Should a startup pay equity to advisers?

A colorfully worded post by Blossom Street Ventures found it’s way to my Inbox earlier today. The author explains his rationale for not giving equity to advisers.

I think he oversimplifies the point a bit. Not all advisers are created equal. In many cases they come on to the Board as advisers as a result of a funding event – and as a result they are ‘free’ anyways – since term sheets often mandate that the VC brings in one of it’s members on the Board.’

I agree that bringing on advisers just for namedropping is a bit “VC 1.0” – it has happened so often that most people can see through it. Rarely, if at all, does it influence a customer, funding, or strategic decision. Many advisers tend to be passive and often enough, try to leverage past reputation to negotiate equity in startups. Founders should definitely avoid such situations.

I’ve seen situations where advisers tend to complement founder strengths and truly earn their keep.  For example, adding deep technical expertise – designing next gen product architectures to founders that are ‘MBA-heavy’ and not having the funding to hire a full-time CTO. In such situations it is definitely worthwhile to offer equity as an inexpensive way to attract and retain talent. I say inexpensive because there is no explicit cost and there is a payout only when an exit occurs – at which point the pie typically grows big enough for everyone to be satisfied with the outcome – at least happy enough not to fret about paying equity to advisers.

Finally, another area where startups err is accelerating the vesting for advisers. Theory being that these are senior hires and as such, should be treated like C-level executives whereby a good portion of the equity vests at an accelerated schedule if ‘things don’t work out’ and the adviser leaves for any reason. Advisers should be offered similar vesting schedules as key employees as a way to align their time, motivation and efforts with that of the company they are advising.

 

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The Flipkart saga continues

Rumor has it, that Flipkart is in the midst of yet another large ($1.5 billion) round of funding from eBay and Tencent – at a valuation of $10-$12 billion.

$12 billion, impressive as it may sounds, is still a discount to the latest round of $15 billion – which qualifies it as a ‘down round’. A down round usually implies that for previous investors, ratchets trigger in – in other words they get additional shares as compensation for the fact that the value of their investment has fallen. All in all, seems like a good new chunk of shares getting issues and a whole lot of dilution taking place.

What is interesting is that strategic investors – in other words not only financial institutions – but corporations that have deep synergies with Flipkart’s strategy are jumping into the fray. What that typically does (as opposed to pure VC investments) is that core operations of Flipkart – like product roadmap – might get influenced by these strategic investors. Who knows – this could even be a prelude to a much -awaited big bang M&A transaction that I’m sure a lot of their investors have been waiting for.

Remember Flipkart has a new CEO – an ex-eBay exec that was hired (at the behest of Flipkart’s lead investors, Tiger Global) to shore up the functioning of the faltering e-Commerce giant.  Seems apparent now, that getting a sizeable infusion of cash from eBay was probably one of his key early mandates. Let’s see what pans out next

 

 

 

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Kudos VcCircle

VcCircle (a NewsCorp company) held its annual LP Summit at the epicurean-styled Taj Lands End in Mumbai earlier this week.  Have to admit, this was truly a wonderful event – the best I’ve attended in my 9-odd months in India.

The participants came in from all part of the India PE ecosystems – LPs, GPs, lawyers, CAs, CFAs, Consultant, Bankers etc. What impressed me most was the quality of the panelists and the compelling discussion topics – ranging from LP-GP relationships to Exit options to Advice for debutant fund managers.

What was also striking was the generally sanguine tone of people I met when it came to articulating their forecast for the PE industry in India. The mood was definitely positive – largely driven up by an uptick in the M&A environment, an increase in the number of secondary transactions (both at a portfolio and company level), a significant increase in the amount of Corporate Venture Capital flowing into the country, and the advent of new exchanges like NSEITP that make it astonishingly easy even for a 1-year old SME to list on a public exchange. (Yes! just 1 year of audited finances). Further, a  lot of strategic investors, especially from outside of India are partaking in acquisitions of B2B (specifically profitable B2B SaaS companies) companies and thereby greatly improving the investment climate.  There was also general consensus that in 5 odd years institutions like PFRDA, LIC, DFID and more would be active LPS into technology funds and ushering in a new era in India’s VC ecosystem.

 

 

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Products over Services, but with a caveat

TechinAsia recently articulated reasons why India should focus more on products versus Services.  The article went on to bemoan some factors that prevent the full growth of product companies in India.

The article, and a lot of the chatter I hear, is a wee bit short-sighted. After all Software exports form a decent chunk of our economy and serve as a good job creation engine. Software Services brought India to the world IT pantheon. So, its importance should not be underestimated.

The growth of a product ecosystem is most relevant and important for the VC and angel ecosystem in India. And that is probably what the drift of the article was in the first place. It is no secret that product companies get funded more often on account of the favorable economics of their business models and typically more exit options. Product companies, at least good product companies, are rightly perceived to have “inherent value” – that is significant value in the product and the embedded IP.

Services firms often are not perceived as being “fundable” because a good chunk of their business is turnkey in nature and does not lend itself to favorable economics or IP-building activity. Also, exits are less frequent – Services companies typically acquire, or get acquired, to facilitate geographical expansion or entry into new verticals (eg Government, Manufacturing etc).

Product companies can also expand pretty seamlessly to geographies outside of their home country without necessarily encountering politically-charged issues like work visas and H-1 Bs. Since these companies can market, sell and disseminate their products through Web-based interfaces, they can easily accrue revenues without incremental people hiring. And that simply adds to the allure!

 

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Budgetary impact on startup ecosystem

The much-awaited annual budgetary was delivered earlier today in the Indian parliament. An initial read – based on the immediate reactions by experts and the impact on the Stock market – is that it is positive, balances the aspirations of most Indians, is pragmatic and yet bold.

The impact on the startup ecosystem is both direct and indirect and for the most part is positive.

First the indirect impact. I broadly club these impacts as those impact India’s macros. That is the attractiveness of important fiscal parameters to rating agencies (Moodys’ etc), foreign investors etc.  Here the read is that the budget has done a “A-” job. Th government has done well to keep the fiscal deficit in check (pretty remarkable given the temptation to go populist when crucial states are going to elections) by these measures:

  • Widening the tax next by improving transparency,
  • Consolidating spending in PSUs and accelerating their progress towards public listings
  • Increasing the ‘sin tax’ on cigarettes, pan etc,
  • Tightening the laws on absconders/black money/election funding etc

Now to the direct benefits – here the reaction has been somewhat mixed. The government has given in, partially to some of the startup demands on MAT, taxes – lowering the rate on income tax by 5%, increase the period that qualified startups enjoy tax breaks, and carry forward of losses. Also, some sops given to universal broadband and other infra announcements eventually do benefit startups too.

To me, and this is in a philosophical vein, the Budgetary speech stands out for one startlingly honest admission — that India has and continues to be a nation of tax evaders. And that steps need to be taken to address this in a very serious way.

Kudos to Mr Jaitley, but looking forward to more steps to boost the Indian startup ecosystems in the months and years ahead

* Update * — Some more details streaming in. And it’s some more good news for the PE/startup ecosystem:

  • Clarification on capital gains for CCPS that get converted to common stock: Clarity has been provided to confirm that the ‘start date’ for calculation of capital gains is the date on which convertible shares were bought, not on the date they were converted.
  • Clarification on capital gains for LP’s  when selling their stake in funds that invest in India to other LPs or entities.
  • Finally, there was confusion over whether the event of converting preference to common shares would be taxed or not. This has been removed. No taxation.

 

 

 

 

 

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AISI Summit 2017

Had the pleasure of attending the 4th Alternative Investment Summit India in Mumbai earlier this week. Thanks to IAAIF, AIWMI, Unifi Capital and all the wonderful people that made this event possible.

As a relative newbie to the Indian PE ecosystem, I had a chance to learn about how the different enablers are shaping up. To start with – India’s pension system and it’s role in the PE industry. The India pension system with assets of roughly 165,000 crores is still fairly small percent of the GDP – as  compared to places like the US where it’s a multiple of the GDP! The pension system has grown significantly in size after legislation in the early 2000s changed the structure from defined benefit to defined contribution. These pension assets are slowly finding their way into PE funds – for a start, predictably into relatively conservative funds that deals with REITs and Mortgage-backed securities. All in all, a slow start, but a start nonetheless, for a pension system in a country where the informal sector employs more than 80% of the workforce.

There was a panel of VCs from Blume Ventures, Peepul capital and TA Associates.  Blume is fairly well-known in the angel ecosystem as they are often the first institutional investor in companies at the Pre-Series A stage. Peepul and IA associates are classical late-stage, ‘growth’ capital often buying controlling stakes in companies with ticket sizes in excess of $20m. Both these companies are becoming more active in India – a good sign for promoters of mature companies that need to cash out without necessarily going through the rigors of an IPO.

 

 

 

 

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VC versus PE

Back to a definitions or shall we say conventions…I’m writing this one because I see and hear these terms – VC, PE, LBO, used interchangeably – mostly with some confusion.

The term ‘PE’ – a short form of Private Equity has historically been used to refer to three types of investment thesis: Venture Capital (VC), Leveraged Buyouts (LBOs) and Mezzanine or Bridge financing. To explain a bit further:

VC – is what we hear a lot about – Series A/B/C rounds and even Pre-Series A rounds. The only irony to this is somehow angel investing – even though it is about investing in private companies – is somehow never included under the ambit of Private Equity.

LBO –  These refer to large, often “take-private” transactions like Veritas, Dell and SolarWinds. There are differing takes on why these transactions take place in the first place – but most experts opine that these happen to enable firms to make substantive changes to their business strategy – something that cannot happen within the strict quarterly scrutiny of Wall Street Analysts.

Mezzanine/Bridge financing – Again, the term is a bit historical, but these deals are essentially bridge financing deals to enable a company to go public.

PE – which has been historically referred to as the combination of VC, LBO and Mezzanine financing – has in recent times taken a new meaning to allude to “larger deals” and “majority stakes”. Essentially the world is split into 2: Relative small-minority stake- VC deals and Relatively large-majority stake-PE deals.  And, bridge financing towards IPO is not happening anymore..instead bridge is now being used (as I alluded to in a previous post) to refer to Pre-Series A deals that take startups from Angel-funded to Series A.

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