The market conditions are always dynamic and any incident can have an impact on the said milestone. It might end up delaying the later tranches, which could further delay the growth of startups.
If you’re a startup owner looking to raise funds, you might have been asked to state your pre-investment valuation, right? But you need the capital, and you need it fast. So, how do you tackle the challenge – more so when your venture is in the idea stage or early-stages of its market journey? How can one come up with the valuation of an idea or an intellectual property?
Well, fret not. You have your options wide open. There is more than one method of raising funds in India. While you might know some of them, there are also quite a few investment instruments that you might or might not have heard of. Let’s discuss some of them.
Personal Circle (Equity): If you have an immediate capital requirement, one of the best paths to go forward is to raise it via your personal circle. These transactions are mostly in the form of issuing equity to the investor. Someone amongst your family and friends might be an investor already – albeit investing in conventional instruments such as stocks, FDs, or real estate. With the right pitch, you can convince them to either lend you some fund or come onboard as an investor with equity dilution. It can help you get quick access to capital with minimal and even no legal compliances.
However, there are certain disadvantages of this approach. Firstly, seasoned investors (Venture Capitalists) invest in businesses belonging to their core interests. This implies that they not only bring considerable experience onboard but also help you establish partnerships that scale your venture. They further empower you with insights that can go a long way in positioning your business. It might or might not hold in the case of funds raised from the personal circle, especially considering the startup-related dynamics.
Compulsory Convertible Debentures (CCD): In terms of formal investments, Compulsory Convertible Debentures, or CCD, are the instruments that come next. In essence, it’s a debt that has to be converted to shares by a specified period. It is a hybrid security that is a mix of both debt (loan) and equity. CCD generally is a medium-term investment instrument, wherein there are convertible debentures that get converted into equity after a predetermined time. For ventures, it means that they can pay their interests for a certain period and their principal amount during maturity without spending extra cash. Investors, on the other hand, consistently receive interest with the assurance of equity at a later stage. The disadvantage of accepting investment through a CCD is when anything goes wrong prior to conversion into equity. Since it is a debt on the books, it is a liability that needs to be repaid by the company or its founders to the investors.
Compulsorily Convertible Preference Shares (CCPS): Compulsorily Convertible Preference Shares, or CCPS, are the most common investment instrument at present. While it helps early-stage startups with the much-needed capital, they also equip investors with liquidity preference along with other consent rights. The investors also have preferential rights over the payment of dividends and the repayment of share capital if the venture goes into shambles. Though popular, this type of investment turns out to be quite disadvantageous for the startups too as it inclines more towards the investors and restricts the ability of the founders to operate freely and pivot into better revenue streams.
Term Sheets with Staggered Investments (via CCPS): It is a milestone-based investment, wherein the investments are made through CCPS and driven in tranches after a startup achieves certain goals. This approach ensures that the invested funds are not misused by startups and the performance remains the barometer of success. Achieving pre-agreed goals leads to efficiency for both startups and investors. However, the market conditions are always dynamic and any incident can have an impact on the said milestone. It might end up delaying the later tranches, which could further delay the growth of startups.
iSAFE (via CCPS): India Simple Agreement for Future Equity, popularly called iSAFE, is a founder-friendly convertible security note. Legally, as per company law, it takes the form of CCPS. iSAFE is a simple, easy-to-execute, 5-page document that founders can understand quickly. Such investment formats are becoming increasingly popular in India for early-stage startups. It is because while being easy in terms of compliance (for both founders and investors) with their template-driven agreement, they offer favorable terms to entrepreneurs.
iSAFE notes automatically convert into shares upon the completion of specific liquidity events. They address the challenge of valuation for early-stage startups and minimize execution time, documentation, as well as transaction costs during fundraising. iSAFE are of different types. Some include a future fixed equity stake, while others come with valuation caps and discounts. iSAFEs are ideal for early-stage (including seed and pre-seed stage) investments into startups.
These were some of the top investment instruments available to Indian startups, especially the ones in their early stages. Perhaps, the piece of insight might help you save a lot of time in your endeavor to create the next global unicorn. Godspeed!
Source: Business World