while their current business model was perfect for a family run business they didn’t realise that early stage venture capital would demand that they show rapid growth in the value of the company.

So, I explained to them the following math:

  1. As an early stage venture capitalist I want to build a portfolio of startups that will yield atleast 60% irr.  
  2. So if I put Rs. 100 in 10 startups I have a total portfolio investment of Rs. 1000 
  3. My holding period for an investment is 7 years 
  4. After 7 years the Rs. 1000 investment at 60% irr would turn into Rs. 26,843.50  
  5. I expect 9 out of 10 startups to fail 
  6. Therefore I expect that the return from a single startup will return the Rs 26,843.50 
  7. So, the single investment of Rs. 100 should to return a 122% irr or 268x in 7 years to grow to Rs. 26,843.50!  

At the end I explained to them if their business lacked the potential to growing a rapid pace then early stage venture capital was the wrong form of capital to raise. I think something clicked in their mind when I drew out these numbers and they left thanking me.

I just hope I didn’t scare them off venture capitalists, forever! 

The Math of Early-Stage Venture Capital: Part 1

Today I met with an entrepreneur in the travel space that kept reiterating that they wanted to grow organically and without burning money. The “startup” wanted to take it to an offline business model of booking air tickets, where it earned a respectable profit – online.

Coming from a strong referral I spent a couple of hours understanding what they did. I concluded that while their current business model was perfect for a family run business they didn’t realise that early stage venture capital would demand that they show rapid growth in the value of the company.

So, I explained to them the following math:

  1. As an early stage venture capitalist, I want to build a portfolio of startups that will yield at least 60% IRR.
  2. So if I put Rs. 100 in 10 startups I have a total portfolio investment of Rs. 1000
  3. My holding period for an investment is 7 years
  4. After 7 years the Rs. 1000 investment at 60% IRR would turn into Rs. 26,843.50
  5. I expect 9 out of 10 startups to fail
  6. Therefore I expect that the return from a single startup will return the Rs 26,843.50
  7. So, the single investment of Rs. 100 should to return a 122% IRR or 268x in 7 years to grow to Rs. 26,843.50!

At the end I explained to them if their business lacked the potential to growing a rapid pace then early stage venture capital was the wrong form of capital to raise. I think something clicked in their mind when I drew out these numbers and they left thanking me.

I just hope I didn’t scare them off venture capitalists, forever!

Boss, I won’t sign an NDA!

Each day brings with it an opportunity to learn and share.
So today I will share my view on why asking an investor to sign an NDA before sharing your deck is stupid, ridiculous and foolhardy – this blog post has been inspired from events that took place mid-day today.

First, let us all be clear that the strength of a venture is in its execution and not the ideation. I cannot remember where I read or heard this but I repeat it a lot (much to the chagrin of my team),

Ideas are a dime a dozen and you’re still overpaying for it.”

Second, to all my “NDA required” founder friends: Is your idea so simple that anyone who reads your business plan can copy it, create the same result as you would have and make all the promised multiples? Either you’re in the wrong business OR you aren’t someone who believes in his/her execution skills. Neither of those impressions creates a positive aura for you in the mind of the investor.

Third, if I did in my wildest dreams sign an NDA: I would ask the founder to make it a dual-responsibility NDA wherein any advice I have given to the founder or venture can be implemented only and only if my investment is taken. If my advice is implemented without my investment then I should be given the upside that I have missed.

Does that sound ridiculous?

Well so does asking for an NDA to see plan for a business so easy that anyone can do it.

This is not to say that a founder should never request an NDA.

An NDA can be requested if (and when) things move into the due diligence stage and indepth information is required about the venture by the investor OR in the very rare case that your product/service is so unique that it can be protected by an IP. Even in the latter case the Indian IP laws (to the best of my knowledge) do not protect you if you do not move beyond the ideation stage.

Therefore founders, please, please, please… do not waste your time and mine by asking for NDAs to see your business plans – I won’t sign them!