How To Be A Startup Investor

When the family office of the Mansukhanis invested in a completely new logistics company, WowExpress, it was with the idea to become a part of the building blocks of an early-stage company in the fast developing logistics segment. With the e-retail market growing rapidly and likely to climb to $100 billion by 2020, companies that provide logistics in moving merchandise to end-users are rapidly scaling up, and growing fast.

The Mansukhanis through their family trust invested Rs 3 crore in April 2015 supporting the trio of Jayesh Kamat, Mazhar Faruqi and Sandeep Padoshi, who had left their jobs and put some of their own money to embark on an entrepreneurial journey. Now, there is no looking back. Recently, WowExpress raised another round of funding from some investors. The Mansukhanis invested a further Rs 3.6 crore in the recent round. Says Ayesha Mansukhani: “We clearly invested in a good team and saw the potential of the business to scale up rapidly with the use of technology and apps. The business is growing 100 per cent every quarter.”

It’s not uncommon for many high-net worth individuals and family businesses to see investing in startups as a way of mentoring new and budding entrepreneurs. They are also looking at utilising some high-risk money for higher returns. Says Ayesha: “At the end of the day, investing in startups is high risk. You need a lot of patience to see a company through.”

Needless to say, the world of investing in start-ups is fraught with risk, and sometimes thrills, but mostly hard work. Chandni Jafri, CEO, Mumbai Angels, an NGO that brings investors and startups together for early-stage investing, surmises that startups are not at all about giving immediate high returns. “It’s not about quick returns, and it’s not something that will show instant results. It’s a call you have to answer because as investors you too provide the valuable skills of nurturing a business and of mentorship.”

In the startup ecosystem, new entrepreneurs usually pitch ideas to startup networks where they are able to pitch their ideas to a wider audience or even at times go to high-net-worth individuals directly. Startups also tap investor networks, and are usually started by novice entrepreneurs with a business idea or technology that typically seeks investments in the range of Rs 1-3 crore at the seed or initial stage.

In the healthcare technology space, Allizhealth walked the talk when it came to raising funds initially showcasing its model in the Nasscom’s 10,000 Startups programme, where the firm was among the top business ideas. The firm then met up with investor networks in 2014 and raised its first seed investment of Rs 2.2 crore from the Mumbai Angel network in November 2014. Says Chinmoy Mishra, director and CEO, Allizhealth: “We have some very good investors, and they have brought immense value to our firm.” He also reckons that new startups should raise funds only when they need it.

Needless to say, startups should be able to pass the muster of having a sound business model. If start-ups business is sound, wealth management firms including investor networks introduce such startups to individuals who then take a call whether to invest or not. Says Rajesh Saluja, CEO and managing partner, ASK Wealth Advisors: “Some investors may want to look at startups and other ventures. But they need to have a clear understanding of how startups work. One also needs to understand a sector or industry and have sufficient resources to match the risks that an investor might be exposed to.”

Individuals can invest in startups either by taking up direct equity or through the private placement route, which comes under Section 42 of the Companies Act. Direct equity is often straight and simple. An investor gets shares of a company as per the preset terms of agreement.

In recent times, the private placement route is gaining currency in investing in startups. When a deal needs to be structured differently or when many investors are participating in an issue, companies could take this route. Section 42 of the Companies Act permits only two hundred people in aggregate to make investments in a company in a financial year. This does not require companies to increase their capital base just yet, or increase their authorised capital, though it allows for various forms of fund raising for a startup venture such as through preference capital, debentures, and other such instruments.

The rule prescribes that an application form addressed specifically to an investor has to be made in writing or in electronic form. No one would be allowed to apply except the person to whom the form is addressed.

Specialised investment boutiques also bring new business ideas to the market place for high-net-worth individuals and risk-takers for investors to participate. Some investment firms, such as Red Ribbon Advisory, invest seed money in startups, and then introduce them to other investors.

The firm itself invests in startups at the seed stage, and then takes them to the market when additional funding is required for growth. Red Ribbon taps independent financial advisors and wealth managers with an information memorandum. Investors, after studying the business, take a call whether to invest.

One of the instruments being offered are convertible debentures credited to an individual’s demat account. Says Aditya Kanoria: “We share the offer letters, which has all the details about the company. Investing in any business comes with its attendant risk. We make sure that an investor understands an investment before taking a call, and that’s why we reach out to IFAs as they know their client’s risk profile.”

Other investment firms prefer to bring investors and startups together through the online route such as Grex, an online platform for startups and investors. Grex does due diligence of companies seeking investment or early-stage investing, and brings them on to its online platform.

Investors are then familiarised with the business model of the startup, and an investment deal is struck through the online platform depending on the capital raising requirements of the startup. Says Abhijeet Bhandari, co-founder and CEO, Grex: “We are bringing private investors via our platforms to look at startups and invest in them.”

In the last few years, many technology startups and ventures revolving around social upliftment themes or around the environment have successfully raised seed capital. Says Jafri: “There is no dearth of entrepreneurial talent in India, and a lot of startups are still springing. Social sector is also one area where we are seeing a lot activity, especially from small towns.”

A higher risk is associated when investing in startups. Only an affluent class of investors with the resources and the understanding of entrepreneurship could look at this form of investing. In the first stages, a startup might have to go through all forms of teething problems. Although startups can provide huge upsides to an investor’s capital if the business can scale up or if the startup is taken over, startup investing is not for investors with limited risk capital to spare.
Besides, startup investing can take much of your time. That’s why entrepreneurs are also looking for experienced advisors who can add value to a business. Finding the right investor will help their businesses scale up and grow. Says Jafri: “If you are in it for the returns, it’s not for you. It’s high-risk capital; you have to see startup investing through the lens of a mentor.”

Another catch to startup investing is to be able to get a hang of the cash flows. Many startups have to face the hard issue of winding up their businesses because they see a lot of cash being burnt ­— some of the startups spend a fortune trying to acquire new customers, especially if it’s a new business trying to get a foothold and establish itself in the industry.

Startups need to get a grip on expenses and better monitor their cash flows. At the same time, startups cannot avoid making investments where it is necessary to scale up the business. Says Ayesha: “Wow Express operates a very basic asset light model and at the branch level, the idea is to work at a level, where there is an operating cash flow.”

Keeping a watch on the cash-flows has other benefits. Companies that are able to generate cash are able to raise the valuations of their ventures faster than other companies. Investors in these startups also find an easier exit route. Investors have to keep a tight link between their investments and exit route. In fact, this could be the trickiest part of investing in a startup. If you don’t find another buyer, you could remain wedged in the investment for a long time. But if you do, particularly for a business that has scaled up immensely, the rewards, over the course of many, many years, may surpass your wildest expectations.

WHERE TO FIND STARTUPS
Startups typically showcase their business models in trade shows or approach investor networks with their pitches

Typically startups are largely from the tech space, but these days social causes are seeing a mushrooming of entrepreneurs

Startups also approach family offices or wealth managers directly, and online investment platforms also showcase new startups

WHAT TO LOOK FOR IN A STARTUP
One has to be able to understand the business model and also look for how scaleable or how large the business can grow

A startup has to fill a need or cover the gap in the value chain. Hence, investors also have to look for sustainability

Investors should look at the team and the employees. At the same time, startups are looking for investors who can advise on scaling up

Typically, a business should not burn cash fast to acquire clients or scale up the business and expand

Clifford.alvares@gmail.com

This article was published in BW Businessworld issue dated 'July 11, 2016' with cover story titled ' I-Banking Special - Dealmakers'