Entrepreneurs should understand the finer differences that characterise different investors or investments in different lifecycle stages and prepare accordingly during the fund raising process
A man is known by the company he keeps. It is an old saying, and pardon me, the gender is only incidental. Today a company, particularly, is known by the investor it has. Several studies have shown the value addition provided by early stage venture investors in the startups they invest in. There are also differences between investors—the extent of value addition made by top quartile investors is perceived to be higher. Therefore, the entrepreneurs and venture founders flock to the top investors and are keen to obtain investment from them. As capital providers, venture investors face the problem of plenty as they receive investment proposals by the hundreds, while they can invest in just a handful.
A key ingredient in venture investing is the valuation of the investment opportunity. While investors may not decide on a deal based on valuation, they could often pass an investment opportunity when the founders and the investors do not see eye to eye on the expected valuation. A deal is attractive only at a particular price point. In order to get a peep into the mind of the VC’s valuation process, we did a survey of VCs on the important factors that they look at, in an investment proposal. The main results follow below.
The Survey Respondents
The respondents of the survey were carefully chosen so that we had a sample that includes investors who invest in different stages of the company lifecycle—angel investors, seed and early stage investors and growth and late stage investors. Overall, we had obtained 45 responses which were used for the analysis.
Out of all respondents, 44 percent were independent venture capital investors, 24 percent were angel investors and the remaining 32 percent were part of either an Indian or global institutional network. 36 percent of the respondents have been investing in India for less than five years while an equal percentage have been around for more than ten years, with the remaining respondents investing somewhere between 5-10 years. Out of the total respondents, only 33 percent had raised their capital from India, while 36 percent relied completely for funds from abroad. Our sample had more representation from smaller VC firms—56 percent of the sample was investors who preferred investing an amount of less than $5 million, 28 percent preferred investing between $5-25 million and only 17 percent preferred investing beyond $25 million. 33 percent of the respondents had invested between 10-20 companies, while 31 percent had less than 10 companies in their portfolio. The remaining 36 percent had more than 20 companies in their portfolio.
The art and science of valuation
A common question that entrepreneurs have, pertains to the valuation of the venture. Very often, there is very little insight on the thought process of how the valuation of a venture is arrived at. Figure 1 indicates the spectrum of responses received in a scale of 1-9, 1 indicating that valuation is objective and 9 indicating that valuation is subjective. All the respondents were uniform in agreeing that valuation is not objective, and there were a few respondents who have indicated that valuation is entirely a subjective exercise. But a large majority of the respondents indicated valuation is a result of both judgement and objectivity, but with the former dominating the latter. Entrepreneurs in the fund raising mode would do well to remember this, so that they focus more on factors that also influence judgement, in addition to getting their homework right on numbers and projections.
Drivers of valuation
[This article has been reproduced with permission from Indian Institute of Technology, Madras]