Most entrepreneurs fly blind in their first fund-raising. They don’t know what it involves. A lot of them don’t have friends on the investor side, and there are a lot of misconceptions about what investors are looking for. It’s also very unnerving, besides time-consuming, for the entrepreneur to explain his business to an outsider multiple times, without being sure whether a deal will finally get closed.
Cyrus Driver has experience both as an entrepreneur—he founded Calorie Care, a calorie-counted meal delivery service in Mumbai in mid-2004—and as an investor—he is director of Helix Investments, an India-focused private equity fund sponsored by the Culbro and Bloomingdale families of the US.
Early action:Helix Investments’ Cyrus Driver says it’s important not to defer raising funds till the firm runs out of money.
Driver offered 10 tips to around 200 entrepreneurs who gathered at a forum organized by Yourstory.in, an online platform committed to providing visibility and networking opportunities to entrepreneurs, start-ups and self-made professionals, on 29 May in Mumbai.
Here are his 10 lessons, shared seriously, yet in a lighter vein.
1. Pitch directly to the person who has the power to say ‘yes’
In a venture capital (VC) or private equity (PE) firm, there are so few people that there’s an element of title inflation. I myself fall in the middle of the hierarchy. My business card will say director, but the reality is that there’s an investment committee in the US that takes the call. It is important for an entrepreneur to know who is the real decision maker. If he has to wait for a few weeks to pitch to that guy, it’s better, especially if it’s an early-stage idea. If you get the top guy interested, then everything else falls into place. All of us in a PE/VC team have the power to say “no”, but very few have the power to say “yes”. Pitch directly to those that have the power to say “yes”.
2. Don’t listen to your uncle and his grandfather about valuations
Fund-raising takes months in a normal environment. In this particular year, not more than 1% in this room will raise funds. It’s important that you don’t defer fund-raising until the firm is running out of money. Also, when not sure how much to raise, it’s safer to raise more than required. There’ll always be more heartburn (in this) as there’s more dilution. And finally, you’ll always have some uncle, cousin or friend who claims that valuations are this and that. The reality is that for every business, the value you will get this year will be less than that you were getting last year. Either you get real about that or you’ll just keep negotiating.
3. You need a CFO. Now.
Any company with a turnover of more than Rs4-5 crore will need a good chief financial officer (CFO) or a head of accounts. I’ve yet not met an entrepreneur who does not think his CFO is worth the salary being paid. A good CFO will help you with fund-raising. And more importantly, investors speak the financial language which first-time entrepreneurs rarely speak. Investors don’t want to hear anecdotes about what your customers said. They want to see the business by segments, margins and understand what drives margins. That’s the language the CFO speaks. Also, while interacting with an investor, the CFO takes a lot of pressure off the entrepreneur.
4. Bargain hard for a good price, but don’t believe your own spiel
In most negotiations, the entrepreneur says his company is worth so much even though it has a limited profit margin now because next year this is going to happen, and the year after that is going to happen, and so margins will expand. But the investor says he can pay value only for what the entrepreneur has already achieved. As a compromise, they link the value to the profits one or two years from now. In 99% of the cases, the entrepreneur goes through sleepless nights because he’s missing targets. I would suggest entrepreneurs take fixed valuations. Bargain as hard as you want, but don’t start believing your own spiel if you want to close a deal. Everyone has to market themselves, but you need to know where to draw the line.
5. Don’t fight investors’ exit rights, there’s no escaping them
If an entrepreneur reads through each line of a shareholders’ agreement from the day he starts fund-raising, it’s more likely that he’d stop the process immediately. Because, in theory, you can’t scratch your nose without the investor’s permission, you cannot sell your shares to anyone, sometimes you cannot sell your shares for three years, and in some cases, if you don’t do (an) IPO (initial public offering) in a certain period, the investor has the right to sell the entire company. These clauses are very unnerving. Most of the times, these are not used. The broad rule is if the entrepreneur is honest, these will never be used. If he is cheating, then it’s the stick hidden behind the investor’s back. So don’t fight it, you can’t win.
6. Stick to your business area, investors love more of the same
Focus, core competence, etc., are clichés thrown around, but most private equity investors do not have the confidence in their own ability to spot a winner. And it is a rational decision to back a company that is going to do more of what it has already done. They’ll probably back a company that sells baby powder and shampoo, and now wants to get into soaps. But investors will not take a risk with a company which sells soaps and powders and now wants to start a film studio. Private equity investors love more of the same. Entrepreneurs, when they approach funds, should not have a fund requirement for some unrelated business. It dramatically reduces their chances of success.
7. Don’t pay more than 3% to your investment banker
Bankers get joked about a lot, but a good investment banker will go a long way. First, he speaks the language of the investor, so he’ll summarize your business into a document that the investor can understand quickly. Most investors, in their first instance, want to understand your business in half an hour to an hour. A good banker will also negotiate on your behalf and get you the best terms, and he’ll give you access to a lot of investors. But first, you should get a banker who has actually done deals. Second, there’s a lot of opaqueness around the fees. Anything above 3% of the funds raised is too high, no matter what the banker says. The bankers also use the “bait and switch” technique where they’ll start by promising you a very high valuation, but later say, “What can I do, the market is like this.” So don’t get fooled by big talk.
8. Investors always ask the right questions; you look for answers
Investors are typically non-risk-taking, highly informed professionals who can add value in mergers and acquisitions, get information about similar businesses around the world, and help you with future fund-raising. In India, they typically do not have operational experience. So they are not going to be your mentor or guru. Many will claim value-addition, but entrepreneurs need to look deeply whether that value is there or not. What investors are good at is asking the right questions. Don’t expect them to provide the right answers. If they could, they themselves would be running the business. The entrepreneur himself has to eventually come up with the answers. Investors ask searching questions and they are not afraid to ask them because they are not emotionally involved.
9. Being honest helps; give your investor bad news early
In dealing with the investor, it really helps to be honest, especially after investment. Whoever you’re interacting with—in every investment firm there’s one guy who’s managing one investment—he will very soon become your ambassador. He will look good if your business does well. So, he’s really on your side. And the worst thing you can do is not to give him bad news early enough and make him look stupid. Then you stand the risk of losing your ambassador. There’ll be decisions later on—whether to raise more money or not, whether to enforce these scary rights or not—when you need this liaison person to stand by you. So just be honest with him. People expect that something will go wrong in the business every now and then, but what is unacceptable is giving bad news later than when it should have been shared.
10. Don’t give ‘hockey sticks’ to investors: avoid overused terms
A lot of entrepreneurs and their small bankers always throw in some terms that do not at all convince the investor. In fact, they reduce the credibility of the business plan. “Hockey sticks” is a favourite, which means some metric that has been falling in the past, is suddenly going to turn around and rise very sharply. And then there’s this phrase of “inflexion point”, which means the magical point that every industry is at the cusp of, where suddenly everything will start going right and growth will be fast. And finally, there is the argument of “low penetration per capita”. Whether you’re selling shoe laces, motorcycles or aircraft, penetration per capita in India will be lower because we’re a Third World country. That alone does not justify the business.
Illustrations by Jayachandran / Mint