Perils of Series B Fund Raising

Many a times, it is easier to sell a “Concept” than “Real Business” to Investors. When Investors like the founding team and the market opportunity, they end up making bets. Often these are gut based decisions as opposed to data or deep due diligence driven.

Valuation methodologies differ by the stage of investment and the availability of quantitative and qualitative data. Since a majority of these companies raise their first round at pre-revenue stage, valuations are very subjective. Based on the "ASK" and VC Firm’s ownership requirements, Start Ups' valuation (Pre Money/Post Money) gets determined. For example, on a $2M raise, if a VC firm demands 1/3^rd ownership, the valuation gets set at post money of $6M.

Almost all Start-ups encounter the following bumps during their journey

Markets growing slower than anticipated
• Too many me-too companies creating confusion in customers' minds
• Operational and Execution challenges

It always takes longer and costs more than what’s stated in a company’s financial projections to achieve business momentum for the next round of financing.

Companies that execute well and achieve escape velocity close “UP” (Series B) rounds very quickly. Often there is a race among Investors to preempt financing of these companies.

“Getting to Plan B” and Slow Growing Start-ups, find follow-on fund raising process slow and painful. Though new Investors like the Company and the market space it operates in, Post Money valuation of the previous round acts as a deal killer. This time around, Investors start evaluating real business. An idea of Flat Round doesn’t gel well with Entrepreneurs. From their view point they have made considerable progress on the product/customer/brand fronts, compared to where they were at during Series A financing.

Also existing Investors will expect the highest price for new Investors (UP round) to be able to mark up the value of the investment on their books and look good to their LPs. New investors will always bargain for the lowest price they think will enable them to get a financing done, given the appetite (or the lack thereof) of the existing investors in putting more money into the company.

Caught between the Rock and the Hard Place, Start-ups could end up getting demotivated and distracted, losing value quickly. My advice would be Focus on making the Pie Bigger as opposed to owning a Big Piece of the Pie. Close the round no matter what, get the money into the bank and start executing.

Bootstrapping Vs VC Funding

For an entrepreneur, the eternal area of conflict is whether the bootstrapping method of raising funds is better or is venture capital a better route. The reasons for this conflict are several. You have all kinds of advice and advocacies coming in from various quarters. 

There are news reports/articles to read and counsel to be gained from entrepreneurs who would have gone either way. In all likelihood, the ones who did it the bootstrapping way may guide against venture capital funding, while the ones who hit it with VCs would recommend them wholeheartedly. Besides, there have been successes at both the ends. While Google, Hotmail and Cisco made it big with VC funding, Craigslist, Dell and Siebel did it on their own. So how does an entrepreneur take a call on the route to be taken for funding?

Business Focus/Mode of Operation

The business focus would determine whether venture capital funding would work for a company or not. For instance, intellectual property is something that attracts venture capitalists. Value-added resellers or pure-play consulting companies would not. 

Same is the case with the mode of operation. Bootstrapping works better for lifestyle businesses which are primarily run by a single owner while VCs would go more for professionally managed businesses which involve partners. 

Clarity

An entrepreneur needs to have a decent idea about the product features, the customer value proposition and sales & marketing model that will be applied. In case of lack of clarity it is better to bootstrap, be done with due diligence and then approach the venture capitalists for further funding. The reason is that venture capitalists will expect you to have a clear short-term/long-term strategy and work towards achieving it. Lack of clarity may not go well with them. 

Fast Growing Market/Competition

If the market is growing at a fast clip (online travel previously and eCommerce now) and competition is increasing by the day it is better to wake up and gain momentum. Even if you are better, faster or cheaper than others, you may not always be heard because of the noise. At that point of time, VC funding works as it helps you invest better and rise above the noise faster. 

Strategic Partners

Strategic partners may be able to meet your financial needs. However, ensure that they fund you without excess baggage (like signing a deal of exclusivity with a customer). Investment from such partners should not preclude you from doing free business.

Irrespective of the route that you take, it is always good to gain confidence and achieve predictability before you ramp up. It is better to be clear about your goals, work towards achieving those and be on par with what’s been set, before you go for higher amounts of funding that could range from debt financing to VC funding. 

VCs on their part are not looking at owning your company. The value that they bring to the table includes capital, rolodex and expertise. It is a Zero Sum game for them as well – simply because based on the kind of ventures they usually invest in, it is not physical assets that they are betting on. They are bidding on intangible assets that comprise intellectual capital and innovation. Therefore, even they will win if you have enough skin in the game.

Considering that there are growing numbers of Me-Toos in all sectors, it is a tough task to gain critical mass before appearing on your competitors’ radar. But if it happens with your venture, you’ve lucked out. 

eCommerce in India – Inflection Point or Bubble?

Last few months there has been lot of activity in the eCommerce space. New Startups have got funded and several of the existing ones have morphed their business models “Just In Time”, to focus on eCommerce.

Previously majority of the share in the e-commerce market was contributed by Online Travel (MMT, ClearTrip Etc), Ticketing (Book My Show) and Classifieds (Naukri, Carwale). Emerging eCommerce (E-tailing) categories include Apparel/Accessories (Yebhi), Fashion (F&Y, Exclusively.in), Mobiles/Computers (LetsBuy) and Consumer Electronics/Books/Music and Videos (FlipKart). 

Per IAMAI, size of E-tailing market is estimated around $600M currently, growing 30% YOY. To scale and grow into real businesses, eCommerce startups will require

• Ability to assess/predict Product Demand accurately
• Cost effective Customer Acquisition strategy
• High Click 2 Conversion Ratio
• Repeat Sales and Loyal Customers

“Deep Customer Profiles” are a must to achieve all of the above.

Am sure even scrappy Startups will have to spend serious amounts of cash (tens of millions of dollars) to address business critical issues like Inventory Financing, Logistics and Customer Support.

With Brand Penetration, availability of mature Mobile Payment systems, improved Logistics/Delivery to third and fourth tier towns and Broad Band Internet User Growth, eCommerce in India will grow at a healthy pace.

Group Buying Business Models - Winner Take All

Have heard that there are more than 1500 Groupon Clones in China and 50+ in India. While Group Buying business models are flavor of the season, I do see following inherent issues with business model itself.

• Service Businesses by offering huge initial discounts can only make money if they are able to convert new customers to loyal customers (repeat transactions a must)
• A critical mass of Customers (in and around a location) have to be part of Group Buying Company mailing list for it to make money on each of the Campaigns
• If viral doesn't work, coupon Marketing Costs will cut into margins

Following Critical success factors will decide winners

1. Reach for each of the Promotion (Coupon Sale) on a daily basis with in a location
2. Conversion % (How many Coupons are they able to sell)
3. Commission (% points) offered by Merchants on a typical deal
4. Marketing costs for each of the Campaigns (Is it Viral mainly using FB/Twitter Etc or Do they have to spend money in marketing a deal)
5. Customer Acquisition Cost and Long Term Monetization of a Customer (Repeat Purchases)

Just like many other Consumer Internet Business models Group Buying will also be Winner Take ALL environment