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5 Reasons Why Startups Raising A Smaller First Round Is Good For The Ecosystem

5 Reasons Why Startups Raising A Smaller First Round Is Good For The Ecosystem

Based on reviewing the business plans of thousands of startups, it is clear to me that a number of startups that struggle for months to close $446.2K (INR 3 Cr) – $892.4K (INR 6 Cr) angel/seed round could actually do with $74.3K (INR 50 Lakhs) –$149K (INR 1 Cr) to take their venture to the next level. And they can close the rounds much faster and get on with their business, rather than struggling for months to close a larger round (as many often do).

One of the reasons why the percentage of startups that get investors to actually write a cheque is so low is because they are not quite ready for the funding that they are seeking.

For investors to be comfortable investing upwards of $446.2K as a first cheque in a startup would need the startup to have some amount of organisational maturity and some early-evidence that the concept, market opportunity, value proposition, pricing, business model, marketing programme, sales programme, product/service delivery, etc. are tested and that the results appear to be encouraging.

However, most startups tend to seek this larger investment even when they are not yet fully ready with the evidence. Such startups will find it much easier and much faster to close a $74.3K (INR 50 Lakhs) round, which in most cases will be adequate to build a foundation that will allow them to raise a much larger next round.

Why Do Most Startups Seek Larger Round For First Round Investing

Perhaps because that’s the perceived ‘sweet spot’ of investors for seed/angel rounds.

And it is also true that we have fewer options for startups to raise $74.3K than we have for them to raise the larger amount. It is rare to see such a small deal in the Indian startup space. And we need to change that for a range of reasons that, in my view, are important to strengthen and expand the early-stage entrepreneurial ecosystem in India.

Often, startups hesitate to raise smaller rounds as they worry about valuation and dilution. However, instruments like convertible notes and other options like claw back can easily address this concern.

In my view, if startups start seeking $74.3K-$149K, the investor ecosystem will find ways to service these smaller deals.

5 Reasons Why Raising A Smaller Round Is Good For Startups And The Ecosystem

1. Startups will be able to close investment rounds faster.

2. Smaller deals will significantly expand the pool of angel investors as many, many more individuals who can write smaller cheques can also co-invest in curated startups that are raising smaller rounds.

3. The number of startups getting funded will increase manifold, and that will create a much larger pool of follow-on deals.

4. If the venture does not do well, it is much easier for investors to write off $74.3K in investment rather than the $446K investment. With a larger investment, even if the plans do not seem to be working well, the amount is large enough to try different options to save the investment. Since it is easier to write off a smaller investment, it will free up the entrepreneurs to explore other opportunities, rather than flog a concept that does not appear to be working as expected.

5. With smaller investments, exits with smaller sized M&A deals may be possible. It is harder to find buyers for an asset in which $892.4K has been invested and does not appear to be working well. However, if the quantum invested is lower, an acquisition that frees up the capital for investors may be a possibility, thus not just freeing up the entrepreneur but reducing the risks of investing in startups.

Smaller exits will also expand the M&A market significantly as many more corporates, including emerging companies, can consider small-ticket acquisitions.

Note: The views and opinions expressed are solely those of the author and does not necessarily reflect the views held by Inc42, its creators or employees. Inc42 is not responsible for the accuracy of any of the information supplied by guest bloggers.