10-07-2023

Entrepreneurship and New

Ventures
SESSION 6 & 7
SOURCES OF CAPITAL

Financing New Ventures

 Business is an engine that converts cash into assets to generate more cash
 Factors that determine how much cash is generated and required -
◦ Underlying profitability
o Commodities vs. differentiated goods
◦ Asset Intensity
o Cash-flow negative vs. cash-flow positive
o Payment terms (customers and suppliers)
◦ Speed of growth of the business
o Higher the speed of growth more is the cash requirement

 Business that are less profitable, have high asset intensity and need to
grow extremely fast have greatest dependency on external financing
◦ Consulting vs. online cab service?

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Status quo bias

Loss Aversion – Some examples
 Paperback or hardback books vs e-books
• Gains - ability to download books instantly and to carry them around easily
in e-readers.
• Losses - the experience of browsing in a bookstore or library; and sensory
pleasures such as the smell of ink on a printed page, the look of a book’s
cover art, and the texture of paper

 In-store grocery shopping vs. online grocery shopping

• Gains - convenience of home delivery
• Losses - experience of wandering through a grocery store, opportunity to
select the freshest products, inspiration for dinner, and be reminded of
certain grocery items

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Status quo bias

Loss Aversion – Some examples
 Traditional gas-powered cars vs. electric cars
• Gains - Reduce pollution, gas mileage
• Losses - Refueling convenience at nearby gas stations, greater power afforded by
many gas-only engines

◦ The losses involved in switching to a new product or service loom much larger
in people’s minds than any similarly sized gains
◦ Loss aversion causes the status quo bias also termed the endowment effect
◦ People value products and services they’re already using (their “endowment”) much more than
those they’re not currently using

◦ Experiments reveal that people want 2-4x more compensation to give up

products they already have

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Status quo bias

 Customers view spending additional time in learning about the new
product, spending money and effort as losses
 This contributes to status quo bias

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How to overcome Status Quo

Bias?
 Anticipate a long process of adoption and manage the process
effectively
◦ Status quo is powerful if the innovation has a steep
learning curve
◦ In such cases -
◦ Entrepreneurs must raise capital to cover a lengthy adoption process
◦ Manage costs very rigorously
◦ Consider “lightweight” or “introductory” products
◦ that provide fewer total benefits but minimize required behavioral
changes by customers

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Financing options -
Bootstrapping
 Finance the venture through personal savings, short term loans or
credit cards!!!
 Full ownership and control

 Instills discipline

 Enforces a reasonable rate of growth

X Limits the size of the venture

X High risk

Financing options – Debt vs.

Equity
Debt investors
 Limited investor upside
 No ownership
 Debt investors share the risk – lose all their money if the venture
defaults
 Expected rate of return – 10 to 15%
X High due-diligence
X May come with some covenants
X Fund ventures which are least risky
◦ Steady, stable cash flows

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Financing options – Debt vs.

Equity
Equity investors
 Equity investors share the risk
◦ lose all their money if the venture defaults

 Fund risky projects which have potential

 Bring newer resources and ideas to the business
 Invest only in sectors about which they have knowledge
X Usually demand a board seat
X Invest in projects with a tremendous upside potential
X Expected rate of return – 50-75%
X Get a share in the venture

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Types of Equity Investors

 Angel investors

 VC investors

 Strategic investors

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Types of Equity Investors

Angel investors
 Typically – relatives, friends, local businesspeople, wealthy
businessmen, former entrepreneurs
 Individual or group of investors who invest their own money into a
venture rather than professionally raised or managed funds
 Easier to get, based on personal trust

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Types of Equity Investors

Angel investors
 May offer ‘informal’ advice
 May not provide the venture with professional advice, but
 May help in providing connections to top recruit, advisers, and other experts
 Favorable deal terms
◦ Lesser equity dilution, interest rates compared to professionally owned funds.

 Angel investing is sometimes termed as “for profit philanthropy”

 Smaller fund size
 Chances of relationships getting damaged, if the venture fails

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Ratan Tata’s Angel Investments

1. Tork Motors Urban Ladder
2. Snap Deal Urban Clap
3. Cure fit GOQii
4. Paytm Xiomi
5. OLA Lybrate
6. Repos Energy Infinite Analytics
7. ClimaCell Cash karo
8. Abra Dogspot
9. Car Dekho Bluestone
10. Hola Chef Zivame
11. FirstCry Generic Adhaar
12. Lenskart https://startuptalky.com/ratan-tata-funded/

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Types of Equity Investors

Venture Capitalists Investors
 Required if the financing requirements cannot be met from
bootstrapping or angel investors
 VC firms raise capital from limited partners such as wealthy individuals
 VC firms are run by professional investors
◦ Often provide professional advice and domain knowledge
◦ Demand a board seat and control rights

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Types of Equity Investors

Venture Capitalists Investors
 For the founders raising VC funding is a “Rich” vs “King” dilemma
 Dilution of entrepreneur’s equity
 Usually follow a staging model
 Series of VC fundings as the venture reaches the defined milestones

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How do VCs make money?

Breakdown of a Typical Venture Capatalist Portfolio
70
63.2 61.7
60

50
Percentage %

40

30
20.5
20 13.6
11.6
8.7 9.2
10 3.8 4.3
3.3
0
<1x 1x to 3x 3x to 6x 6x to 10x >10x
Multiple on Invested Capital

Percentage of Cost Percentage of Value

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How do VCs make money?

Category of Projected Dollar Share owned Expected Total invested Total return
outcome value at exit invested per at Exit number of
company investments
Early failure - $5M n/a 5 $25M 0

Complete - $8-15M n/a 5 $55M 0

write off
Money back $50M $8-15M 20% 5 $55M $50M

Successful $200M $8-15M 20% 5 $55M $200M

exit (low)
Successful $350M $8-15M 20% 5 $55M $350M
exit (medium
Successful $500M $8-15M 20% 5 $55M $500M
exit (high)
Total $300M $1100M

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Types of Equity Investors

Strategic Investors
 Usually corporate investors (large firms).
 Motivation is to gain exposure to a new technology or a new product
area outside the firm's core, in addition to financial gains
 Such firms invest in new technologies or entrepreneurial ventures.
 Helps founders to liquidate their holdings and get some financial return
◦ Example – Biotech startups

 Usually caps the amount that an entrepreneur gets in a buy-out (pre-

defined agreed amount only)
 The entrepreneur’s salary after the buyout is capped

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Entrepreneurial finance
framework
High

Capital required to reach positive cash flow

Capital-Intensive, Capital-Intensive,
Proven New Technologies
Technologies Hard to fund
Commercial Banks; without
project finance, government
strategic investors support

Small Businesses New Technologies

Personal credit, Angel Investors;
Bank loans Venture Capitalists

Low High
Novelty of technology or business model

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Company funding cycle

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Financing options and the high growth venture life-cycle

Venture capital seed funds and traditional VCs

Mezzanine and Private Equity

Bootstrapping, Venture debt, Friends, Family, Angels, Strategic Investors, Government financing

Recognizing Product
and Shaping development Launch to Sustainability Growth Turnaround
Opportunity to launch

Investment FIRST SECOND THIRD MGMT

SEED START-UP EXPANSION WORK-OUT
ROUND ROUND ROUND BUYOUT
stage

Identify Experiment Launch first Penetrate Show Establish Operating Troubled

opportunitie to develop product; initial steady privately managemen company
s and product, develop markets; increase in held t acquires with plan for
develop engage marketing, show revenue; company business or turn around
business market sales and ability to achieve division
model distribution generate profitability
revenue

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Equity Division and

(Cap)italization tables

Stage Pre-money/Post-money valuation Distribution of equity ownership

Post-
Pre-money Investment Team Angel VC1 VC2
money
$ 250 K
Seed $1M $ 1.25 M 80% 20% - -
(angel)
Series A $4M $ 1 M (VC1) $5M 64% 16% 20% -

Series B $ 16 M $ 4 M (VC2) $ 20 M 51% 13% 16% 20%

Note: Pre- and post money valuations are directly linked to investors target return and view of potential exit values

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Equity Division and Cap tables

 Pre- vs. Post- money valuations
Pre-money valuation + investment amount = post-money valuation

𝑁𝑒𝑤 𝑖𝑛𝑣𝑒𝑠𝑡𝑜𝑟 𝑠 𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝 =

𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑖𝑛𝑣𝑒𝑠𝑡𝑜𝑟 𝑠 𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝 =

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Emerging Funding Models

Crowd funding
◦ Smaller funds that are not provided by angels or VCs
◦ Non monetary benefits like early use of the product or service
◦ Usually supports a cause – music, arts, etc.

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Emerging Funding Models

P2P lending
 Peer-to-peer lending brings individuals directly to people who need to
borrow money
 Several P2P platforms in India – LenDenClub, Faircent, Paisadukam etc.

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Emerging Funding Models

Accelerators
◦ Provides office space, proximity to other startup entrepreneurs, mentoring,
access to investors etc.
◦ At the end of a certain time duration, entrepreneurs pitch their ventures to
investors.
◦ Gives access to network of financers, other entrepreneurs.
◦ The new venture also has an option to associate itself with the accelerators
brand.
◦ Accelerators in India
◦ 500 Startups, Cisco Launchpad, Indian Angel Network

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Some advice on fund raising

 Pitch for your type
• If attempting to raise VC funding, establish tremendous upside potential of the
business opportunity.
• For banks, the pitch should focus on lower-risk and moderate returns of the
business opportunity.
 Understand that valuation is in the context of a financial negotiation
• There is no ‘true’ value of the venture
• The actual valuation depends on the bargaining power of the parties involved.
 Choose equity investors with care
• Look for investors who can add ‘non-financial value’
 Raise appropriate amounts of money at each stage.
• Raising too less money, the venture may not reach the next milestone.
• Raising too high money, the entrepreneur is at the risk of diluting equity.

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Some advice on fund raising

 Build feelings of desire and urgency in the investors
• Investors usually delay investments as they have multiple options to choose
from.
• One option is to create a media buzz about alternatives available.
• A safer route is to create a strong presentation to increase an investors desire.
 Start early and build relationships.
• Early interactions with investors can build confidence and foster personal
connections.

 Do your homework
• Investors are usually more experienced and have done many similar deals in the
past.
• It is always good to do a homework on investors past preferences, typical deal
conditions and experience of past entrepreneurs.

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Thank You………..

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