Often there is a misconception amongst entrepreneurs as to why an investor is not interested in funding their business even when it is profitable. In a workshop that FounderMates had organized on June 29, 2013, we had this comment from few participants that “Every Business is Fundable”. One of the attendees said, “I have a business on Gift Items and it is profitable. I have great margins. I want to expand to other parts of India and I need an Investor. But no investor is interested in investing in my business. Why? Investors invest millions in Flipkart, which is not profitable, whereas a business like mine, which is making great profit, is not attractive to them. Why this mentality? Are they crazy?”
This prompted me to write this article on why investors invest the way they do.
First of all, let’s clarify few basic questions:
1. Who is an investor?
An investor is anyone who has excess money and willing to invest in other’s business.
2. Why do investors invest money?
To maximize their returns in a short period of time.
3. Why do they need to maximize their return in a short period of time?
Simple; to become richer, faster.
4. Are they greedy?
Yes, we all are.
Now, if you are an entrepreneur reading this article, I would want you to ponder over these basics and put yourself in the shoes of an investor. Once you do that, you will be able to answer your questions yourself.
Why and how do people invest?
People invest their money so that they can be richer. There are several forms of investment. You must have been advised by your parents about putting your money in a type of “Asset Class” which comprises Fixed Deposit with banks, investing in Post Offices and buying various Government Bonds etc. Your parents will advise you on this because this is the safest form of investment. But the returns for these investment classes are very small and low.
You cannot aspire to grow your money by investing in these Asset Classes. Given the rate of inflation in India and globally, the returns that you realize through bank deposits and Government Bonds will have no effect on your wealth over a period of time.
This is the reason people invest in another Asset Class called Stocks. They do so either as an active trader buying stocks themselves or buying stock portfolios via Mutual Funds. The benefit here is that the rate of returns is much higher and you can realize your returns much quicker.
If you are a pro at stock market investment, you would know that you invest your money for a small period of time, and then you sell your stocks at a higher price and pocket the profits. And you may reinvest your profits in buying other stocks.
Each Asset Class is characterized by risk and return. You might see the correlation by now; riskier the asset class, higher the returns realized. There is a higher chance that you will be broke by investing in Stock Market than by investing in Government Bonds.
Apart from these Asset Classes, there are others known as “Alternate Asset Classes”– examples include investing in Gold, investment in Real Estate or investing in privately held small companies. Investors investing in private companies are typically known as Angels or VCs.
Now why do investors invest in small companies?
Like any other asset class, people invest here to maximize their returns in a short span of time. And this asset class is riskier than other classes, because the chances of a company going bust in early stages are more, as opposed to a company that is established and is listed in the stock market.
Investors take the risk of investing in early stage companies for 2 reasons:
- To make lot of money in a short span of time. And by lot, I mean, much more than what you can get in stock market.
- They are passionate about startups
However, you would notice that point 2 is more prominent for investors in Silicon Valley than the ones in India. In India, point 1 takes precedence over point 2 for investors.
Please note that investors are either shelling out their own money (angels), or investing money of others (VC’s). So in essence, they are not doing this as a favor to you, but because they believe your business can give them 10 times returns in the next 4 years. They want to sell out their stake in the next 4 years and make 10 times the money they have invested in you. They believe they will get more returns by investing in your business than investing in the stock market, buying mutual funds or Government bonds.
Can your business deliver that? You need to sit down and calculate this basic fact! If no, then you are not fundable.
Flipkart is not profitable. Yet they seem to be raising money so easily. And each of their rounds is in several hundred millions of dollars. Are investors crazy?
Flipkart might not be making profits. But Flipkart is surely on its way to becoming the biggest e-commerce player in the country. They are aggressively capturing market share. A company’s net value increases based on the revenue, based on their assets, based on their customer base, based on the target market and how fast it is growing. If these things are positive for a company, investors will be happy to put in more money. The investors know that when they exit in the next few years (when probably Flipkart goes for IPO or there is an M&A) they would have made loads of money.
So what does all this mean to you, the entrepreneur?
Too many entrepreneurs have skewed perceptions of raising investment. Some think that they have a great idea which will change the world, hence they need investment. Some think, since they have a business already, they need investment to scale up. Some think as they are profitable, investors should put money in their business. While those are criteria that are taken into consideration by an investor, one cannot ignore the most crucial question, “Can I give around 10 times returns to my investor in the next 4 years?”.
If you can answer this question with proper logic and data and show it as an achievable thing by your startup, then it is highly likely that you will not be wasting your time chasing the investors. Remember, the more early stage your startup is, the riskier it is for the investor, therefore he will expect higher returns.
Until then, just focus on what you do best; building your business.
Do share your thoughts and comments.
ABOUT THE AUTHOR
Raunak Guha – Co- founder FounderMates
Raunak holds an MBA in Innovation and Entrepreneurship from Imperial College London. Prior to starting FounderMates.com, he was working as a Business Development Executive with a Financial Analytics SME in the UK. He has been very active in the startup eco-system in London and possesses a deep passion to foster entrepreneurship globally.
He can be contacted at +91 9008 639 690 and his email id is: firstname.lastname@example.org
Raunak’s past article(s): Find them here