The just-concluded Zomato Initial Public Offering (IPO) was subscribed 38.25 times. Founded in 2008, the food-delivery company became a household name over the years. The IPO was to raise Rs 9,375 crore. Unlike most companies that hit the IPO market, Zomato is yet to make profits. But that did not matter for the investors and they gave a huge thumbs up to the offer.
It was among the top 10 private internet companies to be listed, according to an October 2020 AllianceBernstein report. If investing in a start-up excites you, despite its weak financials, with the hope that the company would eventually make money by disrupting an existing market, then there are ways to do so. You could invest before these companies go public.
Bridging the gap between investors and startups
Angel investing platforms and alternative investment funds (AIFs), registered with market regulator SEBI, are the two broad paths to investing in startups. Your option depends on how much money you are willing to deploy and how early in the life-cycle of the company you would like to invest.
Angel networks work at a smaller scale, comparatively. They are essentially platforms where startups raise money from investors. “We do the match-making,” says Shanti Mohan, founder, LetsVenture, an angel investing networking platform. Mohan says that her platform has investors from 55 countries who are willing to fund startups. When a startup reaches out to LetsVenture to raise money, the platform examines the proposal, does a thorough background check of the founders and assesses the business viability. Then, the pitch calls start. Mohan says her platform does at least 10 pitch calls a week. Eager founders give detailed presentations to potential investors and try convincing them about their business idea. If investors like the idea, they commit the money.
For those who wish to invest in more established startups or rely on a fund manager to do the due diligence, AIFs are the way to go. Professional fund managers hunt for companies that look for capital to grow. But unlike mutual funds that invest in listed companies where all corporate information is in the public domain, startups are unlisted. Hence, SEBI has fixed the minimum investment in an AIF at Rs 1 crore. In addition to early stage startups, different AIFs can also invest in private equity (investing at a much later stage in the lifecycle of a startup when profitability may have been achieved already), small & medium enterprises debt, Real Estate, alternate equity strategies, and so on.
“High networth individuals (HNI) don’t want to get personally involved in vetting startups. They are not consistent investors in the start-up eco-system, but they don’t want to miss out on an opportunity, either. These investors prefer to invest in AIFs,” says Rohan Paranjpey, Executive Director – Alternative Investments at Waterfield Advisors, a multi-family office firm. Paranjpey, who earlier used to work at Blume Ventures- a firm that specialises in early venture investing- now advises Waterfield Advisors’ family office clients on start-up investing.
Angel investing networks, on the other hand, call for smaller investment amounts because they focus on very early-stage funding. Mohan says investors on her platform get to invest amounts starting at Rs 2-2.5 lakh. But a single startup ends up raising at least around Rs 3-5 crore in a single round, often from a consortium of investors.
Startups are fraught with risks
If Zomato’s IPO success sounds tempting to search for the next start-up, Mohan sounds the alarm bell. “You mustn’t invest in a start-up asking, when it is headed for the IPO. That may not happens for quite some time. Partly because for years, a start-up company would, typically, show loses before it shows an exponential growth,” she says. Private investors come for growth, says Mohan, while public investors invest for profitability.
Padmaja Ruparel, co-founder of Indian Angel Network, says that this is a high-risk, high-return investment. “Startups don’t have a history; they just have future projections. There is no data, no analyst reports unlike listed companies. There is an art and science to evaluate whether these companies would do well in future. It is critical for investors to invest in startups as this asset class provides a kicker to the portfolio. However, high return investments also brings high risk and the only way to lower the failure rate is to build a multipronged risk mitigation strategy,” says Ruparel. Kunal Bajaj, Head of Capital Markets, Blume Ventures says that bulk of returns from start-up investing comes from just a handful of companies. A majority of the companies in an investors’ portfolio are bound to middle-through or fail. “Don’t be surprised if you invest in just two companies, and both companies fail,” he says.
That is also why SEBI has mandated only qualified investors to invest in the relatively higher risk “angel funds” (very early stage) AIFs. Under the broad Venture Fund category AIFs can launch these specialized funds that invest in very early-stage companies. Only those individual investors who have net tangible assets of at least Rs 2 crores and have either hands-on experience with startups or senior level professional experience can invest in such “angel funds”. No such restrictions, however, exist in on-boarding various angel network platforms. SEBI-registered Angel AIFs come a minimum investment ticket size of Rs 25 lakh.
Should you invest in startups?
Munish Randev, founder and CEO, Cervin Family Office & Advisors says that if you are suddenly thinking of investing in startups, after seeing Zomato’s IPO rush, “then avoid investing due to fear-of-missing-out.” He says that IPOs such as that of Zomato’s are not usual; these are loss-making companies. The bets are on futuristic events. He says that if you are keen to invest in startups that are headed for IPOs, it’s best to opt for select pre-IPO AIFs. “Such funds invest in companies about to go for an IPO in the very near future; there is a near-certainty,” he adds.
To be sure, you don’t really need to wait for an IPO to sell your shares in a start-up. Angel network platforms and AIFs also advise that investors take their money off the table if they want to retain the profits. “Aside from bringing the start-up founders and investors closer, venture capital fund managers and angel investing platforms like us also mentor startups and work closely with them. This enables us to have a better understanding of the company and also give exit calls to our investors,” says Ruparel.
That doesn’t make start-up investing any less risky. Retail investors must stay away. Only those with deep pockets, high risk appetite must consider startup investing. This club, says Paranjpey, is a small world. “You need to consistently put money on the table to be able to see good proposals. You need to be an active investor. Just by sitting on the side-lines, you can’t be present in the circles,” he says.
That just raised the stakes.