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Venture Capital
Many first-time entrepreneurs have been tempted to try their business acumen by the booming IT industry. As for funds, mushrooming venture capital sources have increased the options for entrepreneurs.
Entrepreneurship has finally come of age. Not only have people shed inhibitions about starting a business on their own, the ‘E’ word has also suddenly caught the fancy of everybody 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 has 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 have 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. Most of the entries in the recently organized India Venture 2000, an initiative sponsored by McKinsey and Company, had been from students and young professionals.
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 it is 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, ecommerce, 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 three to five 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. The VC 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 investee companies 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.
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