If you have interacted with anyone in the startup ecosystem in the last 9-12 months, chances are it would have taken only a few minutes for your conversation to drift towards the gloomy investment climate. And, of course, there is no smoke without fire. Aggregate startup funding did dry up significantly this year. A recent YourStory analysis revealed a 40-percent drop in the capital invested in Indian startups between H1 2015 and H1 2016.
We at Treebo Hotels raised our Series-A round in June 2015, when investor confidence and feel-good about India was at its peak. And boy, was it anything but a super quick raise, or, dare we say, a relatively easy one. Towards the beginning of this year, however, when we hit the road to raise our Series-B round, we found ourselves bang in the middle of the proverbial nuclear winter. With the heady days of 2014-15 behind us, the normal contours and considerations of raising capital were now at play. By the time we closed our round in July, having seen these contrasting environments, we had gathered some valuable learnings regarding fundraising, which we thought we’d share through this article. We’d talk about the four questions – a) how much to raise, b) when to raise, c) who to raise from, and d) how to run the process.
How much to raise
Unfortunately, given the somewhat misplaced sense of pride associated with raising capital, this question often gets only a frivolous answer. And that is, “as much as you can”. Instead, having a fact-based, well-thought-through answer to this question should be the first step of the fundraising process. We found it immensely helpful to have this clarity upfront. And it prevented us from pursuing tempting but suboptimal—possibly even damaging—outcomes.
Raising too little is surely not desirable. It can, in best-case scenario, stifle your ability to make big and bold bets for the future, and, in worst-case scenario, sound the death-knell of the organisation at the slightest sign of turbulence in the market. It was for these reasons, that some of our well-wishers with experience in the startup world pushed us into raising our Series A in June 2015, soon after we decided to start up. In hindsight it was absolutely the right decision for us.
Raising too much, on the other hand, can have even more perilous consequences. A) It can murder innovation. We saw around us hyper-funded organisations developing almost a compulsive DNA of throwing money at problems rather than figuring out their viable solutions. B) It leads to unwarranted dilution of founders’ stake, thereby disturbing the critical alignment between company success and their long-term wealth creation. And c), if not justified by commensurate value creation, it can fundamentally distort a key performance metric - ROCE, or return on capital employed, which tests a company’s P&L success not just in absolute, rather against the aggregate funding raised by it.
On balance, given our requirements and the environment, we decided to plan for a 15-18-month runway with our Series-A raise, and 24-30-month runway with our Series B. The ‘runway’ metric is key. Raising a large amount to secure the business for a longer period in a difficult investment climate makes sense. Raising a large amount to spend more on business just because you can does not. Business should dictate capital raised. Not the other way around.
When to raise
Fundraising is sometimes thought of as a periodic activity, where you announce to the investor world at large that you are raising money and that’s how interest and eventually capital is secured. We initially thought so too. But we soon realised that while this may sometimes happen at very early stages of a venture, fundraising is usually a continuous process with a combination of ‘inbound’ and outreach. This is increasingly true in today’s saner investment climate where investors like to evaluate companies (and therefore, teams) over a longer period of time.
Great investors are looking to have these conversations and do not wait for a formal fundraising process to begin because it is already too late for them to start engaging if the company is a potential winner. Over the last 15 months since we launched, we have regularly been in conversations—introductory to exploratory to late stage—with investors.
However, the final decision on the fundraise should also depend upon whether the company is ready to take in the said amount of capital. Equity capital needs to be thought of not as a privilege but as a responsibility. Raising too early without significant value creation can be very harmful. It often leads to companies chasing the wrong goals, eg., a very early-stage company focussing on growth to justify its valuation vs. chasing product market fit.
Who to raise from
Assuming one does have the choice, there are many answers to this one depending upon whom you ask, from “the first one over the line” to “whoever is paying the highest price” to “the one with the largest cheque” and so on. In our limited experience, this is not the right path to go down. Choosing the right investor is as important as deciding on your company’s strategy and just like the latter, the choice of investor has many nuances.
To start with, money matters but the colour of money matters as much if not more. One needs to look at investors, especially early stage ones, as more than just the source of capital. Getting on board a high-quality, reputed investor is also the biggest signal you can send to the broader ecosystem. Even if the better quality investor comes in at a lower valuation, it is totally worth considering.
Second, one needs to find the best investor, not in general but for one’s own specific company. So you should be asking the question “What do we really need help on?”. Depending upon the team’s skillset and the space you are in, the answer could range from product/tech to marketing to retail distribution etc. The answer to this question should influence the choice of investor. For instance, having an investor experienced in brand building was key and did influence the Series B outcome in our case.
Third, it is imperative to find a partner with whom you have complete alignment. While alignment is easy to come by when the going is good, one needs to think through how the relationship would work in difficult times when things don’t go well. Last thing an entrepreneur wants in tough times is a fundamental misalignment on key choices such as growth-experience-profitability trade-off, customer segments, new business lines etc.
In our case, one of the Series-A investors asked us when we presented our business plan during the pitch, “Why wouldn’t you do a lower scale if you must, to deliver a fantastic experience if you are really building a brand?”. We immediately knew that this partnership would work well.
Lastly, there is one additional thing to consider, and that is the topic of dirty terms. Imagine this – you have just walked out of the pitch after shaking hands and verbally agreeing to the offer. An hour later, you receive the term sheet and you eagerly examine its contents. Everything seems in order – the investment amount, dilution etc. Except it isn’t. Lurking in a corner is the ask for a superior liquidation preference (a downside protection element for the investors). To make matters worse, the anti-dilution clause looks very different from what your entrepreneur friend said it would be.
You have just been hit by what is described in the investment world as a ‘structured term sheet’. At this point, the wise thing to do would be to stay as far away from this as possible. Not the most talked about aspect of fundraising, structured term-sheets can kill you. They can dramatically tilt the payoffs and create misalignment amongst shareholders. And impact of these terms only becomes worse as you go along. As these terms get ‘unboxed’ over time, they can create situations that are completely onerous for the founders. If you have the choice, it is a no-brainer to pick a clean term-sheet over a dirty one, no matter what the valuation or size of investment is.
How to run the process
Fundraising can be quite an emotional roller-coaster, with the peaks and the troughs linked to outcomes of investor discussions. One doesn't need the fundraise process itself to become a source of anxiety. Here are a few things that we found helpful.
First, don't let the whole organisation or the whole management team or even the whole founding team become a part of the process. After all, the primary job of business is to do business, not to raise money. We heard from an investor about another startup where growth plateaued for the three months that the founders spent on raising their next round. We were careful from the beginning about not letting this happen to us. So between us, one person took the explicit responsibility of leading the process with the other one getting involved only as and when necessary.
Second, fundraise or no fundraise, keep your books, your legal contracts, your data and dashboards all in top shape and readily retrievable. Aside from being the hallmark of a good, transparent, data-backed business, this readiness of your information could be a huge asset during the fundraise process. It can help expedite the process as well as further strengthen a prospective investor's belief in the quality of team and processes set by them.
Finally, when it comes to negotiating the terms of the investment, push for granular discussion and alignment on the key terms at the term-sheet stage itself. All term sheets have an exclusivity clause that prevents companies from prospecting any other investor till the completion of the current process.
This exclusivity could leave the company stranded without options if for any reason the current process falls through. To prevent this, it is highly recommended to discuss and lock the major clauses—the ones that could lead to an impasse in the process—early on, even if it takes a little longer. Following the same approach allowed us to move from term sheet to definitive documents quickly and smoothly, without any surprises.
Aside from the specific ones above, the other overarching—and heartening—learning we had was that for good businesses, money is still available in the Indian market, and will likely always be. Investors taking long to evaluate a business can only be a good thing for a good business as it signals the making of a solid partnership foundation.
Of course, we are far from being an authority on this topic, and these learnings are not absolute. So, would love to hear about your experiences and views in the comments section.