Why You Need a Business Mentor

The general perception about entrepreneurs is - they are individuals toiling away at their desks to create new products by "themselves", but seldom are the most successful businessmen, individual contributors or hustling singled-handed go-getters. The most common practice of business professionals who are new to the game or veterans like serial entrepreneurs spend a significant amount of time bouncing ideas off of colleagues, teammates, friends and family members.

More times than not, sustainable businesses are created by motivated and educated people that gain these traits through experience. This is where the mentors come in, whose insights help in impacting business practices, ethics and, eventually business success. They have lived through the journey and learning from their mistakes and successes, can impart some of the valuable lessons they have accumulated over the years.

The Value Add of Mentors

a) Knowledge: A mentor who has been in the industry for a while or are ideologically congruent to how you envisage to run your own enterprise can help with the business plans, budgeting tactics and even the day-to-day operations.

b) Objectivity: Mentors can give you an honest review of areas in your business that need improvement, as well as point out the areas that are doing well. So you need a mentor who is honest with you and who knows how to offer constructive criticism.

c) Discipline: A business mentor on the trek ensures accountability in goals and re-circling to check-in how well are we aligned or digressed in the process. A strong work ethic and a drive to succeed can make or break an entrepreneur.

d) Network: Although knowledge plays a significant factor in the success of a business, networking is a critical element and spoke of the wheel that lets the business roll on smoothly. Mentors often introduce you to their own professional networks, expanding your connections and opening doors to collaborations, partnerships, investments as well as help specify your target audience. “It’s not what you know, it’s who you know."

Nava Paath of Nava Durga

Goddess Durga offers life lessons that inspire a wealth of meaning for the management world. Navaratri worships Goddess Durga in various forms of power. The nine forms of Goddesses, which are popularly known as "Nava Durga" signify the conquest of the dangerous demons which draw their parallels and meanings as per context – personal, professional, business and otherwise.

Goddess Shailputri

Significance – Introspection, Strength, Courage, and Composure. Helps in guiding us in our journey to explore and discover our purpose in life Helps to understand the struggle related to the initial years of setting up a business and focus on its successful continuity by evaluating the business goals.

Goddess Brahmacharini

Significance – Confidence, Competence, and Perseverance. A balanced state of mind, immense willpower, desire for success, and confidence are the most important qualities that help us in the most challenging times in the lives of entrepreneurs and businessmen.

Goddess Chandraghanta

Significance – Grace, Knowledge, Bravery, and Vigilance. With supreme bliss by being vigilant regarding any changes in policies and regulations, one must learn adaptability and upgrade technology to maintain relevance and fit to add more value to the business.

Goddess Kushmanda

Significance – Energy, harmony, wealth, and power. To create customer centricity and wealth in your business you must focus on your financial well-being and emotional well-being, which contributes positively to your business.

Goddess Skandamata

Significance – Intelligence, and compassion. A compassionate leader inspires all the team members through coordination and collaboration. This enables the leader to focus well on the business goals.

Goddess Katyayani

Significance – Knowledge, Courage, and Power. Modern businesses are dynamic with policies, trends, and competition and the business must adapt all these accordingly.

Goddess Kalratri

Significance – Happiness, Knowledge, Wealth, Perfection, and Purity of heart. As an entrepreneur or a business leader, one needs to communicate regularly with the employees and stakeholders on the plan of action to overcome the challenges.

Goddess Mahagauri

Significance – Cheerful demeanor. A leader needs to make first impressions with all stakeholders of the company with a pleasant cheer.

Goddess Siddhidatri

Significance – Knowledge, and Wisdom. As a businessman or entrepreneur, one needs to have a thorough knowledge of the business and focus on constantly building new skills and strategies that will help the business grow.

If the entrepreneur, or businessperson focusses on the above 9 important lessons from Goddess Durga, one can take the business to new heights.

Happy Dussehra!!

Money, More Money, Even More Money

To some people, money is power. To some money equals status and prestige, while for others it means security. For some people money allows them to get the things they want in life. Others just want to have enough to meet their needs. How important is money and what role does it play in your life?

While money allows you to function suitably in a capitalistic world, many people do not associate positive emotions with it. Money is associated by people as something that belongs to the future and is supposed to make it secure. This makes a lot of people go through a guilt-trip when it is spent, which eventually leads them to compare themselves with their peers. This induced peer pressure spirals into self-doubt, negative self-talk, and messy future thoughts. Despite all this, there is something that binds all our thoughts, apprehensions, and plannings - everyone is very emotional about money.

The psychology behind our relationship with money is very underrated and there is a great deal of undercurrent to the confusing emotions many of us feel when it comes to our finances. Our feelings are always unrelated to the financial decisions we make and indicative of something much deeper.

Anything important in our lives is emotional. Our relationships are emotional, our work is emotional, and so is our money.

Startup Growth Mantra

India has rapidly moved ahead on the path of economic growth in the last few years, and the startup ecosystem has been playing a crucial role in this exponential growth. The various district-level, state-level, and country-wide initiatives on the ground have created an entrepreneurial buzz that has enabled the country to rapidly attain pioneer positions globally in terms of the number of startups and number of successful unicorns.

Statistically speaking about 15K startups got registered in the country in the last fiscal year alone, which as compared to only a half a decade back was merely ~1000. Having said that, we cannot overlook the fact that about nine out of ten startups fail within the first 3-5 years of inception despite getting funded (by friends, family or third-party) and/or being able to generate early revenue. From the perspective of most entrepreneurs, the top needs they identify besides funding, are access to the right market and simultaneous access to the right guide to take them forward. Let us dive a little more to understand how these may help any startup survive, sustain, and grow in the market.

Funding – paramount at every stage of the startup in technological spearheading, acquiring and retaining talent, strategizing go-to-market activities, product development, business operations et all. The simultaneous need for working capital also grows to build and scale up infrastructure. A brilliant idea may still be at the desk and fight it off for proof of concept and never be able to reach the stage of proven market acceptance irrespective of how effective it is, due to the lack of funds.

Market Access & Fit – Howsoever good an idea may be and be strategized for bridging the gap, achieving market fit for the product or solution is extremely important and critical stage for any startup. When a business is started, it is done with a clear objective in mind to address a market gap that the entrepreneur identifies. However, at the very foundation to actually strive and cater to the objective lies various factors like timing to the market, flexibility & adaptability, credibility, and usability much before the product is even introduced to the market, the needs of which are very volatile and dynamically changing at every stage of the startup. May a times, the well-audited, segmented and tragetted audience might expect a solution that is different than what is being offered by the company. So, it is paramount to develop the product with as much dynamism as possible and be suitably backed by the other mentioend need, that is of funding. Thus right ‘Market Access & Fit’ is an important aspect in every startup's journey.

Mentoring – Mentoring is one of the most important yet neglected, least talked about, and probably the least emphasized need for business growth. An entrepreneur might come up with a brilliant idea, and if it is worth its' salt, pitching it to investors is likely to give access to money as well. However, there are many steps and other challenges faced by first-time entrepreneurs at every step of their entrepreneurship journey. In the absence of right mentoring, a lot of founders get their calculations and strategies wrong, eventually burning cash on things that could have been avoided and leading to a scenario where they are left with no money to sustain or scale the enterprise.

Guidance or mentoring from industry experts or successful entrepreneurs in the domain can give the right direction to the entrepreneurs. They can get inputs on aspects such as compliance and taxation, technology, hiring, procurement, sales, and marketing etc to build more robust and sustainable businesses. Most of the mentors are also people with the right industry connections and can help startup founders get the right exposure or opportunities to network with other important stakeholders such as investors.

It is not easy for first-time business founders to find all these discussed aspects catered to under one roof. The challenge is even more daunting if the startups are in Tier-II, Tier-III, or Tier-IV cities. That’s the reason why setting up of a networked ecosystem is extremely important for extracting the true potential of the talent India offers.

For India to truly become a global startup super-power enunciated not just in numbers, but in terms of economic and employment growth, there is a need to prioritize cultivating this ecosystem across the country. The governments as well as the other stakeholders including universities, colleges, and B-schools have to collaboratively materialize this effort, remove the barriers, and pave the path for speedier and widespread growth for the Indian startup ecosystem!

Fundraising Stumbles

Fundraising for startup businesses has been typically a slow and painful process. Most entrepreneurs would rather spend time growing their business than making fundraising prospect lists, scheduling pitch meetings, and asking for money. Unless the entrepreneur has a track record of business success or excellent sales ability, the reality of fundraising for many first-time business owners is that it takes reaching the final stages of negotiation with at least 4-5 prospective investors before closing the deal with one of the investors. At the same time, most entrepreneurs need at least ten prospective investors to put together a meaningful list of investors for the round of funding and the process of assembling 40 to 50 fundraising prospects is daunting. So, the question is - what is an entrepreneur supposed to do?

While an entrepreneur can start off by identifying private investors and brainstorming with relatives, friends and business associates who would be willing to support the venture. If the intention is to scale up the effort, focus should be on how to maximize the close rate with fundraising prospects. It makes more sense to increase the closing rate from 25% to 75%, rather than expanding the prospecting list to 40 or 50 individuals, thus needing fewer prospects to complete the round of funding.

1. Pick a closing date, then don't enforce it: When raising large sums of money from VC Firms and/or institutional investors, the closing dates are critical. The interest income in most cases is almost the same amount as the total legal fees on VC rounds, so the cost of a closing delay is substantial. In practice, the investors will ignore the closing date and give the money at their own convenience. 

Word of Advice: the standard closing date clause should read "The closing date is [some date in the near future] or another date that is mutually agreeable to both parties." This will keep the documentation valid for several weeks after the closing date in case the investor takes extra time to give the funds.

2. Provide investment options: Flexibility is critical when dealing with non-institutional investors. Take-it-or-leave-it terms seldom work because the motivation for each investor will vary. If the funding is raised in the form of debt, it is prudent to offer different options for participation in the round with the variables being amounts/thresholds, time horizons, and repayment schedules. On the other hand, if the fund is raised against equity dilution, the preferable instrument is convertible debt than preferred stock.

3. Anticipating follow-up meetings: It is best to end each meeting with a definite plan for the next meeting. Even if the whole idea and the story can be told over one meeting, it is better to spread it to two or three meetings since that might be how long it takes for the investor to get comfortable with the entrepreneur. It is also a good idea to schedule reference calls with previous investors, partners, and/or board members to demonstrate the people involved with the venture and who can vouch for the business.

4. Stop selling: The habit of selling and the sales culture of fundraising can seep into the interactions with investors even after the investment decision is made and the formalities are being worked on.

5. Getting the Check: When raising money, often the entrepreneur gets tied up and entangled in the process of answering the questions posed by the investors, negotiations, paperwork, making sure the relationship with the investor can be continued even after. During the course of all these interactions, it is easy to forget that the primary focus and purpose of the process is to get the money.

Word of Advice: It is a wonder that the funding is received earlier than anticipated if it is asked for earlier. One way to ask for the check is to ask your investor whether he plans to make a wire transfer or send a personal check so you can decide if he needs to receive your bank wire transfer details. It might be presumptive to ask this question too early, but it tends to move the dialogue along very quickly. What must be remembered are -- "If it is not documented, it is not said" and "The deal is not closed until the money is in the bank".

You, Him, Her, or Them? Which Investor?

In our last discussion, we deliberated on how to go about choosing the right investor or venture capitalist from the entrepreneur's perspective. We will delve deeper here. 

To get into hot deals, the investor gives founders a reason to pick them over other investors. This so-called “reverse pitch” is the VC’s opportunity to sell a founder on their unique value-add. The “reverse pitch” has become more important as investing has become more competitive. There are more investors than ever before. Founders too are better educated about the fundraising process and what to look for in an investing partner.

While every “reverse pitch” is unique to that investor, here are three main takeaways on what an entrepreneur should be taking care of and how VCs convince founders to take their money:

a) The pitch is relevant, differentiated, and authentic
b) Investors should show than tell founders how they can help and provide support

c) The way an investor makes a founder feel matters a lot, in terms of how well-prepared, responsive, and transparent they are

Counteract: Choose a VC

In recent times, we have watched several business reality television series like Dragon's Den, Sharks' Tank, Money Tigers and many other such presentations adding on to the available offline investor pitch events. Aspiring entrepreneurs pitch their business models to a panel of investors and persuade them to invest money in their idea. The investors use several valuation techniques to debunk or concur with the owner's valuation and decide whether to grant them funding in return for an ownership stake.

The budding entrepreneurs get a fixed amount of time to primarily pitch their business ideas to the in-panel multi-millionaires who are willing to invest their own cash, time, and expertise to kick-start the business or at times t help scale-up the business in terms of geography, expertise, technology, and help the entrepreneur with their business knowledge, market dynamics etc. After the pitch, the investors have the opportunity to ask questions about the venture. The entrepreneurs do not always have to answer or elaborate, but of course, what they choose not to address could very well affect the outcome. The pitch is over when each of the investors have either declared themselves out for further deliberation, or when the entrepreneur secures the full investment that they are asking for.

There are rare occurrences, when the entrepreneur(s) receive multiple competitive offers and deals either individually or collaborated by a few investors. Here the entrepreneur faces a dilemma for which he must think on his/her feet and conclude a response to - How to go about it? Who to collaborate with? Which offer to accept?

The entrepreneur must now choose and pick an offer or investor by analyzing the take-aways and let goes. How does s/he decide? 

Startup Mentors: A Need or Luxury?

Entrepreneurs typically delve into the market with disruptive ideas and big visions, and often than not explore diverse avenues to take the idea(s) to the end of the tunnel and may get entangled and spoilt for choice and scamper to find that one right path to tread on, either tried-and-tested on into the unchartered territory on an unexplored trek. A big impediment in the path of many entrepreneurs is that although they have no perceived dearth of subject knowledge and market dynamics, there are hints of inexperience when they start a business. This hypothesis is backed by the fact that almost 90% of Indian startups fail within the first 5 years, mostly because of inexperienced founders. While this may be a big concern, hell did not break loose and hope is not lost yet, as a way to overcome this obstacle is to engage with an advisor, mentor, coach, or guide, as one would like to call them.

Mentorship is a key factor that shows the way for startups to reach heights. A perfect mentor provides tried and tested ideas, fills your knowledge gap, and helps to reach your goals with less stress. That brings us to the most important set of questions - Who can be the right-fit Mentor for the Idea? Where to find this Mentor? and How to get the best out of the Mentor?

While startup mentors are extremely critical, the foremost objective is to not find "a mentor" but "mentors" who are experts in different fields, because any single mentor may not be capable or sufficient to solve all the problems that the entrepreneur or the venture was, is or will be facing.

There are several diverse factors that contribute to eventual success and meeting the entrepreneur objective and vision of the business. The robustness of the idea, cohesiveness of the team, the sense of association and being integral part of the vision from the employees, the go-to-market strategy of the company in terms of product/solution, promotion, pricing, and timing among others, and the entrepreneurial experience of the frontrunner, These sought-after startup mentors help to maintain focus on the business problems and provide alternative solutions to the problems.

VC Myth 03: Dilution

Myth: The issue is about how much external financing the founders should raise, and when. It also reflects on who and how the company is being controlled, an issue near and dear to the hearts of all entrepreneurs across the globe. This myth exists in many variations, all centering on two themes: control and dilution. This might be stated in diverse ways, with the same underlying belief - if you raise money, you should raise as little money as possible, because then you will give up less of the company now.

The amount of financing a company should raise is often a controversial (internally) issue. Entrepreneurs sometimes intentionally choose to raise lower amounts of funding to minimize dilution or to remain attractive for the quick flip in the unlikely situation (at times it is intended and planned too) sale of the company, but most of the time, that decision is later regretted. The entrepreneur should raise the amount of funding that will enable accomplishment, with some cushion, of the key milestone that will justify a significant increase in valuation. Valuations of early-stage companies do not increase in a linear fashion over time, but instead in a "stair-stepping" fashion, jumping upon a key accomplishment such as a product release, a certain level of customer traction, a big deal, or a technical milestone and then more or less flattening again until the next milestone. Taking an illustration, a INR 5L seed investment to be able to raise "Series A" at a higher valuation makes sense, but only if that key milestone can be reached with the IINR 5L funding.

Very few entrepreneurs have ever regretted taking additional funding when it is offered. At the end of the day, start-up businesses fail for one reason: because they run out of money. Raising money opportunistically helps to weather the storm caused by external factors such as market or economic conditions.

VC Myth 02: Board of Control

Myth: While it is imperative from a fund-raising perspective and can be considered as one of the ten important pillars of early-stage fundraising activities, there is some deep-diving and understanding required of it. Entrepreneurs who are overly concerned about control will need to find a path to success other than venture capital. A glance at the typical ownership percentages as understood previously shows that even after a single round of financing, the founders no longer have "control," while also the VCs would have special veto rights over key matters such as acquisitions, the next round of financing, et all.

The terms of venture capital financings are structured around alignment of incentives, and not control, which is unlike many other routes of corporate financing methodologies. VCs appreciate the fact that the founders must have a sufficient incentive and bandwidth to create value for the benefit of all. Hence, the terms of a typical venture capital financing provide that, after a return of capital invested, the investors do not profit unless and until the management does. Likewise, management does not profit unless and until the investors do. This circular dependency and co-habitation create a mutually beneficial and conducive corporate structure.

VC Myth 01: Valuation of the Idea

Myth: Most entrepreneurs tend to focus extensively on the value of their enterprise, creating elaborate storyboards, extrapolated discounted cash flow models to demonstrate the net present value of their future projected revenues.

In early-stage venture capital financing, the concept of valuation is simply a surrogate - it is more about the percentages and ratios. The typical post-financing value share for a company's initial venture capital financing breaks down as - 

• Main (Lead) VC: typically insist on owning close to 20-25% of all early-stage portfolio companies
• Co-Investor VC: Most VCs prefer to invest alongside a co-investor, which is favorable to both the investors and the company. Here too, a typical 20-25% must be given off, here as well
• Option Pool: negotiating the size of the option pool is a surprisingly effective back-door way of negotiating valuation, as part of the "pre-money" valuation equation, which constitutes 15-20% share of the company
• Founders: taking into perspective and consideration the above dilutions, the founder entrepreneurs are left with almost 35-40% of the company

Unlike valuations of later-stage companies, valuations of early-stage companies do not fluctuate with the financial markets, but economic downturns do have an impact in the number of early-stage companies getting financed, and those who brave the winters and autumns, succeed in smaller funding amounts than would have been otherwise.

Convertible Notes

There has been a lot of noise about how most seed stage deals are being done through convertible notes. The convertible note was really intended as an instrument for a “bridge financing” — when an equity round was imminent, and likely to occur, but the company needed some money in the interim. In such a scenario, it made complete sense to have a debt instrument, where the investor converts them into equity when the financing occurs. As the debt-based investment is made close to an equity round, there is no need to have a valuation-based factor in the note. In a worst-case scenario, where the intended equity-based fund raise fails, the very nature of the instrument being debt-based insures and guarantees that the bridge investor would get priority in case of a liquidation of the company’s assets.

However, somewhere along the way, the usage of a convertible note changed. This primarily happened due to the higher fees and cumbersome process associated with doing an equity round. The convertible note hence came to be perceived as the easier, cheaper, and faster option. Today, the convertible note is no longer a bridge, but has all too often become a pier.

An uncapped convertible note misaligns the incentives between the founders and the investors. Although both the founders and the investors have the common objective of getting the company funded, there is a basic misalignment of incentives when it comes to valuation. While the interest of the founders is to maximize the valuation of the company at the time of a follow-on financing (thereby minimizing equity dilution), the investors' motivation is to minimize the valuation of the company so that the investment committed as part of their note convert in to as large a piece of the company as possible. This concern can be addressed by putting a cap in the note for the pre-money price for conversion, which is the genesis of the term "capped notes". Although entrepreneurs prefer the notes as they defer the process of a valuation to the company, once a cap is put in a note, it effectively prices the company.

Although notes have fewer rights associated with them, they come with one big caveat. Legally, the note is a debt instrument and can be called upon maturity. It is in essence equivalent to being a liquidation preference that is typically seen in a preferred equity. In a lot of ways, the note is not as strong a commitment from investors as equity investors, as they still have the option to pull their money out. By contrast, when investors buy equity, they are fully committed, and usually do not have an option to get their money back before a milestone and their only choice is to help the company succeed or end up losing their money 

Notes have some interesting ramifications for investors as well. When an investor buys equity in a priced round, the capital gains clock on that stock starts as of the date of investment. However, in the case of a note, and especially with long maturity dates, the capital gains clock does not start ticking till the note converts. The intensity is felt at the seed and angel level where a lot of startups make exits. Let us say a company liquidates with a positive outcome. In the case of equity holders, there would be long-term capital gains and they must pay 15% on the gains. However, for a note holder, since there is a chance that either they have not converted yet, or if it had converted, it may not have been 1 year since the conversion. In this case, the note holder would end up paying 35% on short-term capital gains.

My purpose in writing this post is to incite a bigger discussion on this topic and to solicit more opinions and feedback. I would love to hear from founders and from investors on their view on convertible notes.

Preferred Stocks as an Investment Option

We come across the terms - Preferred Stock, or Preference Shares, interchangeably which, by definition, is a kind of corporate ownership that combines features of both bonds and common stock/ordinary shares. A preferred stock (we will carry forward the discussion, taking this term as the representative to understand the topic), is a class of stock that typically has a higher priority and a greater claim on the distribution of the company’s assets and earnings as compared to ordinary stock. Preferred stock has distinct characteristics that make it an attractive investment option. However, understanding the advantages vis-à-vis its disadvantages can help investors make better informed decisions and diversify their investment portfolios.

Types of Preferred Stock

1. Cumulative: guarantees that if a company does not pay dividends over a specific period, the unpaid dividends will accumulate and must be paid before any dividends are granted to common shareholders.
2. Non-Cumulative: does not allow unpaid dividends to accumulate. If the company fails to pay dividends during a given period, non-cumulative preferred shareholders do not have a claim to unpaid dividends in the future.
3. Convertible: allows shareholders to exchange their preferred stocks for a set number of common shares. This feature allows preferred shareholders to profit from capital growth in the company’s common stock.
4. Participating: entitled to additional dividends over and above the predetermined dividend rate.
5. Callable: right to repurchase the shares at a specific price after a predetermined time. This gives the company the flexibility to buy back preferred shares from shareholders, typically when interest rates have dropped, or the company needs to restructure its capital.
6. Adjustable Rate: also known as floating-rate preferred stock, has a dividend rate that changes based on a predetermined benchmark or index. This ensures that the dividend payout reflects the current state of the market, including any changes in interest rates.

Advantages

• Fixed Income: frequently pay a fixed dividend, providing investors with a steady income stream
• Tax Benefits: Dividends may be tax deductible, which helps lower the overall cost of ownership
• Priority Payouts: In case of bankruptcy, the investors are assured a priority in receiving funds
• Call Feature: as it grants the issuing corporation the ability to repurchase shares of preferred stock at a predetermined price, if the market price of the stock surpasses the call price, there is an opportunity to investors, potentially resulting in higher returns
• Conversion Feature: a conversion provision enables shareholders to convert their preferred shares into common shares. Investors who anticipate better performance from the common shares in the future may find this feature advantageous, as it allows them to participate in potential gains

Disadvantages

• Growth Potential: often does not increase in value as much as common stock
• Risk of Default: it is common as it functions as a debt instrument. If the issuing firm fails to fulfil its obligations, preferred investors may not receive their expected dividends.
• Limited Voting Rights: investors often lack voting rights; hence they do not influence how the corporation is governed

Fundraising Jargon 09: Vesting

Although this term does not directly relate to raising capital, it is an important financial term to consider nonetheless, and the investors will expect to know vesting schedules of the employees. A vesting schedule is imposed on employees who receive equity and determines when they can access that equity.  This is useful because it means that if you give 5% of your company to a partner, that partner cannot just quit a couple of months down the line and keep the equity.

A typical vesting schedule takes four years and involves a one-year cliff. The “cliff” means that none of the employee’s shares vest for at least one year. After that year, typically 25% of the employee’s equity is released, and the rest vests on a monthly or quarterly basis. “Vesting” in simple terms means ownership. and are an incentive program for employees that gives them benefits when they have contractually fulfilled a specified term of employment. Each employee will vest, or own, a certain percentage of their account in the plan each year. An employee who is 100% vested in his or her account balance owns 100% of it and the employer cannot forfeit, or take it back, for any reason.

Fundraising Jargon 08: Option Pool

Option pool is a term used to refer to a chunk of equity reserved for the future team expansion. Although it sounds quite simple, straightforward, and harmless, the size of the option pool, as determined during a round of funding, has a direct impact on the valuation of the company valuation and hence, the ownership of the entrepreneur in their business.

The option pool is often included in the pre-money valuation of a company. Let us understand this concept through an example. Say investors agree to invest INR 2Cr at an INR 10Cr pre-money valuation, implying an INR 12Cr post-money valuation. Option pools are expressed as a percentage of post-money valuation, so if the deal includes a 20% option pool, which means the pool is worth INR 2.4Cr. The INR 10Cr pre-money valuation is now effectively an INR 7.6Cr pre-money valuation. The investor will not be taking a larger percentage as a result — they will still own 16.7% (INR 2Cr/INR 12Cr) of the company in this case — but the stake of the entrepreneur will be substantially diluted because the option pool will come directly from management's stake. So, if the entrepreneur owned 100% and they are under the impression that they will now own 83.3% (100% original equity - 16.67% investor equity post-investment), the entrepreneur is mistaken. The option pool, reserved for future employees, is 20% and is contributed from the entrepreneur's end, which means the entrepreneur now owns only 63.3% of the company.

We see yet again how pertinent, and paramount, the understanding of these distinctions is in terms of retaining ownership of your company.

Fundraising Jargon 07: Pro-Rata Rights

The term pro-rata gets thrown around a lot during financing discussions, often in different contexts. Pro-rata is Latin for “in proportion." Replacing the Latin with its English equivalent is helpful in deciphering its meaning in legal documents.

Pro-rata rights refer to the right of investors to participate in later funding rounds so they can maintain the amount of equity they own in a company. Let’s say that a company raises an INR 5Cr Series A round from an investor at an INR 20Cr post-money valuation, leaving that investor with 25% of the company. In a later round, the company raises INR 10Cr at an INR 100Cr valuation. To maintain a 25% stake, the investor needs to throw in at least 25% of the new funding, or INR 2.5Cr, otherwise their stake in the company will be reduced proportionately. Pro-rata rights obligate the company to leave space in subsequent funding rounds so investors can avoid such dilution.

Subsequently, we also have "super pro rata rights” which allow investors to increase their equity stake in subsequent funding rounds. Super pro rata rights are a right of first offer to purchase up to 50% of the total amount of the next round raised. 

Super pro rata rights pose a few unique advantages and disadvantages to founders and investors alike. They effectively prevent other investors from participating in later rounds. Having more investors in a company prevents a greater number of investors from supporting competitors, gives the entrepreneur more networks and more expertise to lean on, and prevents any one investor from having too much control in a company. Super pro rata rights pose an advantage to entrepreneurs in that they effectively guarantee a significant portion of the next financing round being raised. This lessens the often-vast amount of time entrepreneurs spend fundraising, giving founders more time to focus on building the company.

Fundraising Jargon 06: Participating & Non-participating Preferred Stock

There are several types of preferred stocks, each giving its holder different rights, and this is where things start to get a little complicated. For our purposes of immediate understanding, the rights of participating and non-participating stockholders are most relevant.

As we know, preferred stock owners often get a 1X liquidation preference, meaning that in the event of a sale or bankruptcy, they get their money back at the 1X value before common stockholders get a chance to recoup anything.

Let us consider that a company realizes a successful exit, and common stockholders are left with equity worth 4x what preferred stock owners paid per share at the time of their investment. In this case, preferred stock owners can still exercise their liquidation preference to get their money back, but if everyone else is making four times that money, it makes more sense to convert those preferred shares into common stock to enjoy the 4x gains. During successful outcomes, preferred stock owners are essentially forced to convert to common stock. Participating preferred shareholders are also entitled to additional dividends and the predetermined dividend rate. This means they receive a share of any additional dividends paid to common shareholders. For non-participating stockholders, this is where it ends. They convert their shares to common stock and enjoy the same 4x returns as everyone else. Simple enough.

Participating preferred stock works differently and allows venture investors to essentially double dip in the company's gains. Participating stockholders get to exercise both their liquidation preference and enjoy a pro-rata share of common stock gains simultaneously. So, if a participating stockholder owns 25% of the company at the time of a liquidation event, they get their money back plus 25% of the remaining proceeds.

Let us better understand the differences through an example - 

Assume, company sells for = INR 10Cr

Original Investment = INR 2.5Cr @ post-money valuation = INR 5Cr 

Hence, share ownership of investors = 50%

In case of non-participating preferred shares - obligation of converting those shares to common stock

Earnings of Investors = 50% x INR 10Cr = INR 5Cr

Now let us say these investors instead own participating preferred stock. The outcome changes significantly:

Exercising 1X liquidation preference = 1 x 2.5Cr (original investment) = INR 2.5Cr

Also entitled to 50% share of the remaining INR 7.5Cr = 50% x INR 7.5Cr = INR 3.75Cr

Total Earnings = INR 2.5 Cr + INR 3.75Cr = INR 6.25Cr

In this case, they capture most of the exit’s value even while owning just half of the company.

Fundraising Jargon 05: Liquidation Preferences

The primary objective of any VC or other investor is to make money out of their investment. Their investments are no good unless they eventually realize a payday. In venture parlance, these paydays are referred to as “liquidity events,” the moments when everyone with an equity stake gets a chance to cash out. These events come in the form of acquisitions or an IPO.

Liquidation preferences determine who gets paid what and when during these events. If the company goes bankrupt (may come up as a liquidation event for less successful companies), for instance, there are often not enough assets left to pay every creditor and shareholder the money due to them. In such a case, liquidation preferences determine the order in which everybody gets paid. In general, creditors get paid first, then preferred stockholders, then, if there is anything left, common stockholders.

Liquidation preferences are also relevant during more successful outcomes though. The standard and most beneficial liquidation preference from an entrepreneur's perspective is 1X, meaning that preferred stock owners must get their money back (1 x their money) before common stockholders get anything.

Fundraising Jargon 04: Capped Notes vs. Uncapped Notes

As discussed before, convertible notes delay placing a valuation on a company until a later funding round, but investors often still want a say in the future valuation of the company, so that their stake does not get diluted down the line. When entrepreneurs and investors agree to a “capped” round, this means that they place a ceiling on the valuation at which investors’ notes convert to equity. So, if a company raises INR 1Cr in convertible notes at an INR 10Cr cap, those investors will own at least 10% of the company after the Series A round (INR 1Cr/INR 10Cr).

An uncapped round means that the investors get no guarantee of how much equity their convertible debt investments will purchase, making these kinds of investments most favorable for the entrepreneur. As taken as an example previously, let us consider now that a company raises INR 1Cr in an uncapped round. If the entrepreneur ends up convincing the investors at round Series A to agree to an INR 20Cr investment, it will mean that the convertible note investors are left with just 5% of the company, half of what they would get if they capped the round at INR 10Cr.

Fundraising Jargon 03: Preferred Stocks

Venture capital firms are issued preferred stock, rather than common stock in a company. In startup investing, investors typically negotiate for preferred shares, while founders and employees usually receive common shares. Preferred stock confer certain rights and advantages to investors that help them mitigate their risk, such as protective provisions and liquidation preferences. 

Preference shares, more commonly referred to as preferred stock, are shares of a company's stock with dividends that are paid out to shareholders before common stock dividends are issued. If the company enters bankruptcy, preferred stockholders are entitled to be paid from company assets before common stockholders. 

While we learn about preferred stocks, we would also come across related terms like common stocks. Similar to every other type of share, common stocks are securities that reflect the ownership of investors in the company. This means that the investors become part-owners of the company in proportion to the shares held. The primary motive behind buying common stocks is to have the voting power they give to the investors. 

The main difference between preferred and common stock is that preferred stock gives no voting rights to shareholders while common stock does. The preferred shareholders have priority over a company's income, meaning they are paid dividends before common shareholders. Common stockholders are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred shareholders.

Not all preferred shares are created equal. Different preferred share classes may have different rights, which to limit the scope of this discussion will not be explained here and will be understood in detail later. The different classes of preferred stocks are - Cumulative Preferred Stock, Non-Cumulative Preferred Stock, Convertible Preferred Stock, Participating Preferred Stock, Callable Preferred Stock, and Adjustable-rate Preferred Stock (ARPS).

Fundraising Jargon 02: Convertible Debt

When a company is young, quantifying its valuation is often an arbitrary, pointless exercise. There may not even be a product in hand, let alone revenue. But companies at this stage may still need to raise money, and if investors decide on a pre-money valuation.

Convertible debt (also called convertible notes) is a financing vehicle that allows startups to raise money while delaying valuation discussions until the company is more mature. Technically debt convertible notes are meant to convert to equity at a later date, usually at a future round of funding. (Often notes convert to equity during a Series A round of funding.

Investors who agree to use convertible notes receive warrants or a discount as a reward for putting their money in at the earliest, and the riskiest stages of the business. In short, this means that their cash converts to equity at a more favorable ratio than investors who come in at the valuation round.

Your First Unicorn

Employment sounds so 20th century. The youth of the day want to dip their feet into entrepreneurship and be their own masters. This has been evident from the fact that India has the third largest startup ecosystem in the world and with almost 90,000 startups (of which 115 are unicorns), has become a powerhouse for startups in the last decade. Every year, investors spread across the globe come across scores of business plans from eager entrepreneurs who seek funding for their emerging enterprises. For those high achievers who have thoughtfully prepared outstanding plans, with reliable assumptions, they often receive the funding they need for company growth.

I spoke to a good friend of mine, to have his views on the key elements of a great business plan.  Over the years, he has seen numerous presentations from companies, and has seen a combination of terrific and terrible plans. In his view, some people get confused between a business plan and a marketing plan. A business plan is a genetic and molecular definition of the business. It crystallizes why one is there in business; it shouts what it does for the world, for consumers. It dissects the business DNA and how it is unique, and it clarifies why the customers should do business or consume the services and what is it about the product that will delight the customers.

So then, that brings us to the paramount question - what should be included in a well-conceived business plan?

1. What is the need that is being addressed?
2. Why and how is the company relevant to address this?
3. What is the overall state of the market and any important trends?
4. Why will customers buy the company's product or service?
5. Who the customers are?
6. Who are the current competitors and their advantages?
7. Which competitors will the company complement or supplement?
8. What are the product offerings?
9. How do these compete with other brands?
10. Why are competitive products or solutions needed?
11. What resources, including the people, will be needed and are at your disposal?
12. What are the corporate priorities and the processes to achieve them?
13. How do conservative financial plans shape up, with realistic and achievable sales revenues, margins, expenses, and profits on a monthly, quarterly, and annual basis?
14. How do moderate financial plans shape up, with realistic and achievable sales revenues, margins, expenses, and profits on a monthly, quarterly, and annual basis?
15. How do optimistic financial plans shape up, with realistic and achievable sales revenues, margins, expenses, and profits on a monthly, quarterly, and annual basis?

The purpose of the plan is to allow the entrepreneur, and everyone involved in the business to know the building blocks of the business and its purpose for existing. The value of the plan is to think, visualize and memorialize the business DNA so that successors can work consistently with the original vision, character, and purpose of the business through future generations.

Is Bootstrapping Worth It?

Nothing can make you feel anything even close to running a bootstrapped startup. Most have plans based on their extremely limited budget and choose to stay cash positive until they get stable customers. Here are Here are 12 pointers that can help an entrepreneur bootstrap a startup and provide structure to the process: 

1. Passion: Bootstrapping a startup does not start with great ideas but with a passion to make a mark and solve genuine business issues.
2. Research: Sometimes an idea should remain only an idea. This is the stage where a founder determines if his startup can grow to become a significant business.
3. Niche: Every idea must solve a problem in society or provide utility. It is only when the product or service is really needed that someone is willing to pay for it and the business is sustainable.
4. Market, Audience, and Users: Once the need is identified, it is important to define what constitutes the target audience.
5. Team: A founder cannot do a startup alone. Every entrepreneur needs a team to execute the idea and sometimes finding the right team is more important than a brilliant idea. A partner with complementary skills compared to you and who can handle a different part of your business can help you focus on your strengths more.
6. Mentor: Cultivating a network of mentors and advisors is one of the best things about running a startup. It is also prudent to reach out to other startups and talk to them in person. Most of them have the same worries and challenges, even if they are funded, and would love to share their story.
7. MVP (Minimum Viable Product): Creating the first prototype - Whatever may be the nature of the startup it is particularly important to get a working prototype of the key elements.
8. First Customers: Unpaid customers are needed primarily for two reasons. Once a definitive version of the product or service is ready, the real feedback and word-of-mouth advertisement comes from the customers.
9. Scale: In its infancy, things are easier to manage for a startup, but teething problems begin when a startup grows bigger and starts addressing the higher volume of clients or consumers, and hence fail to scale, due to lack of planning.
10. Strategy: Timing is the key when launching a product or service. From prototyping to marketing to servicing to hiring, all bases must be covered. 
11. Outsource: Outsourcing is a great option when there are limitations in terms of skill, money, and time. Outsourcing allows you to have skilled professionals solve any problem (as long as the right problem is attended to) for a nominal fee.
12. Branding: Just like how first impressions matter, so does the business’s branding. Trying to create a coherent picture of what the solution does for users is important for long-term success.

Staying consistent in efforts and working hard are inevitable for success, but it is more so for a budding startup. Bootstrapping has advantages and disadvantages, but the decision also takes into consideration the current economic situation and the need to fulfill the vision as quickly as possible. This is where bootstrapping becomes a boon for some and a risky option for others.

Fundraising Jargon 01: Valuation

In quite simple words, valuation is the monetary value of the company. More often than not, internally, all company shareholders agree on a formula or arrangement to determine valuation in the event of a partner’s demise or exit, which is also ideally documented and captured in all relevant agreements and communications within the firm, whether partnership, private limited, or public companies. When looking for venture or angel financing, the valuation is, honestly, whatever the entrepreneur can convince investors to agree on.

The difference between pre-money valuation and post-money valuation is also very simple. Pre-money refers to the company’s value before receiving funding. These terms are important because they determine the equity stake the entrepreneur will give up during the funding round.

Post-money valuation = pre-money valuation + new funding

Let us understand this with an example. Say a venture firm agrees to a pre-money valuation of $10 million for the company. If they decide to invest $5 million, that makes the company’s post-money valuation $15 million. Here, the investor’s $5 million stake means they are left with 33% ownership of the company ($5 million/$15 million).

Let's consider a counterexample. Say the company was valued at $10 million post-money instead, implying a $5 million pre-money valuation. This means that the investor’s $5 million counts as half the company’s valuation. The investor comes away with 50% of the company in this scenario, rather than 33%. Given the difference in equity, one can see how important it is to have a clarity on pre- and post-money valuations when discussing investment terms.

Know Before You Seek

While there are a lot of ways to wobble or worse, flounder while building up a company, failing to understand financial jargon should not be one of them.

You want to build a company, keep control, and earn a fair share of any windfall. Similarly, with their own vested interests in mind, investors and venture capitalists want to profit from the company as much as possible, minimize their financial risk and, often, gain the operating control needed to do so. Balancing these interests is a delicate process that requires a clear-eyed understanding of the terms involved during negotiations.

Amidst an abundance of technical jargon that entrepreneurs face during fundraising discussions, let us visit and learn about (each of these are covered in subsequent blogs) for understanding them better on our journey. Familiarity with the phrases below will help you avoid needlessly giving up equity, control, and profits in the event of a successful exit. While it is always advisable in my perspective to have an expert legal person to assist, knowing these will hopefully help any entrepreneur in talking sensibly and put forth a better impression on prospective investors.

1. Valuation: the monetary value of the company
2. Pre-Money Valuation: company’s value before receiving funding 
3. Post-Money Valuation: cost of company after investment
4. Burn Rate: how fast is the cash blown (or burned)
5. Convertible Notes: allows startups to raise money without valuation discussions
6. Capped Notes: ceiling on the valuation of notes converted to equity
7. Uncapped Notes: no guarantee of how much equity the debt will purchase
8. Preferred Stock: comes with certain rights attached
9. Participating Preferred Stock: get liquidation preference
10. Non-Participating Preferred Stock: convert shares to common stock
11. Liquidation Preferences: determine who gets paid what and when
12. Pro-rata Rights: right of investors to participate in later funding rounds
13. Option Pool: chunk of equity reserved for future hires
14. Board of Control: composition of the board post-funding
15. Vesting: an incentive program for investors and team

My Numbers in a Startup

Financial statements reveal the strategies and the tactics for designing the go-to-market strategy. While there are innumerable metrics and number crunched data for reference, a few of them which standout as the most essential while sifting through a startup’s operational model, whether for an investment or in an internal progress analysis board meeting --

a) Revenue: the growth in income indicates how quickly the company can grow if it moves at the same pace on the same path as today. The revenue growth projections indicate the potential of the business.

b) Net Income: the bottom line or burn rate is the revenue minus all the costs incurred. Net Income dictates the minimum amount a startup needs to raise to become profitable. By comparing Cash, Net Income and Revenue, one can estimate the financial profile at the time of the next funding round.

c) Gross margin: a measure of how expensive it is to make the product. It is calculated by taking the revenue and subtracting all the COGS (costs of goods sold). Gross margin is the glass ceiling of profitability because the net margin can never exceed the gross margin.

d) Sales Quotas: provide indications of how easily the product is sold and how well run the sales team is.  At the initial stages of a startup, more importance is of the value consistency: smaller deal sizes but more predictable deal velocity.

e) Sales efficiency: a gauge for how aggressive a company can be in marketing and selling its services. The longer the payback period, the greater the risk that a customer churns and the marketing expenses paid to acquire the customer are lost, and vice versa. A 12-month recovery window is typical.

f) Churn: a quantification of the revenue potential and lifetime value of each customer. The greater the churn, the more challenging revenue growth becomes over time. This often means a company will stimulate demand using paid acquisition, decreasing contribution margin, and impacting profitability.

g) Contribution margin: it measures profit per unit, without considering fixed costs. To calculate contribution, take the total revenue generated by selling one unit and subtract the variable costs to sell that unit. The greater the contribution margin, the more profitable the business is on a unit basis, and hence more sales and marketing expenses can be spent to acquire customers and fuel growth.

h) Marketing Spend (Non-personnel): is the most significant controllable expense in a business. It typically includes ad spending and event spending. This expense bucket can be turned on and off from month to month unlike salaries or rent. 

i) Fixed costs (HR): single biggest expense for most startups is salary. By looking at salaries across functional areas, one can get a sense for how a startup pays its employees relative to market rates. Low salaries could spell employee retention questions in the future. Excessive salaries reduce the company’s runway.

j) Revenue per employee: the beauty of any business lies in their leverage. Google’s market cap is 40% larger than Walmart but it has only 2% the size of Walmart’s employee count. Revenue per employee is a measure of how efficient a business is in using technology to bring their product to market. Some sectors and products intrinsically need more people to be sold.