Doing Due Diligence on VCs

These days, there is a lot of good advice online – see examples here and here – on raising Venture Capital in the Indian context.

A lot of knowledgeable persons advice entrepreneurs to do due diligence on a VC firm before accepting their money. For instance, here’s US-based investor Bill Burnham on his blog:

One of the more unfair aspects of VC fundraising process is that VCs are allowed to take months probing every orifice of your company, but entrepreneurs are expected to make one of the most important decisions of their life in a week or two and often with little or no information. There’s no good reason for this and all entrepreneurs would be well served by taking some time to do some basic due diligence on any investor who has offered them a term sheet.

I suggest, at a minimum, talking to at least two entrepreneurs that the VC has funded and then talking through with the VC (about) A) all the deals they have done and what happened to them (and) B) the current status of their fund and partnership.

Doing your own due diligence has 4 main benefits
1) it may help you avoid making a bad decision
2) it will create the perception of a competitive process
3) it will make you appear more savvy and diligent to the VC
4) it can come in handy when you are trying to stall while you get your second term sheet.

But how does an entrepreneur go about locating a list of VCs who might be interested in investing in his/her sector and also learn the list of companies they might have already invested in? Thus far in India, there has been no single place entrepreneurs could turn to for researching VCs and their existing investments. Which is why Venture Intelligence has come out with The India Venture Capital Directory providing an exhaustive view of VC firms actively investing in India.

The Directory helps entrepreneurs get a clear understanding of the VC landscape by providing a brief profile of the VC Firms, their focus areas, names of key executives along with the contact details in an easy-to-use spreadsheet format. Also, it includes a list of investments by each VC firm – so that entrepreneurs can try and avoid conflicts-of-interest and select other entrepreneurs to reach out to for checking out the VCs.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the Private Equity and Venture Capital ecosystem in India. View sample issues of Venture Intelligence India newsletters and reports.

"Get competing term sheets"

So, you have managed to convince a VC to issue a term sheet? What next? Is it time to celebrate? Not according to VC-turned-hedge fund manager Bill Burnham, who has a post on "4 Things to Do After You Get Your First Term Sheet".

Here's item 1 (emphasis mine):

Get a second term sheet: It may sound flip, but this is the single most important thing you should do upon getting your 1st term sheet. Nothing loosens up a VC’s purse strings or makes them more flexible on a particular term than the threat of competition. Without competition (real or perceived) you have very little leverage against a VC. Now getting one term sheet, let alone two, is tough enough, but getting two must be your goal and you must not waiver in pursuit of that goal even after you get the 1st one.

The biggest problem most entrepreneurs have executing on this strategy is that they have mismanaged the sequencing of their fundraising. Many entrepreneurs make the mistake of pursuing an “in order” fundraising process whereby they take one meeting, run that process to its logical conclusion and if that doesn’t work out try to get a meeting with another VC. VC fundraising must be pursued concurrently! You must put as many irons in the fire in as short a time as possible so that all the firms start the process at roughly the same time.

As firms progress through the process, you should do your best to try and “herd” them along by trying to slow down the ones pushing ahead and speed up the ones lagging behind. The ultimate goal is to ensure that when you receive your first term sheet you have several other firms that are very close (within a week or so) to potentially issuing their own term sheets. Proper sequencing ensures that you are not forced to take an inferior “bird in hand”.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the private equity and venture capital ecosystem in India. View free samples of Venture Intelligence newsletters and reports.

THE BUSINESS PLAN – PART I - By Sanjay Anandaram

I’m writing this piece from Singapore where I’m on a teaching assignment of a course called Business Plan Workshop at the INSEAD business school. And given the last Indipreneur column, I thought it would be good to also talk in some detail in this and the next columns about one of the more important documents an entrepreneur will deal with (outside of dealing with investment documents and a last will!), namely, the business plan. A business plan gives birth to the start-up. It enables the entrepreneur and the team to envision and plan how the business will be run and how funds will be raised. The business plan addresses the needs of both the investors and the entrepreneurs because both have a similar objective – creating a successful business.

Writing a business plan is easy. Writing a clear, concise and fundable plan is not. Investors are not likely to be impressed by gimmicks or by flashy and flaky presentations. If they are, you probably don’t want such investors.

Clarity of thought, understanding of the market and its dynamics, building a competitive advantage are some of the elements that the plan should demonstrate. Usually, savvy investors don’t spend too much time looking at the financials of a startup as opposed to the team, business model and market environment.

So having said that, what’s a business plan to look like? Should it be the size of a dictionary or the size of a pamphlet? How should it be structured ? While there are no hard and fast rules, its usually a good idea to keep a business plan to a maximum of 20-25 pages in length. Number the pages, check spellings, and make sure the document is logically consistent. Investors don’t have the time to read a 100 page document to understand what you are trying to sell!

One good way to approach a business plan is to first develop a presentation in a maximum of 15 slides (including the cover and the “thank-you” slide), then the 3-4 page executive summary and finally the business plan. The presentation should have no more than 5 bullets per slide and use diagrams to explain key points. Remember, a picture is worth a thousand words. The executive summary is a like a candidate’s resume – you should want to meet the candidate after reading the resume.

Here are some guidelines for writing a business plan. As mentioned before there are no hard and fast rules, but following the guidelines below will force discipline and ensure focus. All of the following has to be condensed into a 20-25 page document in a clear and precise manner.

Section 1.0 Introduction
When was the company formed & by whom. Team backgrounds Where is the company based. What does the company uniquely offer.

Section 2.0 Market Opportunity
What is the opportunity/need/problems in the market? Who is experiencing the need? How big is the opportunity? How fast is the opportunity growing?

Section 3.0 Offering
What is being offered to address the need in the market? What are the different components of the offering?

Section 4.0 Competition
Why/How is the offering unique? How will it successfully compete against competition? Why will people buy/use the offering as opposed to competition?

Section 5.0 Market
Who are the customers of this offering? How will they use it? How is the market segmented? How large are these segments? What is the value of this offering to them?

Section 6.0 Business Model
How will the offering be delivered to customers? What does the delivery chain look like? What is the value proposition across the chain including to partners? How will the support process work? How will revenue and costs flow across the chain?

Section 7.0 Sales/Marketing Plan
What will be the company and offering positioning? How will be the positioning be achieved? How will customers be acquired – what will you do to acquire customers both direct and indirect? What are the alliances/partnerships that will be established? What are the different modules/components to be sold? What are the price points?

Section 8.0 Product/Service Development Plan
What are the timelines and technologies? What is the strategy for product development?

Section 9.0 Road Map
Over the next 24 months what will be the sales/marketing objectives? What will be the company objectives? Product development objectives? What is the exit strategy?

Section 10.0 Current Situation
What stage is the offering/company in now? Are any customers testing/using the product? How much money has been invested? How many employees are there? What are the milestones ahead? How much money is required? For what purposes will the company use the money? How many employees will be hired?

Section 11.0 Financials
How much money do you need? When, how and at what levels will you break-even? What’s the monthly outlook for the next 12-18 months? In all of these, the most important is the cash-flow statement!

Easy?

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.

Operating Plan or Business Plan? - By Sanjay Anandaram

Often times I meet entrepreneurs who submit a great looking business plan with all kinds of fancy colour pie-charts and trend lines. It is evident that a great deal of time and energy has been spent in creating the plan. The plan contains enormous amount of secondary data about the market, the performance of Indian and U.S. companies in the similar/allied space, their valuations and the like. But precious little in the business plan about the business that’s currently seeking funding!

On the other hand, I also meet entrepreneurs who submit a non-colour 10 page stapled-together document without any fancy pie-charts and trend lines. Even more of them simply send in a presentation which essentially talks in simple language of the following:
•What is the problem that is being solved and who is experiencing it
•How is the problem being currently solved and the problems with the current solutions
•How will the company deliver a strong competitive solution and why will it win
•How will the business make money?
•The people behind the venture

Of course, there is some data on the market. But the focus is on the business that’s seeking funding. The plan is meant to be a guiding light for the company. It is meant for the investors and the management. It is intended for employees and potential partners. It is not supposed to be a showcase for cut-and-paste marketing data.

The point here is that a plan is not an end in itself. A business plan captures, distills and details the knowledge, strategic and operational matters of the business. Each functional aspect of the company should be covered – sales, marketing, operations, development, human resources, finance. A clear articulation of the strategy and the tactics for each of the functional areas demonstrates clarity of thought and purpose. The plan is something the key management team signs off on and is used as a management and measurement tool. Else, various functions will tend to exhibit random Brownian motion i.e. will operate in a knee jerk manner, in fits and starts and with no real end goal in sight. And as we all know, the total displacement is zero in Brownian motion even while a lot of distance is traveled!

A plan is a guiding light. A plan is not something that is done once a year to develop a fancy report. And then forgotten. In fact, a plan is a very live document undergoing constant change and revision. In the early days of the startup, it is not unusual to find large gaps between the numbers in the plan and the actual performance. The reasons for the deviations need to be analysed and fedback to create a revised plan. It is a continuous process. For example, the pricing assumptions may undergo a change based on experience and market situations. So also, various cost assumptions. The business model may be refined. Revenue assumptions may need to be restated. Remember, we are talking of a startup here that’s struggling to find its place in the sun and carve out a unique position. It is losing money and has to find customers. Quickly. The strategic and the operational or tactical at times merge and the plan should reflect it. The plan should be a management tool. And should therefore be measurable. Abstractions and generic statements (“we will create value for our customers”) have no place in the plan. There should be details about how the service or product will be developed, priced, delivered, supported, financed. The resulting financials must be captured. Projections for the next few months must be made. Feedback from operations must be used to refine strategy, refine the medium term goals, and sharply focus on the immediate near term milestones. In short, the business plan and the operating plan should be the same!

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.

Startup Funding: The Luck Factor – By Sanjay Anandaram

We hear all the time about the amount of money that's available to fund startups. For example, that private equity funds invested over $ 3.3 billion in just the first 3 calendar months of the current year. That VCs are always looking out for good deals as most of the plans they see merit little or no attention. That they invest in about 5-10 a year out of the 500-1000 business plans they get. And so on…But the truth is that a majority of deals that get funded are those that come through a referral or because the VC knows (of) the entrepreneurs; its natural because VCs don’t have the time to look at all the plans that they get to pick out the Rediff, Naukri, or Tejas Networks. Deals that come through some trusted source or through a trusted filtering process are therefore valued higher and rise to the top of the pile of business plans. It is therefore easy to see how many plans don’t get funded. And also how competitive the race to secure funding really is.

Given this situation, what then makes a VC invest in an unknown company started by an unheralded first-time entrepreneur? Imagine this situation: A first time entrepreneur in say, Bengaluru with degrees from Tier 2 educational institutions, average work experience in a regular job in a reasonably well-known company, but with no experience in building a business, no references you know or care for, and with no experience in building products or delivering productized services, sends you an email describing his vision of the way software will be used in the future. Now ask yourself: Will you take that entrepreneur seriously? Will you invite the entrepreneur for discussions? Will you then fund the business to the tune of say, a couple of million dollars with no business plan? Answer honestly.

Sure, there is passion in the eyes of the entrepreneurs; sure, they have conviction and confidence; sure, they have researched the market and the business model; sure, they have a powerful business idea; sure, they know what they were talking about; But then so do many other entrepreneurs.

Is it the element of chance? Is it that elusive thing called luck? Is divine intervention? What would have happened to such a startup if the founder had not had a chance meeting with the VC in a conference? After all, it was only because the founder met the VC at the conference was he able to talk about his plan, a plan that made the VC resonate with his business idea, right? Surely that meeting was due to luck, right? Especially, when other VCs had rejected the idea?

Well, in our haste to qualify it as luck, we overlook the fact that the business idea and model had emerged out of research and market validation. Not from a pipe dream. We overlook the fact that the entrepreneurs at the startup were superbly prepared. And yes, they were in the right place at the right time. Luck is what happens when opportunity meets with preparation. Without preparation, opportunities cannot be recognized and capitalized upon. Without opportunities, preparations can go abegging. So the next time somebody ascribes something to luck or chance, ask them if they were adequately prepared to exploit the opportunity. It seems that “lucky” people constantly encounter such opportunities whereas unlucky people don’t.

A 10 year research project that led to the 2003 book The Luck Factor by psychologist Richard Wiseman has revealed that “lucky” people generate their own “good fortune” through four basic principles that every entrepreneur will do good to internalize:
i) They are skilled at creating and noticing chance opportunities
ii) Make “lucky” decisions by listening to their intuition
iii) Create self-fulfilling prophesies via positive expectations
iv) Adopt a resilient attitude that transforms “bad luck” into good

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.

TIE-Canaan Entrepreneurial Challenge 2008 opens for entries

Extracts from the Press Release:

Canaan Partners and TIE come together to launch the second edition of the TIE-Canaan Entrepreneurial Challenge

Canaan Partners and TIE, today announced the launch of the TIE-Canaan Entrepreneurial Challenge, a business plan competition open to early stage entrepreneurs from across the country.

Entrepreneurs from across India will have an opportunity to compete for business mentoring, access to early stage investors and recognition in the second edition of this unique business-plan contest.

To compete in the challenge, participants will need to download and submit their applications from http://www.tienewdelhi.org/canaan/. The deadline for submission of the business plan applications is May 12, 2008.

Eight teams will be shortlisted based on their potential scale of the business, the strength of the team and sustainable differentiation in the business model. These shortlisted applicants will be invited to participate in the final round in the month of June which will see them presenting their plans and ideas in detail to an eminent jury of the country’s leading entrepreneurs and corporate heads. At this stage the shortlisted participants will gain valuable inputs and be mentored on their plans by these jury members.

This year’s jury will include Pramod Bhasin (CEO & President, Genpact), Raman Roy (Chairman, Quatrro BPO Solutions), Saurabh Srivastava (President, TIE Delhi), Sanjeev Bikhchandani (co-founder and CEO of Naukri.com), Mahesh Murthy (Partner, Seedfund) and Alok Mittal (Managing Director, Canaan Partners India).

The Illusions of Entrepreneurship

Businessweek has an interview with Scott Shane, professor of entrepreneurial studies at Case Western University, and author of a newly published book with the above title.

At the individual level, the core fact here is the typical, median, right-smack-in-the-middle entrepreneur is a failure. The cost is everything associated with that. So if you start a business and the business dies, you could have been working for somebody else. You could have been making a salary. You could have had the stability—you wouldn't have had that kind of stress that comes from the up and down of running that business.

So there's the personal costs. From an individual level, the myth is that somehow if you manage to hit the average or hit the median, you're going to be fine. The reality is that the distribution is so skewed you have to hit the top for it to matter, and in fact, you have to hit the top 10% to have income as an entrepreneur better than what you would have gotten working for other people.

...It makes a lot of sense if people say, "You know what? I'm going to earn less money running my own business, but I really don't like to work for other people, and that's why I'm doing it. It's making me happier and I really don't care." I think that's great. The part of it that becomes a problem is when people just won't admit the reality that it may make them happy and they're doing it because they want to be independent, [but] then they delude themselves into believing that also it's financially better.

Arun Natarajan is the Founder & CEO of Venture Intelligence, the leading provider of information and networking services to the Private Equity and Venture Capital ecosystem in India. View sample issues of Venture Intelligence India newsletters and reports.

Do QCs on the VCs - by Sanjay Anandaram

India is an attractive venture capital (VC) destination today and the future will only get better. Many more VC funds will come in and entrepreneurs, at least the good ones, will be badgered by VCs for “lets-get-to-know-each-other-better” meetings. This capital availability and increased VC activity is good for the entire entrepreneurial ecosystem.

But, in all this hype and hysteria about round and about VC and entrepreneurship, something has been missed. Namely, that in as much as due diligence is performed by VCs on entrepreneurs prior to making an investment, a reciprocal arrangement needs to be in place for VCs. Wheat needs to be separated from the chaff, the genuine from the pretenders.

Classic VCs are partners in business, not purely opportunistic money makers. They see themselves as company builders, not just as investors. They don’t take short term stock market oriented investment decisions. They help build successful businesses, not spend time on financial engineering. In the early days of the Indian VC industry (that’s less than 20 years old!), most of the VCs had a lender’s mindset where risk minimization (zero risk?) took precedence over risk management. They found it hard to understand the startup situation used as they were used to more stable and less risky companies. The situation today has undergone a sea-change with the entry of Silicon Valley style VC funds. Therefore entrepreneurs will do good to keep the following in mind:

a) Don’t adopt a servile attitude towards VCs (perhaps a social ill that puts someone with the ability to invest on a higher pedestal?) or for that matter, anyone! Learn to also ask questions. Among other things, probe the backgrounds of the VCs, examine their track record of investments, talk to fellow entrepreneurs who have raised money from these VCs, understand their investment focus and approach, and what can be expected from them. The real quality of the VC is known during the singular moments of crises in a startup: Do they want to cut their losses and run? Or, are they willing to help redefine the business? Can they bring in additional resources (management, financial, technical) to boost the company? Can they help make the deals? Can they open doors? Can they help hire people?

b) Get to know the person who’s going to represent the VC firm on your company’s board. Even if a top notch VC firm is investing in your company, it is useful to know which individual from that firm will be dealing with your company. At the end of the day, it is this individual who will play a key role. Is this person experienced? Can this person really help your company? What is this person’s experience with companies in your stage and sector? Is the person a straight-shooter who will give feedback or someone who engages in back-room wheeling and dealing? Can you trust the individual to take speedy action or is he someone who’s bureaucratic?

VCs spend a lot of time and effort understanding the market opportunity of the startup, the backgrounds of the founders, the business model, and the likely paths the company could take post-funding. Entrepreneurs should also do the same with the VCs. After all, the entrepreneur and the VC must see eye-to-eye and there must be absolute congruence on objectives and philosophies. For example, timelines can be an important consideration. Is the VC willing to wait to realise value from the investment or is the VC in a tearing hurry to exit? Notwithstanding the fact that the nature of the business calls for a minimum of 4 years to build a successful company? A mis-match in time-lines that can therefore lead to unwanted complications.

Choosing the right partner is therefore as important to the entrepreneur as choosing the right entrepreneur is to the VC. After all, when you don’t even buy a washing machine without talking to a few people, shouldn’t you at least talk to a few people to check if your VC will take you to the cleaners?

Remember VCs need QCs (quality checks) too!

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.

The "Am I Good Enough?" Question - By Sanjay Anandaram

Recently, I was a panel member at a mentorship event. One of the presenters was the founder of a company whose business card simply read “Chief Architect”. On being asked who the CEO of this company was, he surprised all by saying, “I’m looking out for a CEO. I realise that I don’t have the ability to be the CEO and that I’m the bottleneck in the company.” Needless to say, this remarkable self-realisation and public articulation astounded all the panel members.

It is a tired cliche that the most important thing in a startup is the team. But, it has yet to be internalized by many founding teams (and in several cases by VCs!). So, what is the problem? Is it that the people don't "get it" or is it that they believe that they are indeed the best team? The team lives in a self-delusionary world, in a state of denial. This is very dangerous.

There's also a third angle to this. Many times the founding team realises that the existing team has gaping holes and there's a crying need to bring quality external talent on board. But this realisation does not lead to action. There's a intention-implementation gap, or a knowing-doing gap. While the abstract description and jargonization of the situation helps in putting a framework for analysis, the bitter truth is that in a startup, there is no time for such analysis. Where the CEO and the senior management fail to deliver the goals for the business, they need to step back and ask the reasons for their failure. They need to ask: "Am I good enough?" "Does the business need additional, different skills?"

Clearly, it is very hard for the founding team to accept and acknowledge that they are "just not good enough". In fact, it would be hard for any of us to do so. But to be confronted with a situation where the founding team's competence is questioned can be quite a draining experience; especially given there's so much emotion and passion involved. It is this emotion and passion that sometimes acts to the detriment of the company. The emotion and passion creates a kind of security blanket that masks the competence of the team members. Hard work, loyalty, and excitement start becoming substitutes for competence, analytical insights, and action.

So what does one do in a situation where one of the founders isn't performing and has to be let go?

It was a matter of friendship, of common aspirations at least once upon a time. The true test of the CEO and the leader is the ability to differentiate between self and company. And the CEO/leader has to ask: Is what I'm doing good for me or for the company? Will my company be better served by other more talented people? So, the ability to make that clear distinction between self and company is a critical first step.

After all, if the startup is the founding team's baby, the "parents" have to do what is good for the baby not what is good for the "parent". The baby has to be trained by qualified teachers in various disciplines, be punished and rewarded by the teachers. The parent feels proud when the baby grows up to be a high achiever and a top performer. The parent has a role to play not all the roles. There are other people who have significant influence and impact on the baby as well - teachers for example.

There are situations where the CEO is totally insecure and insists on hiring people who are of lesser mettle. The CEO is concerned that he/she will lose the position of authority. This kind of CEO soon becomes the bottleneck in the company and very quickly drives the startup to the ground; or ensures its survival only as a corner-grocery-store equivalent. The VC has no business funding such a CEO. This kind of a CEO cannot attract talent; will be obstinate; will insist on things being done his way. In short, this kind of a CEO is better off by himself. This kind of a CEO is not a team player. And that can mean death in the business!

You may be a superstar but only if the team supports you. You cannot shoot goals or score runs if the team does not support you. You have to play in the larger interests of the team. Think football, cricket, hockey, basketball. On the other hand, if you believe that it’s better to be an individual star, then don't play team sports - golf, tennis, chess are games for you.

Unfortunately startups are like team sports. So, what kind of player are you?

What do you think?

Sanjay Anandaram is a passionate advocate of entrepreneurship in India; He brings close to two decades of experience as an entrepreneur, corporate executive, venture investor, faculty member, advisor and mentor. He’s involved with Nasscom, TiE, IIM-Bangalore, and INSEAD business school in driving entrepreneurship. He can be reached at sanjay@jumpstartup.net. The views expressed here are his own.