How Start-up Funds are Putting a Price Tag to the Moral Karma of Investors and Mentors
It works great for investors to incentivize people who refer start-ups to them.
It is otherwise called ‘giving back to the ecosystem’. For anyone – entrepreneur, investor, mentor, professional etc., who has been part of the ecosystem building or even those who simply saw it growing, helping great investors meet great start-up ideas has been somewhat fulfilling. This networking impact is the primary driver for many start-ups to get funds. However, for most of the ecosystem stakeholders, capitalizing their efforts to help an investor find a good start-up or to themselves mentor start-ups has been an absurd idea. For investors, however, that works great - allowing anyone to refer a start-up to them which if gets funded, the referrer is incentivized.
For Mumbai-based early stage venture capital fund Astarc Ventures, which has backed 10 start-ups including Hyperloop One, the deals have come from unlikely sources such as its friend circle. “Since we used to get lot of inbound requests from different people, we realized why not open it up for everybody,” says Salil Musale, Executive Director, Astarc Ventures. For those, who have only surface-level understanding about start-ups, the idea of offering incentives answers the question - why should I refer it to someone and what’s there in it for me?
The problem that doling out incentives solves for investors is not about getting random start-ups in their deal pipeline but to come across quality ideas, which are also sort of vetted by the referrers. “There is no constraint in several start-ups pitching for funding but quality is certainly a constraint,” says Sushanto Mitra, Founder and Chief Executive Officer, Lead Angels – Mumbai-based angel investment network.
More than the start-up being referred, it helps investors getting a sense of the referrer’s perspective and understanding about start-ups. “We always prefer start-ups coming through a reference. Here, we don’t just evaluate the start-up but also the quality of the referrer. So certainly a start-up referred by an entrepreneur, mentor, incubator or accelerator will be more attractive to us,” asserts Mitra. Lead Angels pay a fixed sum of Rs 25,000 to the referrer on completion of the funding process. In case, the referrer wants to offer mentoring and support throughout the process of fundraising, it offers up to two per cent of the funds raised. So far it has backed five start-ups via references.
Seeking references, on the other hand, sometimes pushes away a problem, though not much significant – too many requests in the email, LinkedIn and phone messages. Screening all of them might eat up a little more time for investors, even as some stupid ideas also creep in. However, putting filters in terms of size, scale and market may not be the way to solve it. “There might be some ideas that we don’t want but putting criteria of what kind of start-ups can be referred may lead to good ideas being left out. We are okay with spending time in screening all of the business plans we receive,” adds Musale. Astarc Ventures launched the initiative around three months back and gets around five-six start-ups referred daily. The fund, is currently evaluating start-ups coming via this route. The referrer will be given Rs 50,000 post the deal and 0.5 per cent of the profit made on the investment will be shared. This also interests the referrer to help the start-up grow.
Act of Gratitude
For investors, who don’t need references to enhance their supply quality, aligning the start-up mentors and advisors on-board with profit sharing is an expression of gratitude.
“Your deal flow is associated with the brand image of your fund. You don’t need to give incentives for that. That’s how start-ups come to us,” says Sunil Goyal, Managing Director and Fund Manager, YourNest – early stage venture capital fund based in Gurugram.
“You need industry experts during start-up evaluation or post investment to handhold the start-up. For that, the profit sharing is more of an honorarium to appreciate the time and support offered by these people,” he adds.
YourNest had four advisors in its first fund and three advisors in second fund, launched in 2016. It also has around 10 mentors, including Amrita Gangotra, who heads enterprise technology at Vodafone, United Kingdom and Ashish Gupta, who co-founded knowledge process outsourcing major Evalueserve. There is no upfront fee given to them by YourNest. The share comes along with the fund’s life. For example, a Rs 100-crore fund would try to make five times the money, which is Rs 500 crore, over a period of around 10 years. Assuming for the profit of Rs 400 crore, usually 20 per cent share or Rs 80 crore would go to the fund managers. Of Rs 80 crore, a significant part is shared with mentors, advisors and employees of the company after seventh-eighth year who supported the start-ups without investing in them. “If the significant part is even 10-30 per cent then it is a decent amount. We too share 30 per cent. In this case, it would be Rs 24 crore,” maintains Goyal. The fund, he claims, get 500 applications per month.
Investors, however, seems to have taken a leaf out of Finder’s Fee book. The pretty common practice in the West offers a commission to the person who discovers and facilitates a deal. “The incentive given is equivalent to the Finder’s Fee whether we or the company pays it,” says Mitra. Irrespective of the concept unique to India or not, aligning references with monetary benefits is perhaps best suited for developing economies like India, where the ecosystem is still in its infancy. Also, the network platforms don’t always serve as the means to the end – which is raising capital.
(This article was first published in the June issue of Entrepreneur Magazine. To subscribe, click here)