How to get Venture Capital funding for your Startup?

An Entrepreneur’s journey to success starts with an idea. In the initial stage, his/her business requires capital to grow. Earlier, I wrote an article on 5 ways to fund your Startup or Business in India.

Raising venture capital is one of those options. In this article, we’ll discuss Venture Capital funding in detail.

What is Venture Capital Funding?

Venture capitals (VC) are professionally managed funds (AIFs in India) that invest in companies or small businesses that have huge potential for growth and can become market leaders in the future. VCs usually invest in a company against equity and exit when there is an Initial Public Offering (IPO ) or Merger & Acquisition (M&A).

Most venture capital comes from a group of wealthy investors, investment banks, and other financial institutions that pool investments. In India, venture capital funds are governed by SEBI (venture capital funds) regulation 1996.

Unlike popular beliefs, VC funding is not a long term investment. The central idea here is to infuse capital in an organization to improve its overall infrastructure until a predetermined size and market creditability is reached so that it can be later sold to bigger corporates by means of IPO or M&A.

How does VC Funding work?

Some VC firms invest in great industries that do well irrespective of the existing competition and the current market while some invest in great people having great ideas.

VC firms focus on the central part of the traditional industry S-curve. They stay away from the early stages. When the technology hasn’t been perfected and the market needs are also developing.

An ‘S-curve’ describes the mathematical arc that typical companies go through as they enter the marketplace and begin to undergo cycles of growth and stagnation.

VCs also stay away from later stages (maturity stage) when competition in the market is high and growth rates slow down. VCs only remain invested during the expansion stage.

Once the VC has funded a company and the expansion time has elapsed, VCs exit the company and possibly the industry before it reaches the peak of the maturity stage.

The logic of a VC Deal

Irrespective of the structure of the deal, the logic of the deal remains the same i.e to provide investors in the venture capital fund with:

1. sufficient downside protection
2. favorable position for additional investment if the company proves to be a winner

venture capital firms need protection from investment risks which is why VCs co-invest in a company with other VCs. It is very rare to see a sole VC firm funding an entire company. Another positive effect of such a collaboration is that the credibility of both the funding and the company goes up.

The venture capital industry has 4 main players:

1. entrepreneurs who need money
2. investors who want higher returns
3. investment bankers looking for companies who need capital
4. venture capitalists who generate money for themselves by making a market for the other 3 players

How to attract VC Investors

Getting funding from a VC or any other investor requires an entrepreneur to be very tactical in his/her approach. An entrepreneur should do a proper study of the market and should be aware of the right ways to allure the investors.

Steps involved:

1. Pick the right VC: The first step is to pick the right VC. For this, the entrepreneur should do a market check and list down the VC firms looking to invest in his/her sector. From all the options available one should approach the VC that can provide the right mentorship/expertise to the company or has previously invested in a successful startup in that particular sector.
2. Creating the pitch: To get the investment from VC the entrepreneur needs to convince the investors of the potential of his/her business, growth paths, and competitive advantage. The business presentation placed with investors should be lucid, effective, and well-structured. This business presentation is also known as Pitch Deck.
3. Approaching VC: With the pitch deck ready, the next step is to approach the analysts and associates of the VC firm to arrange a meeting with the General Partners (GPs) to get them interested to invest in the business. Later, the entrepreneur needs to convince the GPs and LPs (Limited Partners) for the investment.
4. Practising Healthy Concern: While convincing the VC, the entrepreneur needs to very careful with what type of information is being passed on to the VC firm because if the deal is not finalized then the startup could be at risk of failure due to spread of information and business idea in the market.

How VCs select Startups

To have a clear idea of how VCs select startups and how do they work, one needs to understand the structure of a VC firm and its working process.

The topmost layer of a VC firm is made up of the people who pool in their money and are known as Limited Partners (LPs). These people are important for finalizing deals with startups but they don’t interfere with how the money is managed or where the funds are invested. They only earn returns on the money they had provided to the VC firm.

Money management and making investment decisions are the key responsibilities of General Partners (GPs) of a VC firm. GPs earn fees for managing the VC fund and smartly investing it in startups. They also get a share of the profits VC makes after providing returns to the LPs.

Speaking from an investor’s perspective, they look for entrepreneurs having:

1. a clear vision of where they want to see their business
2. knowledge of the industry/sector they are in
3. strategies placed to plan and upscale the business

How to choose the right VC investor?

Choosing the right VC investor is a prime concern because after funding the investors will have control over the startup’s functioning and business decisions.

So, to make sure that your business is in good hands and that the business is running successfully with investors in the decision-making, the entrepreneur should choose investors having a thorough knowledge of the sector/industry.

For example, think of a fintech startup that provides digital portfolio management/advisory services to working professionals. Here, the business owner needs to find investors who have extensive knowledge of the financial sector, various financial products, and client preferences based on age-group, income level, and standard of living.

Trends in VC funding in India

According to a report by KPMG, VC investments in Indian startups plunged to $ 2.2 billion in the first quarter of the calendar year 2020. In October-November quarter of 2019, a total of $ 6 billion were pumped into Indian startups. Also, the number of international investors has also increased over the years.

Source: techcrunch.com

The plunge was due to a combination of global macroeconomic uncertainty and the Covid-19 issue. In total, the previous calendar year saw a record-breaking $ 14.5 billion inflow into India, spread over 909 deals.

Several new funds also invested in India during 2019. Notable among them are Tanglin, A91 Partners, Arali Ventures, Samsung Ventures, an early-stage VC fund by Investment Trust of India.

Meanwhile, the Indian government introduced several regulatory programs to boost the Indian start-up ecosystem, such as Startup India, Digital India, and the Alternative Investment Policy Advisory Committee.

India’s ranking on the World Bank’s “ease of doing business” index also increased significantly from 130 in 2016 to 63 in 2019, which indicates that investors’ confidence in the regulatory ecosystem has increased.

Bottom Line

1. Some VC firms invest in great industries that do well irrespective of the existing competition and the current market while some invest in great people having great ideas.
2. Choosing the right VC investor is a prime concern for any entrepreneur because after funding the investors will have control over the startup’s functioning and business decisions.
3. While convincing the VC, the entrepreneur needs to very careful with what type of information is being passed on to the VC firm as the startup could be at risk of failure due to the spread of information and business idea in the market.

Note: DGM Capital is a proprietary trading and investment firm offering services like M&A Advisory, Startup Valuation, Startup Funding, and Wealth management.