Speaker: Padmaja Ruparel – Co-founder of Indian Angel Network (IAN), Founding Partner of IAN Fund and Co-chair of Global Business Angel Network (GBAN)
Moderator: Deepak Mundra, CFA – Valuation Services Manager at KP Synergies
Contributed by: Srividhya Venkatesan, CFA
India is at the forefront of the start-up boom, with homegrown brands like Flipkart, Byju’s, Paytm, Ola, etc. competing head-on with their global counterparts. One of the most crucial factors that have helped the start-ups succeed is the backing of investors at the right time –especially the Angel Investors.
This fascinating ecosystem of Angel Investing was covered in a very engaging webinar by Padmaja, who has been at the forefront of the entire start-up ecosystem evolution in India through Indian Angel Network(IAN). In this webinar, she covered the three critical aspects of Angel Investing – the Why, Who, and How.
Evolution of start-ups and their impact
Innovation could be the real engine for creating employment and economic growth in a country. Start-ups challenge the existing setup with innovations, fill in the market gaps, solve customer’s main pain points and create jobs.Furthermore, these start-ups deliver this value rather quickly, with lower capital and in lesser time.
Often when established corporations find innovation and R&D expensive, niche start-ups exhibit better capital efficiency with sharper minds with innovative technologies, with a speed which is unimaginable at large organizations due to bureaucracy. A case in point being,multiple start-ups that are working today on developing in-need solutions like manufacturing economic ventilators for tackling the current pandemic. These start-ups by young entrepreneurs are challenging the established large players and catering to the new challenges of this new world.
India: The booming start-up ecosystem
India is one of the fastest-growing start-up nation. From about 1,000 start-ups in 2004, the count grew to around 7,000 in 2008 and from there to approximately 50,000 by 2019.Some of these start-ups have managed to establish a niche place in their segment and command a billion-dollar valuation.A total of approximately $39 billion in funding has been injected by investors in the Indian start-up ecosystem since 2014.
Besides India, innovation is most prevalent in countries like Luxembourg, Chile, and the US. India is estimated to have around 125 unicorns by 2025 (pre-Covid19 estimate).
So, what makes India one of the fastest-growing start-up hubs in the world?
- Young country with a median age of 31 for founders (vis-à-vis the late 30s in the US and 40s in Europe)
- Diverse and large population with varied customer preferences (creating demand for a variety of products and services)
- Different price points
- Growing talent base of knowledge workers
- Opening up of new sectors, demanding innovations like electric vehicles, clean-tech, consumer IoT, biotech to name a few
For these start-ups, success is synergistically linked to capital availability.With initial funding from family-friends and own savings; start-ups look for financial capital for their survival and growth. And that’s where the Angel Investors step in.
Why do start-ups need Angel Investing?
Angel Investing is the financial kick-start that most start-ups need to begin production or fund their marketing strategy. With limited operational history, they often find it difficult to get traditional bank lending.
With only a prototype ready or limited revenue, Angel Investment is their only viable source of funding. Angel Investors bet their money on the entrepreneur, market size, and the viability of the product while making an investment call.
Angel Investors also provide critical hand-holding, strategic inputs, operational guidance, team mentoring,and global network access that is extremely useful for the start-ups in their initial stages of growth.
Who does Angel Investing?
Angel Investment is an investment in start-ups by strangers, who are betting on the investment proposition and the founder(s)
- They are very similar to venture capital investment, but typically come in at seed stage
- Its typically an equity investment done with a significant minority stake
- It’s a high risk – high return investment
- Investors look for capital gains and not dividend returns, with a typical Internal Rate of Return (“IRR”) expectation of around 30-40% (there is no standard IRR, it may vary on a case-to-case basis)
- Typical sweet spot of INR 25 Lac – INR 3 Crore (there is no standard rule on investment size)
- Done professionally, with proper due diligence, research, and legal documentation
How is Angel Investing done and what structures are used?
Along with the traditional investment classes like real estate, fixed deposits, or public equity, most high net worth individual’s portfolios have started featuring a new asset class – Angel Investment, due to the high return potential. These investors have dispensable capital and a high risk-taking ability.
Angel Investment is the highest risk asset class.On an average 4 out of 10 investments fail, 4 breakeven, and only 1-2 give bumper returns. Hence, investors often follow a risk mitigation and diversification strategy to protect their interests.
They often diversify their portfolio across multiple start-ups operating in varied sectors, geographies, etc. and co-invest with peers,to leverage on the domain expertise of fellow angels and not just the founders.
Angel Investors do proper diligence on the investment proposition before taking an investment call. In evaluating the start-ups, they look for answers to some of the key aspects of the business like:
- How large is the addressable market?
- Is it rapidly growing?
- Who are the key competitors?
- Is the opportunity arising from market fragmentation or a greenfield opportunity?
- What is the need for the customer to pay for the product/service?
- What are the alternative products in use?
- Execution strategy of the firm
- Track record of the founder and his/her team
- Coverage of skills among team members
- Team retention strategy
- Customer acquisition cost
- Risks mitigation strategy
- Financial performance – historical and projected (both top-line and bottom-line are key)
In evaluating projected financials, they look at aspects like:
- Have all revenue possibilities been covered in the model?
- Has there been enough sound and deep research on the business proposition?
- What is the amount of funding required?
- What is the valuation expectation?
- How can the investment be monetized (exit strategy)?
- What would be the expected term of investment?
There is usually one Lead Angel Investor who leads the due diligence, sits on the Board of the company, and keeps an eye on all critical activities of the start-up, keeping the point of interface alive between the investors and the start-up.
Angel investors eventually make their return when either next-round investors give them an exit or the investee company gets acquired by a strategic investor.
Angel Investing is a high-risk, high-return investment route that’s here to stay as (a) risk-taking investors look at alternative medium to multiply their returns; and (b) the start-up ecosystem look at non-traditional funding to scale up their revenue and growth.