Smart Hunt for Money

The ‘e’ word has caught the fancy of every body–from

generation X to veterans of the corporate world. Stories of Sabeer Bhatia of

Hotmail, Rajesh Jain of IndiaWorld and Siva Kumar of Onebox.com are by now part

of entrepreneurial folklore. Apart from these well-known names, there are scores

of others who have come up with flying colors.

The sudden spurt in start-ups has been prompted by many

related developments in the marketplace. Two of the most prominent developments

in this regard have been the rapid growth in the IT industry and Internet, and

the almost exponential growth in the availability of venture capital (VC) funds.

The virtual explosion of the VC industry in the last few months, apart from

increasing the quantum of funds, has also increased the choices of sourcing

capital for the entrepreneur. The rapid growth of the IT and the VC industry has

reduced entry barriers for the prospective entrepreneur.

The results of these developments are clearly evident in many

areas in the country today. Adrenaline flow has increased, particularly among

students and early stage professionals, who have been attracted either by the

thrill of starting their own business or by the prospect of raking in millions

at the click of a mouse.

Finding the funds

The first step for the prospective entrepreneur in starting a

business venture is to identify the funding sources, which would enable

transforming the idea into a viable business proposition. Before approaching a

VC investor, the entrepreneur should have done the homework thoroughly. Half

baked ideas, unless very convincing, do not arouse the interest of the investor.

Doing the homework

While approaching the VC investor, the entrepreneur should

highlight key features that the investor looks for while making the decision to

invest. Some of the key features that a VC investor looks at before making a

funding decision are listed below:

STRENGTH OF THE IDEA: The promoter should clearly

indicate the business potential of the idea, highlighting the need for the

service or product in the market. It should also highlight superior features of

the product, if there are competing products available. The technology that is

being used to deliver the service should also be identified.

REVENUE MODEL: The model should indicate the source of

revenue. It should indicate whether the revenues would be through advertising,

e-commerce, licensing, or by selling exhibition space on the site–if it is a

Web related venture. It should highlight the sales and pricing strategy, and

sales forecasts.

PROMOTERS’ BACKGROUND: In the absence of a track

record, this is the key area that a VC investor looks at. The background should

provide the educational and professional history of the promoters. It should

highlight the contribution and strength of the promoters and their commitment to

the venture.

BUSINESS PLAN: The plan section should indicate

projections of income for the next 3-5 years, ratio analysis and the proposed

investment plan. It should also provide an industry analysis, the different

participants, a study of the competitors and the proposed promotion and

marketing strategy.

EXIT FOR THE VC: The final aspect that VCs look at is

how they can exit from the investment. The exit section should highlight the

possible exit options for the VC, whether it can be through a strategic sale, or

through an IPO.

Choosing the right VC

Once the homework is done, the next stage is to identify a

suitable VC investor to fund the project. While deciding on the source of

capital, remember that VCs bring more than just funds to the table. This concept

of bringing along a bundle of capabilities along with funding is called ‘smart’

money. VCs can contribute in any of the following areas:

MANAGEMENT CAPABILITIES: VCs can bring in management

expertise, which the technocrat entrepreneur may lack. Angel investors and other

VCs can play a prominent role in taking the start-up from conception through

operation till expansion in the market. VCs can nominate senior people on the

board to provide direction or they can themselves be involved in day-to-day

operations–an approach called hand-holding. They can also help investees to

identify proper people for key positions in the organization. Therefore,

depending on the expertise required, the entrepreneur can look for angel

investors, seed capital investors or institutional investors.

MARKET ACCESS: VCs, by their extensive networks in the

industry, can help start-ups get their initial business. Providing such initial

breakthroughs can be critical for the start-up in its struggle to gain

credibility and a foothold in the market.

DURING IPO OR SALE: The reputation of the VC that has

funded the project can be important at the time of strategic sale or during the

IPO. Association with a reputed VC would help in obtaining better valuation

during the IPO or for getting a superior offer during a strategic sale.

Before deciding on the VC investor, the entrepreneur should

also decide on the nature of funding required for the venture, whether it is

seed capital, start-up capital or later-stage funding. Seed capital is the

initial funding required to validate the idea and finance the initial

feasibility studies. Start-up funding is required for product development and

initial marketing. Later-stage funding is required for working capital finance

and business expansion. As different business stages would demand different

business capabilities, the nature of the VC investment would depend on the type

of funding sought. While seed capital and start-up funding can be obtained from

angel investors, incubators and start up venture capital funds, later stage

funding can be obtained from institutional venture funds and mutual funds.

The future is now

Several new initiatives have been started–like the India

Venture 2000 and the e-mahamillionaire project of NIIT–to nurture and guide

prospective entrepreneurs to obtain VC funding. Notwithstanding the recent

developments, the VC industry is in a nascent stage in India today. With the

prospect of more growth in the IT sector, a lot more activity can be expected in

the VC industry with the availability of more investible funds. Some of the

recently launched technology mutual funds have earmarked a portion of their

funds in unlisted companies, which make them more like VC funds. All this is

happy news for the entrepreneur. Venture funds have been an engine for economic

growth for over a decade in countries like USA, Israel and Taiwan. The situation

is now ripe to be replicated in India.

Dr Thillai Rajan A



is assistant manager at IL&FS Venture Corp and a Fellow of the Indian
Institute of Management, Bangalore