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Tag Archive : finance

The Funded Entrepreneurs Group

I just got back from my trip to Kolkata which was planned in order to introduce the founding team of an upcoming investment to Mr. Aditya Ladsaria of Chaibreak (an Artha investee) and Mr. Miftaur Rahman of Wow Momos (a fantastic venture that I deeply respect but unfortunately didn’t get a chance to invest in). The objective of the trip was to give the new founders the chance to learn from two sets of successful founders that had no previous background in food, yet managed to fund their respective successful food startups from customer capital before raising venture capital. I especially admire Aditya & Miftaur’s razor-sharp focus towards addressing the customer’s needs through constant innovation in both, the product and operations.

I was a mute spectator (for the most part) in the conversation between the new founders and the experienced ones, but thoroughly enjoyed listening to their detailed discussions about operations, product innovations, customer loyalty management, HR, etc and all the other topics that concern building a business, except “how to raise money from VCs”. This experience gave legs to an initiative that I have wanted to launch for the last 8-12 months i.e. the Funded Entrepreneurs Group.

The idea is to put a group of founders that have already raised money (seed, angel, pre-series A, series A, etc) into a conference room for a couple of hours every 4-6 weeks to talk about matters that only another founder that has raised money can relate to – ‘how to build the venture!’ The discussion shall take place behind closed doors with no recording so that any founder from any stage of the business growth cycle can ask questions – no gyaan sessions only mutually beneficial universal learning.

I strongly believe that when a founder learns the solution to a problem from a fellow founder who has faced a similar issue and managed to overcome it, the solution seems more do-able and the problem less enigmatic. This will also help form a stronger and more cohesive ecosystem for all entrepreneurs. Going forward, the group can also share business leads or transact with each other and the possibilities remain endless, but for now, lets stick to getting a first meeting done.

Artha helped organise a meeting in an open discussion format for angel investors under the age of 50, with a minimum of 5 investments with a similar objective of learning from each other’s experiences. Those meetings have successfully been going on for the past 11 months with beneficial results for all the participants. Currently, the discussion has graduated to deal sharing and evaluating each other’s investments.

My team and I are excited to be able to organise the first Funded Entrepreneur Group meeting for the founders of our ecosystem. The meetings won’t be sponsored by anyone so that the attendees’ independence will be maintained, but there will be a thorough scrutiny of each person that attends to ensure the sanctity of the event. The exact costs of the event shall be shared between the attendees but I do not expect the cost to exceed 500-1000 per attendee inclusive of tea/coffee and a snack.

So, if you are an entrepreneur who

  1. Has raised outside capital
  2. Are willing to share your experiences to help another founder
  3. Are interested in meeting other founders to build your business

Then email us on feg@artha.ventures with

  1. Your full name
  2. The name of your venture
  3. Link to the article announcing your latest funding round
  4. Your mobile phone number(s)

If there is enough interest, I would love to organise the first FEG meeting in 2-3 weeks (based on everyone’s ability). Email us as soon as possible!

30/2018

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Fluff Metrics

An interesting phenomenon has been noticed in startup presentations over the past few weeks. Founders have come up with innovative ways of showing large numbers that have nothing to do with what counts as revenues to the startup.

Let me share a few examples with the explanations as provided.

  1. Gross Transactional Value: this the value of the transaction that is taking place because of the service provided by delivering the service. Therefore, a simple example would be that if a truck delivers 5 MT of steel the GTV is the value of the 5 MT of steel which has no correlation to the revenues of the trucking company since that is dependent on the route or no of kms
  2. AUM (Assets Under Management): the value of the videos that have been uploaded to sell to customers. This has no correlation to the revenues as they are made on a pay per click model. How the videos are being valued and by whom – I have honestly no idea
  3. MRP Sold: the sticker prices of the items that were sold. These were very different from actual revenues as there were coupons and discounts that were given. So, if I stick the price tag of a Mercedes on a Maruti the MRP sold would be ginormous but the actual number would be a fraction. These MRP’s are set by me so MRP sold is also in my hands. Do you feel fooled just yet?

Do founders really want to attract investors that are awed by such numbers? Of what use will those investors be who themselves don’t understand that these numbers are useless?

My sincere request to founders is to have the courage to tell me the real numbers. They may not be as awesome as the fluff metrics, but I’ll respect you for your honesty and I’ll work with you until your actual metrics look like the fluff metrics that your peers are showing me.

Just remember this immortal quote attributed to Abraham Lincoln:

359048-Abraham-Lincoln-Quote-You-can-fool-some-of-the-people-all-of-the

24/2018

Why We Must Become that Asshole Investor (from time to time)

2018 started off with a bang for Artha India Ventures. 4 of our portfolio companies successfully raised new rounds with pre-money valuations of more than $5 million. As a team, we are very happy with the solid multiples that we received on our investments and it validates our thesis of getting in early, building solid value and increasing wealth for all shareholders. These are the times when we look forward to celebrating with our founders for a job well done and to wish them luck on the new journey that has just begun (with the incoming investor).

However, there are a couple of founders that bring forth disturbing issues at the time of signing documents that hold up the entire round of investment. Usually, I can classify the issues that force this reaction into two buckets. The first and most contentious issue is the diktat issued by the incoming investor to disallow any of the previous investors from participating in the new round.

As an investor who invests in multiple stages, we have specific clauses in our investment documentation that allow us to participate in future fundraising rounds of a company. Whatever the logic the new investor can provide (more on this in a later post) we as the early backers of the venture expect the founders to stand up for us and remain loyal to their word and contract, that were negotiated and signed when we initially decided to back them. While many founders ensure that we get to participate in the new round (thank you to them), we do not have sympathy for those who behave this way even without being coerced by another investor.

At the time when these founders needed the money, they eagerly signed the documents with these terms clearly being stated, but when it comes to actually following through for a follow-on round they want to cry foul. To completely sell yourself to the incoming investors and screw over your earliest backers doesn’t bode well for our ecosystem. Firstly, the new investors will only put in stronger clauses to ensure the same doesn’t happen to them in the following round and secondly, the later investors will be way more cautious and hesitant when considering the opportunity to participate because of your past behavior towards investors.

Unfortunately for them, Artha does not respond well to oppression tactics and while we can understand the occasional tough spot a founder finds himself/herself in, the founder cannot always cry wolf.

To be involved in a bitter conflict at a time when we should be celebrating victory is a situation I want to avoid at all costs, but founders need to understand and respect that just like them we too are running a business and to deny us the rights that we mutually agreed before entering the relationship, tinkers with our business model. Just like they would not like to tinker with a business model that is doing well – neither do we!!

21/2018

 

 

Part 2: Early stage investment math – the rule of 3x

Monday’s post, the math of early stage venture capital sparked off interesting debates on various forums. Generally, there is a belief that 268x return in 7 years is unrealistic, many conjectured that early stage VCs expected lower returns, some made the argument that 20% irr was the return expected from a VC (answer to that later).

It occurred to me that maybe (just maybe) the naysayers haven’t looked at the math behind the multiplier effect of early stage investments. So herein below is the math of how a 1 crore investment in seed turns into 243 crores in 6 raises over 75 months. I have refrained from naming the rounds to avoid a tangential debate otherwise here are my assumptions:

  1. A startup raises money for 18 months and starts scouting for a new round in 12 months therefore I have taken a median time of 15 months for a startup to raise the round.
  2. The valuation increases by 3x for a startup between the last round and the next (ideal scenario). The numbers move up or down by a factor of 1x due to many factors that may or may not be under the control of the founder (or funder) but in an ideal scenario the valuation should multiple 3x.
  3. This model may not apply for startups that require long development cycles like startups in the medical space, manufacturing, etc.

 

Valuation Multiplier 3
Timeline (months) 15
Round 1 Round 2 Round 3 Round 4 Round 5 Round 6
Timeline (months) 15 15 15 15 15 75 #of months
Pre-money valuation (in crs) 4 15 56 211 791 2966
Raise (in crs) 1 4 14 53 198 742
Post money valuation (in crs) 5 19 70 264 989 3708
Seed Investment Value (in crs) 1 3 9 27 81 243
Founder’s Holding (Post Money) 80.00% 64.00% 51.20% 40.96% 32.77% 26.21%
Founder Valuation (in crs) 4 12 36 108 324 972

 

The message is clear, money invested in early stage venture capital demands that the investor provides more than just risk capital and that they stay invested for 6-7 years to see a surge in their valuation. When the startup starts scaling new heights, the investor’s early risk is rewarded handsomely. Granted that most startups will not pan out the way the investor and entrepreneur expected and that is the risk the investor must live with and get rewarded for.

Lastly I am a firm believer in risk adjusted returns for my money which means that money should flow to those areas where it achieves the highest reward to risk ratio (and not the other way around!).

So, I compare the returns of my team’s work at Artha India Ventures to the work my team at Artha Energy Resources is doing wherein they have placed over $5 million capital from a clutch of investors (including us) into operational wind power projects on long term PPAs at 15% irr in the last 6 months. If my money can earn that return, why should it be deployed at 20% irr in highly risky early stage investments?

The clearer the investor and the entrepreneur are about what they expect from their investment… the easier it is to keep each other happy!

 

Thank you Vijay Anand of The Startup Centre for sharing the previous edition of this discussion.

Decoding Sun Edison’s Record Bid for Selling Solar Power in India – Realistic or Wildly Optimistic? (Part 1)

The recent brouhaha over Sun Edison’s record low bid of selling solar power at Rs. 4.63 per kWh has shaken up the entire solar universe (which just 3 GW in size… by the way) in India. On November 9th an article in the Business Standard mentioned that

there is nervousness among investors in the segment and the supply chain. Experts say leading project developers are putting aggressive bids for 50-200 Mw projects, to be relevant in the market

I am personally quite surprised at the record low rates that have been achieved. It is easy to appreciate that there has been very little (if any) progress with the financial institutions lending to this sector. Banks don’t bat an eye lid when asking for an arm, a leg and your dog’s kennel as collateral or putting deals through committee after committee while the project owner suffers. There was a brief ray of hope for investors when panel prices dropped below 50 cents per watt but a rapidly devaluing rupee nuked the opportunity created and the panel prices remain firm on a rupee level.

So when the reverse bidding prices for the sale solar output start touching record lows without much changing on the input sides – it intrigued me to further investigate how these projects made financial sense for investors.

Instead of assuming a certain project cost and then getting an IRR based on the bidding done by Sun Edison I decided to and was encouraged to (by a senior executive at a leading EPC) to  reverse calculate the project cost by using the tariff as the final product and taking CERC or market accepted levels of return for such projects to find out the truth for myself.

First I refurbished a worksheet that I found online on www.IndianPowerIndustry.com and utilised by the website for “Calculation of Solar Power Tariff”. The sheet is quite comprehensive but I found a few errors both clerical & logical that I corrected and figured that for a bid of Rs. 4.63 to make sense the project cost would have to be about Rs. 4.40 crore per MW (all inclusive).

The assumptions made were (all figures are in lakhs of rupees) :

Project Capacity MW 500 Return on Equity for 1-10 years Per Annum 18%
Annual Energy Production Lac Kwh 8322 return on Equity for 11-25 years Per Annum 22%
Total Project Cost Rs. Lac 440 Depreciation till loan repayment 5.83%
Project life Years 25.00 Depreciation after loan repayment 1.54%
Equity to be Invested Rs. Lac 66000 Total O&M expenses for 1st year 4000
Loan Component Rs. Lac  1,54,000 Escalation in O&M Expenses 5.72%
Loan repayment period Years             15 Discount Rate 9.88%

Please note: The discount rates input of “Return on Equity”  was 16% (post-tax) as per CERC guidelines. So the final calculation was (70% x 11% x (1-33.99%) + (30% x 16%) = 0.0988

The final calculations were (all figures are in lakhs of rupees):

Year 1 2 3                4                5                6                7                8                9             10             11             12             13             14             15             16             17             18             19             20             21             22             23             24             25
Energy Sold (degrading by 0.84% per year) 8322  8,252.10  8,182.78  8,114.04  8,045.88  7,978.30  7,911.28  7,844.83  7,778.93  7,713.59  7,648.79  7,584.54  7,520.83  7,457.66  7,395.01  7,332.90  7,271.30  7,210.22  7,149.65  7,089.60  7,030.04  6,970.99  6,912.44  6,854.37  6,796.79
O&M Expenses (includes OPEX) 4000.0 4228.8 4470.7 4726.4 4996.8 5282.6 5584.7 5904.2 6241.9 6598.9 6976.4 7375.5 7797.3 8243.3 8714.9 9213.3 9740.3 10297.5 10886.5 11509.2 12167.5 12863.5 13599.3 14377.2 15199.6
Principal Repayment 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 10266.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Interest on Term Loan 16422.4 15293.1 14163.7 13034.4 11905.1 10775.7 9646.4 8517.1 7387.7 6258.4 5129.1 3999.7 2870.4 1741.1 611.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Return on Equity (Pre-Tax) 11880.0 11880.0 11880.0 11880.0 11880.0 11880.0 11880.0 11880.0 11880.0 11880.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0 14520.0
Total Outflow 42569.1 41668.5 40781.1 39907.5 39048.5 38205.0 37377.8 36567.9 35776.3 35004.0 36892.1 36161.8 35454.4 34771.1 34113.2 23733.3 24260.3 24817.5 25406.5 26029.2 26687.5 27383.5 28119.3 28897.2 29719.6
Cost per Unit of Electricity 5.1 5.0 5.0 4.9 4.9 4.8 4.7 4.7 4.6 4.5 4.8 4.8 4.7 4.7 4.6 3.2 3.3 3.4 3.6 3.7 3.8 3.9 4.1 4.2 4.4
Discount Rate for Net present Value 0.099
Discount Factor 1.0 0.9 0.8 0.8 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3 0.2 0.2 0.2 0.2 0.2 0.2 0.1 0.1 0.1 0.1
NPV of Cost per Unit 4.65
Therefore Tariff (Rs./Kwh) 4.65

I also devised an alternate sheet of my own which wasn’t as comprehensive as the one created by  IndianPowerIndustry.com but was based on IRR versus NPV. In this approach I estimated the investment cost by charting out the net cash-flow at the project level and hitting a target IRR (14% post tax) at the project level.

Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Generation 8760 8686 8613 8541 8469 8398 8328 8258 8188 8120 8051 7984 7917 7850 7784 7719 7654 7590 7526 7463 7400 7338 7276 7215 7155
Tariff ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63 ₹ 4.63
Revenues ₹ 40,559 ₹ 40,218 ₹ 39,880 ₹ 39,545 ₹ 39,213 ₹ 38,884 ₹ 38,557 ₹ 38,233 ₹ 37,912 ₹ 37,594 ₹ 37,278 ₹ 36,965 ₹ 36,654 ₹ 36,346 ₹ 36,041 ₹ 35,738 ₹ 35,438 ₹ 35,140 ₹ 34,845 ₹ 34,552 ₹ 34,262 ₹ 33,974 ₹ 33,689 ₹ 33,406 ₹ 33,125
O&M -₹ 3,000 -₹ 3,172 -₹ 3,353 -₹ 3,545 -₹ 3,748 -₹ 3,962 -₹ 4,189 -₹ 4,428 -₹ 4,681 -₹ 4,949 -₹ 5,232 -₹ 5,532 -₹ 5,848 -₹ 6,183 -₹ 6,536 -₹ 6,910 -₹ 7,305 -₹ 7,723 -₹ 8,165 -₹ 8,632 -₹ 9,126 -₹ 9,648 -₹ 10,199 -₹ 10,783 -₹ 11,400
OPEX -₹ 1,000 -₹ 1,057 -₹ 1,118 -₹ 1,182 -₹ 1,249 -₹ 1,321 -₹ 1,396 -₹ 1,476 -₹ 1,560 -₹ 1,650 -₹ 1,744 -₹ 1,844 -₹ 1,949 -₹ 2,061 -₹ 2,179 -₹ 2,303 -₹ 2,435 -₹ 2,574 -₹ 2,722 -₹ 2,877 -₹ 3,042 -₹ 3,216 -₹ 3,400 -₹ 3,594 -₹ 3,800
Cash Before Tax ₹ 36,559 ₹ 35,989 ₹ 35,410 ₹ 34,819 ₹ 34,216 ₹ 33,601 ₹ 32,972 ₹ 32,329 ₹ 31,670 ₹ 30,995 ₹ 30,301 ₹ 29,589 ₹ 28,857 ₹ 28,103 ₹ 27,326 ₹ 26,525 ₹ 25,698 ₹ 24,843 ₹ 23,959 ₹ 23,043 ₹ 22,095 ₹ 21,111 ₹ 20,090 ₹ 19,029 ₹ 17,926
Effective Tax Rate 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10% 10%
Tax ₹ 3,656 ₹ 3,599 ₹ 3,541 ₹ 3,482 ₹ 3,422 ₹ 3,360 ₹ 3,297 ₹ 3,233 ₹ 3,167 ₹ 3,099 ₹ 3,030 ₹ 2,959 ₹ 2,886 ₹ 2,810 ₹ 2,733 ₹ 2,652 ₹ 2,570 ₹ 2,484 ₹ 2,396 ₹ 2,304 ₹ 2,209 ₹ 2,111 ₹ 2,009 ₹ 1,903 ₹ 1,793
Net Cash Flow(s) -₹ 2,00,000 ₹ 32,903 ₹ 32,390 ₹ 31,869 ₹ 31,337 ₹ 30,795 ₹ 30,241 ₹ 29,675 ₹ 29,096 ₹ 28,503 ₹ 27,895 ₹ 27,271 ₹ 26,630 ₹ 25,971 ₹ 25,293 ₹ 24,593 ₹ 23,872 ₹ 23,128 ₹ 22,359 ₹ 21,563 ₹ 20,739 ₹ 19,885 ₹ 19,000 ₹ 18,081 ₹ 17,126 ₹ 16,133
IRR 14.14%

In both models the total project cost I arrived at is between Rs. 4 – 4.40 crore per MW. Now comes the really important part… is that cost realistic or attainable?

So the few things that are constant in such projects are:

Interest free Performance Guarantee Deposit Rs. 10 lakh per MW
One-Time Solar Park Development Expenses Rs. 42 lakh per MW
Service Tax & Other Taxes which I will estimate at 5% of project cost Rs. 20 lakh per MW
Panel investment* Rs. 297 lakh per MW
Inverter Rs. 20 lakh per MW
Total = 389 lakhs or 3.89 crore per MW

*Panel costs (this is the tricky piece) for a project of this size should be quite low.. Below market quoted prices for sure. I estimated them to be $0.42-0.44 per watt. However with 30% of the capacity under the DCR category it is my estimation that the average per watt procurement cost will be $0.45 per watt. You can argue that the panel prices may/will fall 10% in 12 months i.e. when they are needed. I would say that the rupee will most like devalue 10% by that time as well negating the gains made in panel procurement cost. Lastly one should also note that a significant percentage of these modules are to be sourced from Indian Panel manufacturers who charge  a premium to international rates.

Even if I take the average of the “derived project cost” I get 4.20 crore per MW as my project cost.. Deducting the break-up above I get a balance of 31 lakhs per MW to cover the remainder of my expenses which are:

  1. Balance of Plant Investment
  2. Transmission Investment
  3. Labour Costs
  4. EPC Margin (this goes to Sun Edison if they do their own EPC)
  5. Project Monitoring Costs
  6. Legal Costs
  7. Equipment transportation
  8. Financing costs like:
    1. Processing fees
    2. DSRA
    3. IDC
    4. Bank Guarantees
    5. EMD Costs
  9. Stamp Duties & other taxes

Do you think that 31 lakhs can cover all this?