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How Are Funds Revamping Their Investment Philosophies PE funds do not want to invest in companies that are entangled in legal disputes or have material non compliances.

By Vivek Gupta

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If we talk about the approach of an investor towards funding, there are three discernible trends to take note of -- firstly, with investors still looking to exit close to 70% of $50 billion worth of investments made during period 2000-08, focus is shifting from copy-cat models to sustainable models with strong unit economics. Bottom line is becoming the flavour of the season versus top line.

Secondly, with an onset of a weak funding environment, private equity and venture capital funds are adopting a more cautious approach to deal-making and are expected to spend more time on evaluating opportunities. Now besides conventional due diligence, scope maybe expanded in specific cases to include litigation history, political affiliations, unfavourable publicity, promoter background checks, and other such information unavailable in the public domain.

Thirdly, several funds are revamping their investment philosophies. On one hand, earlystage investors feel that the startup space is getting overcrowded and are looking to invest in growth-stage companies. On the other hand, many venture capital funds such as SAIF, Helion, Matrix are leaning towards early-stage deals to catch companies young as valuations of startups begin to soar in a short span of time.

Promoters should brace themselves with tempered valuations

VC and angel investments reached an all-time high in 2015 with approximately $5.5 billion worth of investments.However, given the first quarter deal activity, the frenzy is now slowing down and the deal environment is expected to witness a significant correction in 2016.

At the backdrop of low deal activity, it is imperative that startups go back to the business fundamentals which are supported by solid execution. Moreover, it is essential for promoters to take a reality check and brace themselves with tempered valuations.

The softer the funding economy, the more judiciously one should use the existing cash reserves, even at the expense of scale. A capital-efficient approach including accessing capital via bridge financing before a mainstream round, can help in extending the runway as well as make companies stay relevant in the market instead of shutting shop.

Importance of a legal team in a startup

Startups need to be mindful of legal issues right from the very start. PE funds do not want to invest in companies that are entangled in legal disputes or have material noncompliances.

Legal advice becomes very vital during any fundraising process. Entrepreneurs do not always fully understand implications of several clauses drafted in the legal documentation and are often caught with a rude shock when investors exercise their rights subsequently.

Criteria a startup should keep in mind before onboarding an investor

How investors evaluate startups can vary on a case-to-case basis but certain rules can be applied. Early-stage investors lay significant emphasis on the idea and team since there is limited history of financial or operating performance. The opportunity should cater to a sizeable addressable market with enough headroom for a new company to gain a meaningful market share and achieve a satisfactory IRR for the investor. It also becomes vital to exhibit that scale can be achieved in the business without compromising on profitability.

This article first appeared in the Indian edition of Entrepreneur magazine (May 2016 Issue).

Vivek Gupta

Partner, BMR Advisors

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