Tag Archives: VC

Does raising institutional money at the seed stage help or hurt?

In 2009-2010, during the peak of the eCommerce bubble in India, there were very few seed stage options for raising funds for startups. You could either get money from angel investor or look to raise money from large VC’s, hoping they would put money at the seed stage so they can be part of the later round.

During that period, larger firms in India, such as Sequoia Capital and few others did many (over 15-20) deals in a year. The typical check sizes were about $500K in India (about 2 CR that that time).

The main reason why entrepreneurs were looking to raise money from institutional investors,  besides needing the cash and finding not many other options was the belief that “if they were in early, they would be an automatic in the next round”.

Of the over 40 deals  that were done by institutional investors in 2008-2010 in the early stage (largely in eCommerce), only 4 are still around. Of the companies that took money from institutional investments in their seed round, only 5 secured investment from the VC in their post seed round.

This weekend I had a chance to read the ET survey on Why startups are raising seed stage capital from VC firms.

The average % of the company that entrepreneurs gave up is about 15% and the amount they raised from VC investors at the seed stage is about $500K.

There are many good reasons to raise money from traditional Venture investors, but assuming they will definitely invest in the later round, is quite possibly wrong based on previous history.

If you are looking to raise money and you have an interested later-stage VC investor willing to put money in your company, by all means you should take it.

Assuming they will invest later is a big leap of faith.

There are, like most things in the startup world pros and cons to this approach.

The pros include the “name brand” value of the VC firm on your cap table early on, the ability to tap into the expertise of the VC investors and also access to their network and connections.

The downsides are the signalling effect if they refuse to invest in the follow on round, the likelihood of them investing in other competing startups in the same space in later round (since they understand the market) and finally the smaller pool of investors available for you (since many VC’s wont invest if a lead VC investor passes on the follow on) in the next round.

While I dont think there are many options in India for entrepreneurs, the best bet I would still recommend is to get the right investors at the right stage of your company. At the early stage, angel and seed stage firms make sense, and later on using their help to get VC’s is a good approach.

Credit: Paul Martino, Bullpen Capital
Credit: Paul Martino, Bullpen Capital

Paul Martino of Bullpen capital puts this week in the chart above.

Given that seed is now a perpetual and continuous process until your series A, I would recommend you raise constantly and raise often.

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If someone gives you absolute answers to entrepreneur questions, understand their framework first

I am always wary of absolute statements such as “We only invest in entrepreneurs” or “The best way to hire is to have a strong culture” or “Raise money from top tier VC’s, else you will not have a Unicorn exit”.

Why? Primarily because there is no one right answer. The answer is always “It depends”, but “it depends” is a hollow and unsatisfying answer.

So I prefer frameworks.

A framework is a mechanism to think about your particular situation and unique constraints and apply the possible approaches to come up with a personalized strategy.

I was reminded of that by Dave McClure, who talks about portfolio size in his latest post on Venture Capitalists.

When VC’s tell me they want to be “stock pickers” not index fund managers, I tend to have a lot more questions.

A “stock picker” assumes they know something everyone else does not. They have a key market insights, some differentiated information that’s not available to anyone else or knowledge that most others are missing.

An “index fund” manager believes that they dont have that insight, but can make money nonetheless by tracking market returns.

Turns out in the VC world, most VC’s think of themselves as “Stock Pickers”. That is one strategy to win in Venture and generate outsized returns.

To call every other strategy not-workable, is incorrect. While many folks call the other approaches “spray and pray” or “finishing with a net”, the strategy might work.

A framework to think is probably a better approach. That framework has to put desired outcomes on one side, the constraints in the middle and the inputs on the other side.

Outcomes and Constraints
Outcomes and Constraints

This framework visualization is not the only way to think about answering a question. There are many cases, when an “expert” might have learned something unique, analyzed the situation and provided the constraints in a more prioritized fashion. So, instead of looking at all the constraints, you can look at the 2-3 that matter.

Over the last 3-4 weeks, I have been putting together more frameworks to outline problems and questions I have encountered and worksheets or templates that work.

Going back to the VC conundrum, if an investor believes that there’s only one way to approach early stage investing, then they are possibly wrong.

The constraints I have heard from VC’s who follow the stock picker approach is that they dont want to sit on too many boards, dont have time to help more than 5-6 companies at the same time, or that they dont have time to find more than 10 companies are worth investing in.

If those are the constraints, then there are better and more different ways to solve for those constraints.

You can not sit on the board, and still have influence rights, you can hire people to help your portfolio and use technology to find more relevant companies and founders.

Most constraints can be solved, as long as you are clear about the outcomes you desire.

Some constraints you do not want to compromise on, and that is a constraint as well.

As an entrepreneur, though, if you are given only “one answer” or “one approach” or “one strategy” to be successful, you are talking to a fairly inexperienced person who you should probably not take advice from in the first place.

Dealflow management is now harder than fundraising for #microVC in India

In 2008 (before Angel List) there were roughly 1000 technology startups in India starting each year. of these about 50+ got funded by VC each year according to Thomson Reuters.

The percentage of services (consulting, IT enabled services, BPO, outsourcing) companies was about 29% – those that started and 33% of those that got funded.

The number of eCommerce companies was about 3% of the total.

Services and eCommerce Companies India
Services and eCommerce Companies India

Fast forward to 2014 and those number of companies starting at 22% of the total for services and 5% of the total for eCommerce.

The structural changes of the services companies have changed as well. We have gone from 8% of the companies in IT Services to 5% from 2008 to 2014.

Service Category Startup in India
Service Category Startup in India

While Thomson Reuters does not break out the data, anecdotal evidence suggest that there are a lot more digital marketing & design outsourcing companies now than before.

The number of eCommerce companies has been steadily increasing as a % of companies started, but has increased significantly as a % of funded companies and a % of total funding.

The only other category, which has grown (for which I dont have a breakout again) is software as a service (SaaS).

Over the last 7 years, the number of Micro Venture Capital firms has also grown. We have gone from none in 2008 to 5 in 2014, and I think we will end up at about 10 Micro Venture Capital firms (those that have less than $25 Million in capital to invest) in 2015. These include Angel Prime, Oris, India Innovation Fund, Blume Ventures, and others.

I have talked to about 5-10 angel investors and industry veterans who are all looking to start their own Micro VC, seed fund and combination accelerator or incubator in India over the last 3-4 months.

In 2008, the average amount of time it took to raise a fund (regardless of size) was about 9 – 12 months. That number is lower for Micro VC funds, obviously, but we have no way to know how long it would have taken.

In 2011 of the 3 funds that raised, the average was about 7 months.

This year, I am hearing funds that are < $25 Million close their raise in less than 4 months.

That means the time taken to raise their fund has dropped. It is easier for fund managers to raise their capital, they can do it in shorter periods of time and they can raise more than they initially desired.

The challenge for the fund managers seems to be no longer raising capital, but efficiently deploying it.

The gold standard for VC investing has been proprietary deal flow (startups that come to the investor for funding exclusively and go to no other investors). That’s becoming harder for all VC’s now.

If the number of companies starting up has grown significantly (as from the graph above) and the % of non services companies have grown as well, then there is a real democratization of founding startups.

So the problem has now moved to sourcing, building a brand for your Micro VC firm and convincing entrepreneurs that you are the “smartest” capital available.

The best entrepreneurs have multiple sources of funding, and they have many investors of different type chasing them.

The challenge for Micro Venture firms with no brand visibility or “magnet” founders is that their deal flow is largely limited.

From our own data, I can confidently tell you the “best” deals are usually referrals, but 3 in every 5 companies we get into our program are non referralsSpeaking to Accel and Helion last week, I confirmed that 25% of their funded opportunities were cold (unsolicited).

So while the Micro VC fund manager may have a decent network, their biggest challenge is going to be that they will not be able to attract at least a quarter of deals which come because of having a good brand in the startup ecosystem.

The problem for a lot of the Micro VC’s is going to be that they have poor quality deal flow or deal flow that’s not proprietary.

While they will still go to many events, and review Angel List startups, I suspect they will have a tougher time getting good quality companies to apply.

The bottom line is that now it is as hard for the investors to get good companies as it is for the entrepreneurs to get good investors.

Which is why I love this quote

“Every morning in Africa, a gazelle wakes up, it knows it must outrun the fastest lion or it will be killed. Every morning in Africa, a lion wakes up. It knows it must run faster than the slowest gazelle, or it will starve. It doesn’t matter whether you’re the lion or a gazelle-when the sun comes up, you’d better be running.”

― Christopher McDougall, Born to Run: A Hidden Tribe, Superathletes, and the Greatest Race the World Has Never Seen

The one question you need to ask VC’s in #India to understand how quickly they will move to fund your #startup?

I was in Bangalore for 3 days, meeting about 30 entrepreneurs on day 2 and about 50 earlier stage in-the-process-of-starting-a-company entrepreneurs. The first thing that strikes you is how amazingly vibrant the ecosystem in Bangalore is. I met with over 100 investors (angel as well as a few VC’s) as well at the Lets Venture event and they while many were complaining that “valuations are higher” and “entrepreneurs are pushing them to make decisions quicker”, they were very upbeat about the opportunity in the Bangalore ecosystem.

The entrepreneurs are also much more savvy than folks were even about a year ago (I know that I spoke with a curated list, but previous curated lists were provided as well and this cohort of entrepreneurs were far ahead of those a few years ago).

The most interesting part that I noticed was that there was a bigger focus on “traction“.

I can confidently say that having been to 23 cities in the last 6 months including New York, Beijing, San Francisco and other cities in the US, Bangalore has a clear shot at being in the elite “top 5” entrepreneur ecosystems (Of course it will be Silicon Valley (Snow White) which will be #1 by a wide margin, but the other cities (the 7 dwarfs) are doing well relatively. I look at ecosystems for entrepreneurs around cities more than countries.

That optimism also bears itself out in the numbers. From look at IVCA funding and other locations, Bangalore is trending stronger than other cities such as Seattle, New York or Austin.

There were many observations I had in my 3-5 indepth discussions with Venture Capital investors in India. One of them was their necessity to now “compete” to get entrepreneurs’s attention.

Which in itself indicates a strong and vibrant startup funding ecosystem.

The most important takeaway for you as an entrepreneur, that I have learned is this –

If a venture firm has spent any time forming an “investment thesis” in a particular market or segment, then they will move much quicker than other firms who have not.

So that’s the million dollar question you can ask to determine if a VC will move quickly in India. I know this is the case in other locations as well, but the funding frenzy has been more acute in Bangalore than I have seen before.

I would ask a variation of the question – “What is your investment thesis in XYZ market”? Or “Do you have an investment thesis on “my XYZ” market”?

if they do, then your job is only to convince them that you are the best team, company and startup with the right traction to invest in.

If not, they will take weeks to understand the lay of the land, look at competitors and then form an opinion on your market.

Let me know if this works.

Does who you raise money from limit or grow the size of your ambition?

I was speaking to a prominent angel investors in the Seattle ecosystem yesterday. He has been pretty prolific, doing over 20 deals in the last 5 years. He does mostly syndicates and has a band of investors he works with. Having been a successful technology executive before, he understands the market and the landscape fairly well.

We got talking about accelerators and their place in the startup food chain.

Most VC’s and angels will tell you that in the last 2-3 years, accelerator backed companies have gone from 0 to about 5-10% of their portfolio. Many seed (angel, individual) investors still believe that proprietary deal flow is critical to their success in building a strong portfolio.

The thing that struck me was how he mentioned that in the last year he has changed his position from “angel investor education” to “entrepreneur education”.

The reason was that he felt entrepreneurs were not clear on the market landscape for exits and how angel investors need to make money as well. I can understand and empathize. If angel investors don’t make money, they wont be able to convince other new investors to come along.

He was talking about the example where most of his companies (of the ones that exited) have been acquired for between $25 and $100 Million. He has 4 exits, so there’s clearly insufficient data to form a trend.

Nonetheless, he felt it was important to ensure that entrepreneurs understand that the series A VC round was getting bigger and getting harder, so he was pushing for his entrepreneurs to be capital efficient and raise as little as possible, expecting to raise < $3 million ($500K – $1Mill, first seed, followed by a < $2M post seed). That way he felt, that a < $10 Million valuation in your post seed will still get you a 2 – 5X multiple return.

Normally I would have filed this under “investor that cares about returns only so don’t bother”, but this investor is really smart and has been helping his entrepreneurs successfully raise their follow-on’s. Of the 20+ companies, he has helped 80% of them raise follow on funding within 18 months. Pretty impressive.

Then it struck me as I was speaking to a valley VC later in the evening, who mentioned there was “frothiness” in the valley and that companies were raising money because everything is just so much more expensive. He was advocating the “Go big or Go home” strategy.

Turns out there are multiple options indeed for entrepreneurs – if you can get to the valley, and plug into the network, you tend to raise a lot more money, grow big and scale fast.

If you are not in the valley, you grow slower.

I have a few questions though:

1. Do you know what drives you – making good money or making a difference? – Saying both is an easy cop out. What would you prioritize?

2. Does the size of your ambition affect who you raise money from and where?

3. Does who you raise money from (not the amount) affect the size of your outcome as well?

I suspect the answer to all these questions is a qualified yes. I’d love your 1-2 sentence answer (or 140 character tweet) to these questions.

2014 is the year when India became #3 worldwide in tech #startup funding

I am finally going through all the reports from PwC MoneyTree, E&Y reports and Venturesource data to determine how the tech startup ecosystem did in terms of funding and growth of VC investments. Here is a snapshot from 2013, the report is available for download.

Worldwide Venture Capital Investments 2013
Worldwide Venture Capital Investments 2013

If you look at 2013, US dominated with ~3500 funded startups by VC’s and that represented ~70% of all tech startups funded. There were a total of 5700 companies that got funded by VC’s alone, worldwide.

In 2014, the number (have to get permission to post since it is behind a paid wall) of VC funded startups rose to ~6500. Depending on which number you seek some say it is 7200.

The US was number 1 with 65% of startups, Europe (primarily UK, Germany and France) #2 with 1500, China #3 with 451 and India #4 with 312.

If you treat UK, Germany and France as separate countries (which they really are and I am not sure why E&Y and PwC group them together as Europe for the purposes of the report), then none of them made it to the top 5.

Looking at countries alone: 1) US, 2) China, 3) India, 4) Canada, 5) Israel, then UK, Germany and finally France.

In terms of invested dollars as well, the numbers are the same:

1. US $38 B – $45 B

2. China $4.5 B – $5.2 B

3. India $2.4B – $2.9B

4. Canada $1.7 B – $1.8 B

5. Israel $1.65B – $1.75B

Size and speed – the two most important aspects of your market, to get #venturefunding for #startups

I spoke to an entrepreneur yesterday who is focused on the health and HR markets – two of the toughest markets to target. Health has so many regulations to work with and HR has so little budget. So, take both of them together and unless you have a “head on fire” situation – aka compliance problem, they are very difficult to sell to.

Most, but not all venture investors care deeply about the market you startup is targeting. Here’s a rule of thumb – larger the market, more likely a VC is going to care about your company and to be willing to invest. Billion dollar markets are important to VC’s, and preferably large billion dollar markets. You need to do both a top-down and a bottom-up market analysis to show them that it is a large market. If it is less than a significant size, then I’d advice you not to go pitch VC’s.

In many cases, you wont know the size of the market. It could be small ($100 Million or less) or you just dont know how to position it as a big thing. Most venture investors will take a meeting, but end up not telling you that the market is too small, but tell them to “keep updated”, or “you are too early for us” or “we need to see more traction”.

When you dont know the size of the market or you know that the market is small, then I’d advice you not to go to venture investors. It does not serve your cause and wastes their time.

The second most important reason to get a venture investor on board is if the market is expected to become large “quickly”. While size of market is rather objective, the speed of the market is largely subjective. Which is why venture investors will rely on other “experts”, who understand and know the market well to help them “do due diligence”. If the market is expected to rapidly grow, it makes sense to invest as a VC. Else, your company wont grow quickly and things get difficult.

Many venture investors will also tell you that they invest in entrepreneurs. They tend to focus less on themes and more on the expertise, background, success, knowledge and execution potential of the entrepreneur teams.

Taking a risk on the team is normal for a venture investor, but taking a market risk is rather dumb. If they dont (that’s the problem to a large extent, which is “their” view of the market, not yours) view the market as large or moving quickly then be prepared to have a lot of “meetings with VC’s” resulting in zero follow on meetings or investment.