Finding it difficult to get investment? 2 reasons.

Lets face it, procuring investment for your startup isn’t as easy as it seems given the hundreds of millions which seem to be getting invested by institutional investors, and millions by angels. Many startups wind up because they never manage to get to series A, though the startup idea might seem darned good. So what happens in those cases?

Investing for growthSurely there are many reasons why many startups do not receive funding in-spite of doing something interesting. In this post, I will talk about just two which are directly related to the investor.

As there are many types of bright ideas, many types of startups, there also are many types of investors. I am not referring to the basic categorization of angels, business angels, VCs, PEs etc. I am referring to what type of areas motivate this particular investor you are interested in. What do they like investing in? Do they invest in e-commerce retail, education, social, logistics, finance etc or something else? Get the picture? So, as you look to pitch to an investor, are they even interested in your area and do they even understand it?

Here is an anecdote. I founded, ran and successfully exited a niche e-commerce retail startup. During the process I did a pitch to a VC (founded by a celebrity in the startup circles) in Bangalore. It was a horrible meeting. The partner I met neither understood retail, nor did she understand the space that we were in. She just argued uselessly from an arrogant position of strength. At one point, I stopped the meeting and walked away. What I should have done to avoid the pain is done a little more research. Not just about the company, but also about this person that I was about to pitch to. So, the key statement is:

Know your potential investor

The second is how the arithmetic really works in the background. Assume, you have picked the right type of VC for your series A, in the right space too. They like your product or service. No human chemistry problem either. What might have sabotaged your cause is the returns that you are showing / proposing. So, what is happening in the background? The VCs have received funding from a collective or another much larger fund. This is the money they will disburse among startups by way of investment. The VCs in turn need to promise a minimum level of returns to their investors.

Here is how the math works.

  1. Assume the VC gets a $1000 for a fund life of 10 years. The investor asks for a 20% IRR, implying about $239 a year, and if the VC on a is what the VC needs to deliver on and generate a total of $6192 in all. That is ~6.1X.
  2. In reality the VC will not find all appropriate startups right in the beginning, nor will they want to remain invested for 10 years. Lets us consider the average number of years that the VC remains with a startup to be five years. So, the returns will actually be a $2488, which is ~2.5X. But, what the VC needs to generate is actually 6.1X. So, the funded company needs to generate the 6.1X (of 10 years) in five. So, you already have a 15.25 multiplier.
  3. To spread their risk, a VC would always invest in multiple sectors and spread their investments among a portfolio of startups. Now, market data says that about 50% of funded startups fail. This implies that they will lose $500 of the invested money and now need to recover their money from half the startups that they funded. Say they invested in 10 startups, but now they need to calculate such that they can recover the money from even five of those startups and also generate the return that the VC’s investor asked for. So the $500 now needs to generate the $2488, which is ~30.5X.
  4. And the 30.5X is just the return for money invested into the VC. The VC will want to make some money as well, and take the multiplier to well over 30.5X in reality. Of course the returns do not necessarily need to come back as cash after the five-year period. It also could be an exit, or increase in valuation.

Of course, at an early stage it really is a punt to figure whether the company invested in will generate 30 times the investment or not. Once this basic numbers and perception hurdles are cleared, then the VCs will start looking at addressable market size, scalability, profit potential, competition (and competitor track record ).

 

The second important factor thus is:

Your startup’s perceived ability to generate returns

Make sense?

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