Category: Start-up

How much equity and when?

When you judge a promoter on his interest in the business in terms of equity contribution brought into the business, what would you consider more sensible?

A. bringing in equity capital in phases

All start-ups are prone to initial setbacks but some of them can recover if further capital is pumped in to the changed business model (pivot). If the promoter spends all his money in the first attempt/business model, he would never have money to implement the pivot.

B. Bringing in equity capital in one go right at the beginning

If the promoter has brought in all his money into the business right at the beginning, it shows his dedication and indicates that come what may, he will make his business work.

From an investor perspective:

  • How do you determine which level of capital brought in is enough to prove seriousness of the promoter in the business?
  • Would the amount of personal equity brought in, indicating dedication to the business, vary from industry to industry? (My sense is yes. Tell me if I am wrong)

How would the assessment vary between the first equity investor and the first debt “investor”?

Early stage investment in a start-up

A bunch of articles that talk about seed stage/pre-VC stage investments in startups. The debate is primarily between whether to do a convertible debt or to do a preferred equity. There are arguments both for and against each side.

The basic premise: convertible debt delays the conversation on valuation to the next round. It gives you the time to “set” the benchmark for your company’s valuation. Preferred equity is a simpler way of dealing with investments, if you are sure that your performances now gets you a fair valuation.

Brad Feld lays out the difference between convertible debt and preferred equity and points out that both routes have support. However, he does point out that if you do not intend to raise a big VC round next and hope to continue with small angel rounds, it is more sensible for you to do a preferred equity to be fair to your investors: http://www.feld.com/wp/archives/2006/02/whats-the-best-structure-for-a-pre-vc-investment.html

Josh Kopleman has a clear favourite in preferred equity because it aligns both the investor and entrepreneurs interest i.e. both with be interested in increasing the valuation of the company in the next round! However, he also says that a convertible note could be useful when you are already expecting a round of equity in a few weeks/months. He does give a few other reasons, read on… http://redeye.firstround.com/2006/04/bridge_loans_vs_1.html

Just in case you are suddenly confused about what Preferred stock is, here is a primer from the good old Investopedia to help you. Just go through the basics and come back for the remaining interesting stuff. http://www.investopedia.com/articles/stocks/06/preferredstock.asp#axzz1STNUO900

Seth Levine talks about the two options and clearly spells out the fact that though this seems to have a near term benefits for the startups he is not sure if it is sustainable in the long term. Great explanation of the context! http://www.sethlevine.com/wp/2010/08/has-convertible-debt-won-and-if-it-has-is-that-a-good-thing

Mark Suster clearly believes that convertible debt without cap is not here to stay for long. A nice write-up on how convertible debts came about and how the entrepreneurs should look at the option of convertible debt. http://www.bothsidesofthetable.com/2010/08/30/is-convertible-debt-preferable-to-equity/

Ok, the verdict is clear in the post title, Furqaan Nazeeri lists out reasons why he thinks convertible debt “sucks”. http://altgate.typepad.com/blog/2008/06/5-reasons-conve.html

Bill Payne explains the mechanics of convertible debt.  The graphs are missing but worth a read. http://www.matr.net/article-29148.html

A list of articles by Bill Payne on convertible debt and preferred stock. Great stuff in one place. http://billpayne.com/category/convertible-debt

Human Resource: Could be a complete drain on resources

One out of the three first employees that I recruited, turned out to be a rogue! He forged reimbursement bills, made issues about the work that he was supposed to do, tried to “poison” other team members. The fact that we are start-up, complicated things a bit more for us. I was ready to take his fussy attitude in my stride because these three people were amongst the first few in the entire history of their college to join a private sector job. Understandably, the change in attitude required would take some time. They were freshers.

Well, frankly speaking that reasoning is just a superficial reasoning. The real reason is that these youngsters have an academic qualification which is a basic legal requirement for our work and they were in short supply! The Govt seemed to offer jobs to all of them and let them have a job where pay was guaranteed but without any serious expectation of work!

It had taken us about 6 months to locate people, with the required academic qualification, who could be ready to join a non-Govt job! Once they did join, I was ready to treat them like kings. We had a great business model to operationalise and it was necessary that they  co-operate.

However, within no time I found out that this candidate was more than fussy. Much against the “rules” of a startup, I continued to “tolerate” this person for close to about a month. Incidentally, other than the difficulty of finding another replacement, the worry was that if he is chucked out, the academic institution will see my organisation as a  perfect example of the big bad private sector where people are chucked out at will and that would have killed the organisation because of the basic requirement of the academic qualification. Moreover, since our work was in the rural areas, students from one state could not be placed into another state due to language issues.

I started hoping that he leaves on his own. But when?

After a month of his being with us, he seemed to have been offered a job at another “private” organisation and at double the salary. It was a ridiculous amount. I somehow remebered those times when he was bothered about even the smallest of components in his salary. I had initially taken them as the widely held apprehensions in India about the “private” sector but later I realised that it is slightly more.

Anyhow, he decided to leave but not before claiming that a senior consultant, who was working with us, knew nothing. Moreover, he had rudely spoke to our HR person. Interestingly the consultant had had operational experience of 25 years including the top job at a semi-govt organisation and the HR person was possibly was one of the friendliest sort that I have ever seen.

The story does not end here because one of my worst fears became a reality 15 days later. More about that in the next post.

Learning: If your gut feel says that somebody is a bad guy, in all possibility he IS a bad guy.  Addendum to this learning in the next post.

The approach to the “marketplace” business model

Jason is back with another great post on market place business model. By marketplace, he refers to a platform which connects buyers and sellers who find it difficult to connect.

A few insights distilled from his post: (I must say that the full post is a MUST Read. This summary here, is not the best!)

  • The biggest problem for this kind of business is which side’s problem do you solve first? At the beginning, neither the seller or the buyer would come to you! Jason suggests, tackle the seller side first. Create the right proposition for the seller. It is easier to convince the seller to sell through you because it would anyways increase their sales. This would help you in creating an inventory, so that the buyer knows you have inventory and returns.
  • Do not automate right from the beginning. Wait for some time and find out the right things to automate. Or else, a lot of money might be wasted in automating something which may turn  out to be a wrong approach.
  • In order to get people to your site, SEO and google ads is passe, use a novel strategy like writing a useful guide or something that the chance visitor would bookmark/twitter/FB because it is genuinely useful. This would start getting eyeballs for your website!

Given the fact that my colleagues are fighting with a similar business model in different sectors. I am forced to wonder:

  • How would a platform that connects rural homestays to tourists start? What could be their “novel strategy” as mentioned by Jason? What could get more eyeballs to their website?
  • What would be novel strategy for the marketplace which connects buyers and rural artisans?
  • What would be the novel strategy for the marketplace solution which connects rural distributors of energy saving stoves with manufacturers of energy saving stoves?

No plan survives first touch with customers

  • The last word on startup success.
  • Why writing business plans is NOT done first. It is something different that needs to be developed first and that is – a business model.  A summary of the lessons learned is given below (copied from the original blog of Steve Blank HERE):
  • A startup is an organization formed to search for a repeatable and scalable business model.
  • There are no facts inside your building, so get outside and get some.
  • Draw and test the Business Model first, the Business Plan then follows.
  • Few if any investors read your business plan to see if they’re interested in your business
  • They’re a lot more interested in what you learned

Here is another article on the Financial Times (Read FT Article **). The article discusses the act of pivoting in a startup which refers to making minor changes in the original idea of a business rather than going for a completely new business altogether. It points out that though entrepreneurs start with an idea that looks perfect, it is the feedback from the customer that first triggers a pivot. The more successful you are in pivoting, better are the chances of your startup doing well. The article also discusses how along with many others Facebook and Twitter pivoted and then created history. I guess my previous article on Starbucks (Starbucked)also referred to the same without using the term pivot. I mentioned there that Starbucks didn’t start as a food service concept. Their idea was to sell coffee so that people could make it at home!

One interesting quote from Mark Suster in the FT article:

“Every entrepreneur starts with an idea that they believe makes sense. But then your customers start using your products, your competitors come out with new offerings and your partners decide to launch a similar product rather than working with you. You’re forced to pivot on a regular basis.”

For more from Mark, I suggest you follow his blog which is a must read for any entrepreneur. It talks more than just about pivoting!

** You will need to register for the FT article. Don’t worry, there is a free registration that allows you to see upto 10 articles a month. Trust me, it is a good idea to register free for that! Better still if you can go for a premium membership.