The Dysfunctions of Angel Investing in India

By Kashyap Deorah

angel-sketchIndia has a long history of entrepreneurship. Traditionally, entrepreneurship in India has fallen under one of the following categories: (a) family-owned businesses who pass along established businesses to the next generation of entrepreneurs to grow and diversify (b) forced entrepreneurs who do not get as many lucrative job opportunities as they get opportunities to make a decent personal income without significant investment (c) self-made businessmen with the nose for big opportunities and the acumen to bring together the right stakeholders and provide them with good share of profits in return for their power, resources, expertise or moneys. These three set of entrepreneurs still contribute to a bulk of the innovation and new business in Indian markets.

The late 90s saw a new breed of entrepreneurs, for whom entrepreneurship is a calculated career choice. These entrepreneurs neither have family businesses, nor dearth of good job opportunities, nor the natural tendency or access to deal with government, media, corporations or investors to mobilize a mature market opportunity. These entrepreneurs are usually young graduates from top colleges, returning Indians with a taste of entrepreneurship in the US, or senior employees in multi-national tech companies. This new breed of entrepreneurship, or organized entrepreneurship, subscribes to the ‘American dream’ formula and relies on access to external investment at an early stage of the company. In college campuses and NRI circles, the word entrepreneurship almost exclusively refers to organized entrepreneurship. Unfortunately, organized entrepreneurship in India has not seen enough success in India and probably mis-represents the term. Instead of extending the incumbent models of entrepreneurship in India with the meritocracy and scalability of entrepreneurship in the US, it operates as an elite form and even dismisses the traditional Indian models as rustic and arcane.

Dysfunction breeds dysfunction. In the late 2000’s, foreign investment came looking for investment opportunities in India at all levels – venture capital, private equity, hedge funds, mutual funds, real estate funds, investment banks. Between 2006 and 2007, dozens of US VCs set up India offices and set aside first funds of $50M to $150M for Indian investments. The fund management naturally saw opportunities through the goggles of the funds’ successes in the US and saw market trends from a US frame of reference. A rush to allocate the funds was tempered by the lack of understanding of Indian markets, culture differences in Indian start-ups and lack of access to local deal flow.

People who understood the differences and could translate from one culture to the other were at a premium. Full-time hires moving back from the US were good translators but suffered from the same handicap in understanding. Only a few funds hired management with operational experience in India, though rarely could a fund hire management with early-stage operational experience in India. This gap gave birth to a new culture of angel investing that mis-represents the phrase angel investing, and for identical reasons as organized entrepreneurship, let us call them “organized angels.”

Angel investment usually comes from ex-entrepreneurs or wealthy individuals with a penchant for new ideas, and is invested in entrepreneurs they can trust. The criteria for such an investment is informal, and each angel has a unique way of evaluating the idea, size of opportunity and people. Just like entrepreneurship, there is a long tradition of angel investing in India. Self-made businessmen, individual investors, family businessmen and wealthy corporators have been promoting new ideas and entrepreneurs informally and every successful self-made businessman tells about those in the network who helped him in times of need when no one else gave them a chance. Although angel investing is always active within networks, in India, it could even be seen as an extension of friends & family.

As long as real angels and real entrepreneurs work together to build great companies, there is much room for innovation and development of new ideas in India. As long as organized angels and organized entrepreneurs indulge each other without affecting the outside world, they would not affect the market in a significant positive or negative way. The trouble begins when the two paths cross. Entrepreneurs should be wary of organized angels when seeking investments for their businesses. First time entrepreneurs who are inexperienced with corporate structures, equity structures, and investment structures should especially be wary about raising money from organized angels posing as angels. This would take away their chance of building a company even before they got started. Here are a few ways for real entrepreneurs to identify organized angels.

Angel writes the cheque.
If the individual evaluating the deal is different from the individual writing the cheque, he is no angel. Angels may operate through trusts or other entities, but they do not not invest someone else’s money nor do they need the approval of another individual (besides maybe their wife!). Organized angels insist on council meetings, board approvals, business plan submissions, and defering to someone else for decision making or writing the cheque. If angels are organized as a fund that believes in a process driven evaluation and council driven decision making, the entrepreneur is probably paying the price of an institutional investment while raising money that would only get them past seed stage. Organized angels demand multiple board seats, usually seeking majority control of the board, making them more like institutional investors than angels.

Convertible debt is not Preference equity.
If the investor offers you a convertible note allowing himself sole discretion to convert to equity or withdraw money with interest when an institutional investor participates in the future, it is not an investment, it’s a loan. Convertible notes show as liability in the balance sheet and are not equity. The entrepreneur and future investors must view it as debt since neither has control over their conversion to equity. Preference shares, on the other hand, give investors rights protecting their interests in case of below-par performance, while giving investors all rights and ownership of equity. Preference shares do not force a dividend or return of loan when the company raises more money or generates cash, although allowing for those provisions if all parties find it necessary. Don’t let organized angels tell you that Indian laws do not have the equivalent of US preferred stock or that preference shares in India involve more paperwork than convertible notes.

Planned flip to a VC is not in Company’s interest.
An investor who wants to sell off all or part of his shares in the next VC round to cover his initial investment (with committed IRR) is not betting on the long-term success of the company, only on its ability to raise a VC round in the near future. While a long-term investor bets on the company’s eventual success, an organized angel is focused on the immediate gains. The organized angel would set up the equity structure, board structure and controls that protect this short-term agenda, even if it is in conflict with the company’s long-term agenda. After flipping to a VC, organized angels usually leave the company reeling without enough insider control and handicap future strategic alternatives. Organized angels also maintain sufficient control over the terms of the VC round, the choice of VC and when/whether it is the right time to raise money. In some ways, organized angels are VC brokers who get them good deals in return for a small commission that keeps them motivated.

Tranches are not for start-ups.
Start-up stage is probably the fastest growing stage for the company’s value. Every milestone that the company hits in the first two years reduces investment risk and increases valuations. Just as the organized angel wants to retain the right to not invest a committed amount unless a milestone is hit, the entrepreneur should retain the right to not accept a committed amount if a milestone is hit. If this is not the case, an entrepreneur is probably doing a dis-service to the company by issuing shares on a 6-24 month old valuation after hitting a big milestone. Besides, setting milestones beyond 3-6 months unnecessarily ties the company to a direction which may not be right. At start-up stage, there is tremendous value in agility. One should expect major milestones to change every 3-6 months and structure the business to allow for that change. Tranches help organized angels manage exposure on their loan and manage cash-flow on behalf of their fund. However, this is unnecessary baggage for a seed-funded start up.

Kashyap Deorah is the founder and CEO of Chaupaati Bazaar, Mumbai’s phone classifieds. If you are looking for good deals on computers, electronics, mobiles, automobiles and rentals, call 922-222-1947 and talk to a friendly call center representative. These deals are advertised by thousands of households and local entrepreneurs. You can advertise on Chaupaati too. Just call 922-222-1947.

Kashyap also maintains a travel blog where he logs his travels and tribulations.

2 thoughts on “The Dysfunctions of Angel Investing in India

  1. Harpreet

    I think this is a little too hard on the ‘organised angels’!! But good for a first time guy who is betting his life to read and understand what he is getting into!!



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