Coronavirus pandemic | In survival mode, startups agree to tougher terms for funds

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The coronavirus pandemic is making it difficult for some startups to raise funds, forcing them to agree to tougher terms as investors get cautious and seek a greater say in an uncertain economic climate, source have told Moneycontrol.

Startups and venture capitalists (VCs) always drive a hard bargain but some founders, who desperately need money to survive the lockdown, are giving away rights to investors they otherwise would not.

"While founders have become more aware and aggressive about their rights over the years, COVID is making them negotiate less because the money is more important than the terms and valuation it comes with--it is to ensure survival,” said Roma Priya, founder of Burgeon Law, a startup focused law firm. COVID-19 is the respiratory illness caused by the coronavirus.

For early to growth-stage deals, valuations have fallen 20-30 percent. Some founders are not being too stringent about voting rights, transfer of shares and sharing information with investors, sources said.

In one case, a top VC fund asked a startup for 1.5x liquidation preference against 1x, which is generally the norm. This means if the company were to shut down, the investor will be entitled to 1.5x of the amount invested.

Another clause that founders insist on is that investors will not sell their shares to a competing company at least for five years without explicit consent. However, the founder of an online brand waived off the right to raise a Series A round from a well-heeled VC, sources said.

Similarly, when three big investors were joining a startup’s Series B round, the founder wanted the majority consent voting rights. It basically meant that if the board proposed a motion and the majority of investors agreed, the motion would be passed. But the investors asked for individual rights, so the consent of each one of them is now a must for a proposal to go through. It almost amounts to giving each investor a veto.

Such terms are not the norm but during the lockdown, capital is coming with strings attached.

In most of these cases, the founders did not have the luxury to drive a hard bargain, as both time and money are of the essence, sources said.

Founders asking for more rights has been a feature of the technology ecosystem in India as well as overseas. High-profile founders such as Uber’s Travis Kalanick and WeWork’s Adam Neumann have been ousted from their companies and investors have often seized control.

Closer home, Sachin and Binny Bansal’s exit from Flipkart, the company they founded, and the boardroom battles at Snapdeal also made founders more careful about the rights and ownership they give away.

However, many of these conflicts were restricted to large firms--India’s unicorns. For instance, Ola’s Bhavish Aggarwal refused a further billion dollars from its largest backer- Japan’s SoftBank Group because he did not want to cede control.

In 2019, Oyo’s Ritesh Agarwal changed the hospitality firm’s articles of association to ensure that SoftBank couldn’t increase its stake beyond 49 percent without his approval and that of his backers Sequoia Capital and Lightspeed Venture Partners.

Even in the current situation, only some founders, generally young, inexperienced and in need of capital, are ceding more control.

"Early-stage deals generally tend to sway in favour of investors. However, only founders who have lesser runway and have to raise money right now are raising on stressed terms. Second-time founders, experienced folks or founders who have a runway for the next 12 months will still manage to get funding on fair terms,” said Priya of Burgeon Law.

The terms of engagement also depend heavily on the business. Prospects for sectors like healthcare, online gaming and online education have improved significantly because of the lockdown and the pandemic.

A gaming firm, which in April raised money from a large VC, refused to grant any non-standard terms to investors. “They negotiated as if it is a booming economy, and parties on both sides discussed for weeks until the investor conceded, a bit unusual for early-stage deals in this time,” said a person aware of the matter, requesting anonymity.