Venture Capital

By : |July 14, 1999 0

There is a tremendous undercurrent of vibrancy in the IT
and other knowledge sectors. A large number of entrepreneurial executives who are
currently employed are seeking to pool together their technological, social and managerial
resources to set up their own companies. This article seeks to provide a road map to these
entrepreneurs and to young rapidly growing companies.

Often the first steps for these companies are:

– Writing a Business Plan

– Putting together the core/management team

– Financing

– Approaching a Venture Capitalist

Business Plan
The business plan is a useful document and a draft plan must be written even before the
company is formed. The plan will serve the purposes of:

Bringing focus: on technologies, markets
of the company

Serving as a roadmap: provides direction,
list of goals to be accomplished, timing, resources required, etc.

Starting discussions: with venture
capitalists, bankers, recruitment of senior executives etc.

The plan should include:

– Description of founders’ past

– Management- key professionals and their responsibilities

– Products/Services Offered

– Historical performance

Existing companies: financial and
operational history: description of technologies, clients, major orders completed and
summary of financial performance

New entrepreneurs: achievements of team
vis-a-vis past employment

Market Opportunities: description of size,
unique characteristics, problems, etc of the markets and technologies the company proposes
to operate in the short/medium term.

Competitive scenario: description of some
key competitors and role models

Company plan for the above markets

Vision

Medium term plan (0-3 years)

Long term goals (5-7 years)

People, technology, delivery channels etc.

Investment plan

Financing plan

Financial projections

– 5 year Profit and Loss and Balance Sheets with
description of underlying assumptions

– Revenue projections for major Divisions/Lines of activity.

CV’s/references of founders, reference list of clients etc,
bankers, etc.

White papers, technical papers, press clippings, news items
on founder/founders’ projects.

Building a team

One must realize that one person (however good and experienced) cannot build a company. A
company needs a good management team and key employees. Naturally, these key executives
need to have significant stock options in the company. The critical positions in the
company include heads of departments for finance, marketing, technology delivery, etc.

Financial Planning

A startup or a young rapidly growing company must be financed properly. The simple rule to
follow is to be aggressive in estimation of expenditure (assume that expenses will be more
than planned) and to be very conservative in estimating cash inflows in the company. It is
also a good idea to make a monthly or quarterly projection of the Profit and Loss
statement to determine when the company sales reach the breakeven level. New companies
rarely reach this level in less than six months, so it is imperative that these initial
losses are funded through equity capital. As a corollary young companies need to preserve
their cash to fire their Profit and Loss and avoid making capital investments in land and
buildings during the first 24 to 36 months.

The first round financing for a startup must take into
account a 18 to 24 month horizon and must include:

– Capital expenditure/Deposits

– Research and Development expenses

– Marketing expenses

– Operating (Cash) losses

– Working Capital requirements

The above requirements can be funded through loans and
equity. The Indian banking system is startup friendly and it is not difficult to get loans
for a startup. Banks will finance around 40% to 60% of the assets and working capital.
Most banks will insist on collateral security for the loans from the personal assets of
the founders apart from having a lien on the assets they would finance.

Banks will not finance soft operating expenses such as
marketing expenses, advertising expenses, travel, operating losses and research and
development expenses. These expenses have to be funded through equity capital. Ideally a
startup should be almost wholly financed through equity capital till it starts generating
breakeven level of sales.

Approaching Venture Capitalists

Venture capitalists typically invest in the equity capital of the companies. Venture
capitalists are highly selective, investing in only 1% to 2% of all the business proposals
they look at. The criteria used by VC’s to evaluate business proposals include:

– Quality and experience of management team

– Elegance of the solution (product/service of the company)

– Size and trends in the market for the company’s product

– Competition

– Entry barriers to the business

– Investment horizon

– Entry and exit valuation

The right venture capitalists can add tremendous value to a
company. Venture Capitalists rarely invest in companies that do not reach revenues of at
least Rs. 30 crores to Rs. 40 crores in the software business and around
Rs. 100 crores in
the manufacturing business. They are also looking for unfair advantages enjoyed by the
company through intellectual property rights, proprietary knowledge base and a
high-quality management team. For estimation of returns, VC’s work on the number of
times the money invested rather than the simple IRR (Internal Rate of Return–a method
of calculating investment yield over time assuming a set of income, expense and property
value conditions). The benchmark for investment is at least five times the money in around
4 to 5 years. These hurdles could be higher for seed stage investments.

Good luck and enjoy building your company!

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