SUMMARY
India has now become the focal point for many investors keen to support startups providing innovative propositions. However, the investment process has now become selective.
While investors want to help the ventures scale up further, they also want the relationship to be mutually beneficial. This is why VCs must be vocal about their rights in the startups they invest in
Here are five terms that investors care about and should focus on while they are involved in funding negotiations with startups
We are in the golden era of entrepreneurship, with the Indian startup ecosystem thriving and many ventures even going global. Currently, India is known to have the third-largest startup market, which is also one of the fastest-growing industries.
In the wake of this growth, the venture capitalist community is also actively supporting these emerging businesses. In fact, from 2015 till date, there has been a 15X increase in the total funding of startups.
India has now become the focal point for many investors keen to support companies providing innovative propositions. However, the investment process has now become selective. Investors want to help the ventures scale up further. However simultaneously, they want the relationship to be mutually beneficial.
This is why venture capitalists must be vocal about their rights in the company when they invest in startups. Having said this, here are five terms that investors care about and should focus on while they are involved in funding negotiations with startups.
Information Rights
The first and foremost requirement of any investor with the startup they are investing in is that the company should provide them with relevant information about its performance. It should also be able to share its future projections until the investor will hold the last share in the company.
This is critical as this information guides investors on how the company is doing, its reputation in the market when they should plan to sell their shares, and more.
Tag Along
Investors, especially early-stage, should exercise this right as it provides them with the power to tag along if the founder exits or sells the company. They invest not only in the disruptive concept but majorly, at an early stage, in the team, the founders’ expertise, their execution ability, leadership skills, etc.
Hence, if the founders decide to sell their shares and move on, then the basic premise of investing in the company gets diluted. With the core team going for an overhaul and the new management stepping in, the investors may not have the same view as them or be able to form strong connections with them. Consequently, early-stage investors would not like to remain associated with the company. Hence, this right provides them with an option to exit with the founders.
Liquidation Preferences
Liquidation is triggered when the business is not doing well, and the company sells its assets and distributes them to shareholders. When investors provide capital to the company, they believe in its people, product, and future growth. Hence, they would prefer to have at least their capital back before any sale proceeds are distributed to other shareholders.
Protecting the invested amount is a fair demand and one of the crucial rights for a venture capitalist. In an ideal case scenario, a liquidation preference order is generally negotiated, at the time of investment.
Board Seat & Voting Rights
While supporting the venture financially, investors would like to be involved in critical and strategic decisions. Companies raise money on a strategic and operational business plan. Investors need to ensure and feel comfortable that the company is broadly adhering to the agreed plan and that the investment is efficiently used.
Hence, investors would also for certain affirmative rights like specific voting rights for issues like any change in business, availing a large amount of debt, hiring of CXOs, fundraise, etc.
Right Of First Refusal
Investors would like to have the right to invest more when the company raises its next round of funding. It allows them to double down on well-performing companies, maintain their percentage holding (sometimes called ‘pay to play’), and retain some important rights.
For companies, investors doubling down in future rounds is a great endorsement and provides confidence to incoming investors. This also provides early-stage investors to invest in winners of their portfolio and partake in the growth journey of their investee company.
To Sum Up
Considering the investors’ standpoint, these key investment terms are fair asks. Ensuring the ‘investor-founder fit’ is essential so that founders know the rights investors seek and can only align but leverage them. This will allow founders to build not only a well-governed company but also leverage the experience, networks and different thinking that investors can bring.
