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Funding Game – The rules and the hacks via @skirani & @BKartRed

The weather in Chennai was finally getting kinder & more pleasant in tune with the time of the year, much like the funding climate which has been less testing on the entrepreneur in general. Depending on whether you ask a consumer product entrepreneur or a B2B SaaS product entrepreneur, the level of optimism could vary, but it’s optimism all around.

As a pre-event runup to SaaSx2, we met at Freshdesk’s office in Chennai, for the Roundtable on “What it takes to fund a SaaS company?”.

Shekhar Kirani from Accel and Karthik Reddy from Blume, joined by Girish Mathrubootham from Freshdesk, anchored the conversations.

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Shekhar and Karthik started the round table, with some pretty interesting nuances about what numbers ought to add up, for their investment to make the returns they promised to their limited partners. The conversation touched upon what it takes to get funded at the early stages (upto Series A) and what it takes to be on that path, beyond Series A. Girish chipped in with personal examples of how Freshdesk got funded and his first-hand insight into looking at early stage startups that get funded (or not)!

Here are some bite-sized insights from the conversation that lasted for 3 hours:

On the options for the entrepreneur

  1. Indian B2B entrepreneurs have bootstrapped their startups remarkably well that it’s not an exception. If you are a B2B entrepreneur bootstrap or do more with less. Wait for the right strategic opportunity to scale. With numbers backing you up, raise for growth.

2015-10-07 11.12.22On what drives investors’ decisions

  1. Don’t get discouraged with ‘No’ from a partner of a VC firm. They have their biases and baggages. It’s the partner who has a view and not the firm. Find your champion.
  2. Most investors don’t like it if the outcome has a cap to it — there’s a maximum that you can do in the market and that sets a pretty hard ceiling to crack. In such cases, you’ve to out-execute everyone else and that’s a hard ploy and makes less exciting for the investor. Example: Would you start another CRM company now and if so why would you do what the rest of the 1600 have not done. Even if you execute well, what market share can you capture?
  3. VC firms pitch to Limited Partners (wealthy individuals, family offices, pension funds etc.) more than startups do to investors. They’ve the same issue of having to convince an LP that a certain startup that’s pre-revenue will get an exit worth $100M in 7 years. To do that in India, when there was no such exit till recently, made it even less credible.
  4. Most funds last for 10 years. 3 years to invest and 7 years to grow and nurture those investments towards exit events.
  5. Among the top quartile or decile of startups in a portfolio, one company returns the entire fund. Top 5 companies return 90% of the capital.
  6. Each startup has to be a prospect for a $500M exit, for the fund to meet its “Return on Capital Employed” goals.

On what investors look for in a startup?

  1. In a SaaS startup, front loaded costs are high. So your first two rounds are not about revenue or profitability but more about Product-Market fit and elimination of business model risks.
  2. Integrity, smartness and hard working ethics of the team are important but not sufficient. There has to be a potential for $500M exit for that startup for investors’ math to work. Anything less is already a sub-par outcome.
  3. It’s the job of the entrepreneur to make the VC look and realize how big the market is. They see a 1000 pitches a month and carry stereotypes. Help them make the context switch.
  4. Integrity cannot be stressed enough — Questions about India’s professional ethics do come up.). Indian LPs too find it hard to fathom that it’s possible to legally generate a 25x outcome from a startup, given where they come from and what they’ve seen.

2015-10-07 11.12.37On how to negotiate investment terms

  1. Clauses are there to protect the downsides for an investor. If you understand why they are there it’s easy to have a conversation around them.
  2. Most dissonance that an entrepreneur feels is because s/he does not understand the responsibilities the investor has to his/her fund and their LPs.
  3. Clauses such as liquidation preferences are there to protect the downside of the investments. So long as you cover the down-sides as an entrepreneur, your negotiation leverage for not carrying over these clauses to subsequent rounds is high — Don’t get it yet? Ask entrepreneurs who’ve raised several rounds, on how to negotiate.
  4. Drag along clause is there so that an investor can get the fund its returns as the fund comes to the end of life. If that goal conflicts with your startup’s, look for funds that are early in their life, to take money from and thereby give yourself a better runway.
  5. Everything is negotiable if your numbers are good. All downside protections kick in only during the bad times. So the best way to stay on top of the negotiations is to execute well.

Contributed by Ashwin Ramasamy, ContractIQ

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Want to get our attention? Talk to the founders of our portfolio companies! – Blume Ventures #ThinkInvestor

ThinkInvestor is iSPIRT and ProductNation’s new initiative to serve as a catalyst between Venture Capital firms, Angels, Angel Networks and Entrepreneurs. It is to go beyond brochure ware and dig deeper into the whole life cycle of a typical investment; from introductions, funding, styles of on-going engagement, to exits. And in the process, capture their views on global and local trends, and the entrepreneurial ecosystem in India.

ThinkInvestor-BlumeVBlume Ventures is an early-stage seed & pre-series A venture fund based out of Mumbai, India. They provide seed funding in the range of $50K – $300K to early-stage tech-focused and tech-enabled ventures. They are proponents of a collaborative approach and like to co-invest with like-minded angels and seed funds. They then provide follow-on investments to stellar portfolio companies, ranging from $500K – $1.5 million.

ProductNation sat down with Karthik Reddy, Managing Partner, Blume Ventures for this interview. Here ‘s what we heard:

What made you focus on early stage investing in India? And your observations of this market?

Karthik Reddy - Blume VenturesAdoption of innovative technologies has always been a challenge in India. Early on we realized that growth has to come from other global markets like the US or Europe. We also realized that there was a huge gap in the venture market in India for investments between $150K and $3M. Our intention in our first fund was to bridge these gaps. They proved to be larger than what we thought initially. The venture market at the top of the funnel (late stage) was very wide, the middle had also widened but the lower end offered opportunities for us. But this market has its own problems – bridging the gap between this level of funding and the next stage. Series A funding of companies has been a continuing problem but we have found ways to bridge these gaps. However, with our next fund to be raised next year, we plan to stick to the same strategy, but with a larger fund.

What has been the effect of exits like redBus.In on the Indian ecosystem? Do you think that this improves the outlook for more early stage investing?

Yes. Exits like redBus.in are good for various things in the Indian ecosystem. If not for the individual exit, more examples like redBus are needed sorely. Typically, companies like those take around 8 years to enter, and exit. The public markets are not good options as yet for exits. We do not as yet have a culture of acquisitions within India. Indian companies don’t do them. Companies like Naukri should really consider acquisitions and grow inorganically. Large companies in the US are beginning to take notice of possible acquisitions in India and have started doing some cross-border transactions.  This kind of ecosystem did not exist but things are beginning to change. We still have a huge need for innovative ideas. Ideas that can get built into $40M to $50M companies and get exits are key to putting the ecosystem into higher gear.

How does an entrepreneur get your attention? What kinds of start-ups interest you? How does an entrepreneur get in touch with you?

We are driven by themes. We are not reactive investors. We are interested in Smartphone/Mobile plays and are not interested in web applications. If we see a plan first addressing a web version of an application we are not interested, but those that go straight to a mobile app will get our attention. Our themes are chosen so that they can grow fast and get to a Series A comfortably. The entrepreneur needs to think like a VC and ensure that whatever they are working on is capable of such growth. Founders of our portfolio companies know our themes best. Get in touch with them, see if there is a mapping between what you do, and what we are interested in. Get one of the founders to introduce you to us after this initial filtering. This way, you won’t waste your time and you will get our attention! We do get cold referrals that go through our associates and it will be a long winded process. If you come through the founders of our portfolio companies it will be faster and it can also make sure that there is a mapping between what you are thinking and what our investment themes are. We get 60 to 70% of the introductions like this, with 125+ founders in our portfolio network.

Let’s say there is a mapping between a start-up company and your VC firm. What happens next? What are your typical due diligence efforts? How long does it take for an investment?

We are primarily looking for leadership in these companies that can survive the long haul of entrepreneurship. Can they survive the first year of marriage, primarily between the co-founders? Do they have 2 to 3 layers of leadership in the start-up, not just a single layer with the co-founders! And are the co-founders super-compatible with each other? We have seen too many founder breakups! We are not looking for problem solvers – people who solve a problem with a technical solution. We are looking for business builders. Can they build a business around it? They are not the same! In 1 or 2 meetings (in 2 or 3 weeks) you can get an idea of whether we want to proceed ahead with due diligence or let you know that the fit between our themes and your business is not there. If you can find co-investors on your own is a positive thing in your favor. The ability to excite other investors is key to us. The ability to line up other clients or customers during this period is important to us. We look for some red flags during the due diligence period – like being very casual about relationships or client opportunities. The fastest investments have been made in 4 to 5 months from introductions. The slowest ones have taken 12 to 18 months. The latter ones are usually because of syndicated investments.

Let’s say a start-up gets funded by you. How hands-on or hands-off are you with your portfolio company? What’s your style of engagement with a portfolio company?

Portfolio companies should consider us a Super-Concierge on Demand. They should be comfortable with knowing exactly when we are needed and come to us. In the early stages they come to us with quite a few problems for advice and guidance. Luckily our founder network usually has many of the answers.  We have a Google group for our portfolio company, sort of a private Quora. This helps solve 70 to 80% of the problems our start-ups face. Someone has come across most of the problems any new portfolio company is facing.  Typically these will be questions like whether to incorporate in the US or not. We are more like a platform than a VC firm in that sense, an 18-24 month accelerator program. We are as hands-on or hands-off with companies as needed. We do take a board seat as a seed investor and invariably meet with each portfolio company in person, at least every couple of months.

Let’s talk about going beyond the early stage funding and getting to the next level of funding and growth.

Series A funding  is becoming more difficult with the bar being set higher and higher. There are only 10 to 12 active Series A investors in India doing 1 or 2 investments a year. With such a thin ecosystem for Series A investing, pitching the wrong partner may mean not getting funded. The other problem is making these businesses 10X propositions for Series A (they are not interested in 5X business plans)  that require these companies to become $200M companies. We do bridge rounds that can get start-ups to get the growth necessary to qualify for a Series A funding. We are planning to raise a larger fund next time so that we can make these kinds of deeper investments.

Do you think it is possible to build a $200M company focused on the Indian market?

Yes. There are some promising areas in India that has that potential – travel or taxi services. Technology solutions like Knowlarity, NowFloats, and Exotel have that potential. The Enterprise market in India is too slow but the SME market in India has the potential to build some $200M companies. That market will also explode only when the smartphone/mobile market in India leapfrogs. The SaaS market, especially when built for a global market could grow a few $200M companies.  We are optimistic overall and feel that lots of opportunities are yet to come.

Now, let’s talk about Exits. What do you see coming in this area?

The subject of realistic venture exits is the one that somewhat dictates what the focus of a start-up should have been. Hoping to get acquired by a company in India is somewhat unrealistic. However, there are a number of companies in the US that have started coming to India to acquire Indian companies and grow inorganically. Autodesk is hiring a person in India to look for such companies, They have done a number of acquisitions already. Unfortunately, the Indian arms of Google and Yahoo are not empowered to make acquisitions.There are some companies like WebEngage and OrangeScape that are focused on foreign markets that could make good acquisition targets for companies outside India.

What about some parting advice for entrepreneurs?

Go outside India for markets. You cannot grow fast enough to raise funding and grow focusing on Indian markets currently. This is true especially if you are a technology play. Someone in Silicon Valley could start 2 years later than a company in India and beat them to it if a company is growing only in India. Grow fast and get acquired!