April 9, 2011

Vouching for venture capital

Posted in Uncategorized at 7:25 pm by chait83

These are the snippets that I collected from the session organized by NeN on business plan writing, conducted by Mahesh Murthy.

Mahesh Murthy is an accomplished businessman and a VC. His company Seedfund is ranked as the best VC fund in India.

A VC typically has close to 60 secs for any business plan to scan around, based on the flood of business plan they receive each day. In that time a VC has to take a decision to throw the plan or try digging more into it. So how do you compel a VC to do that?

Here is some insight from a investor’s point of view.

A VC is similar to mutual fund business, where money is pooled form people and invested into startups in for some share in the startup. Unlike mutual funds, a VC firm cannot sell it’s shares in an open stock market.

So then how

  1. Does a VC firm book profit.
  2. How is it different from a mutual funds.

Typically a VC firm would return 25% IRR, which is way higher than mutual funds. It’s a high risk high gains fundamental.

Lets assume that a VC firm invests 10 crores in 10 different companies. Generally a VC firm would expect this at the end of 5 years.

3 venture would die
3 would be break even, but there is no exit visible for the investment.
2 will give 5 crores on exit
2 will give 10 – 15 crores on exit.

So ideally an investment of 10 crores, the VC firm has made 30 crores of profit.

Now coming back to original question, is your company worth returning 10x returns on investment at the end of 5 years. VCs have to think with that conviction for every company. A 10x return on the investment is achieved only if the company is no. 1 player in the segment, no. 2 position is far fetched. So do you have in you what it take to be no. 1 in your segment?

Now on to the exit strategy. How does the VC firm book it’s profit.

A VC firm would never want a pie out of your company’s profit. They book profit only when they sell their share to someone and exit from your company.

  1. Management buy back: Typically when the management has 70-80 % share of the company why would it buy more. Deal is uninterestin for the management and a tough bargain for the VC.
  2. Merger or Acquisition : Best option for the VC to exit from the company
  3. Public issue: Very unlikely, a startup making headways into the stock market. None the less this is a viable option. Typically a IT company would have to have valuation of 50 crores, a manufacturing company should have valuation of 200 crores, etc

Now another important question for the VC can you survive with the money that they handover you and thrive thereafter.

Let’s summarise what a VC looks into your business plan.

  1. 60 secs pitch that should arouse interest. So business plan has to be concise and not an encyclopedia  of what your business is all about.
  2. Before getting into the deal, does the investor have a profitable exit door after 5 years.
  3. Can you survive with the money given by the investor to you.
  4. Can you thrive to be no. 1 in your market segment.

For an investor all you need to give is a spreadsheet with shows when the break even point occurs and what happens at the end of 5 year.

So just grab an excel sheet and start filling the numbers. Doesn’t matter if they are right or wrong. Start planning, get it vetted from peers, successful businessmen, investors.

As Mahesh Murthy has put it, business plan is a model not the real thing. In reality no business runs the way it was planned for. The business plan is a blur reflection of your ideas for the investors to which they can relate to.
Some number nuggets:

  1. Typically a VC firm would be looking forward for investment in the range of 2-5 crores, with a share of 20-30 %.
  2. For that share of your company should be close to 50 – 200 crores at the end of 5 years, for the VC to rake in their 10x profit.
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2 Comments »

  1. Ashish Sapkal said,

    Excellent article and good information. What is Venture Capitalist? Is he someone who has a company which deals in high volume of shares and focuses to make profit out of that?

  2. chait83 said,

    VC is a firm which specializes in investing early stage startups. The prominent difference is that invest in pvt ltd companies, while a mutual fund or insurance company would invest only in Public listed companies.

    So a mutual fund can buy and sell shares anytime of the year, a VC firm has to wait for 3-5 years for the company to be a formidable player and then sell off it’s share to company who is willing for merger or acquisition.

    Some share of the profit is retained by the VC firm and rest of it goes to the investors who invested their money with the VC firm.


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