Basics of Investing in Startups with Paresh Gupta

Headstart has been one of the largest startup organisations in the country ever since we came to be. Over 13 years, we have built a wide network of over 4000 startups in 50+ cities, we finally unveiled our plans to launch Headstart’s Investor Circle.

Appealing to a community of next-gen investors who want to be investors, we organised a series of Startup Investing Bootcamps. The first of which was organised on December 5, and saw Prajakt Raut, Applyifi, and Paresh Gupta, NEOS Angles & GCEC, talk about the basics of investing in startups.

Paresh began by explaining his journey as an investor and mentor in the world of startups. And then further explained how he was going to be talking about ‘Investing in A Startup’. He started by explaining what it takes to be an Angel investor as per the SEBI.

To register as an Angel Investor with SEBI, here are some basic criteria you should meet:

  • An Angel Fund should have a minimum of 5Cr
  • Every Angel Investor needs to invest a minimum of 25L in the fund
  • Should have 10yrs of experience OR should be a serial entrepreneur OR a serial investor
  • Should have tangible assets worth 2Cr

For smaller amounts, investors can invest through Angel Networks and SPVs (or SPE- Special Purpose Entity). How this works is that Angel Networks propose startup opportunities to investors. Once 1-2 investors volunteer/agree to be lead investors, others join in. The money is then placed in an LLP with all the investors and an SPV/SPE is created. In some cases, some networks will allow all those willing to invest through their vehicle.

Paresh echoed the sentiments of Prajakt as he explained why new investors should co-invest:

  • A larger pool of money
  • Diversified Portfolio
  • Better choices/offers
  • Better exits
  • You get to learn by tagging along

For newer investors, valuing a startup accurately is slightly tricky. Here you want to look at the ROI potential by considering the following factors:

  • Team: Can this team achieve what they have set out to achieve?
  • Exit Options: Unless you’re investing in debt-based instruments/convertibles, the only money you will get is when you exit the company. So, you want to look at how easy it is to exit the company.
  • Scalability: Is the business ever going to become 10x from what it is today? If it’s not going to be the biggest player in the market, then that limits your exits.
  • Business Idea
  • Sustainability
  • Competition

Although this might seem obvious, research has got to be your best friend through this entire journey. You need to be super informed about the business you’re entering, the opportunities available to you and your company, and the competition. The best way to do this is by reading and asking the right questions to the right people.

Paresh then began to talk about exit options, he broadly identified 4:

  • Horizontal/Vertical Integration (M&A)
    Vertical integration happens in the same value chain, you will probably integrate with a supplier or a buyer. A Horizontal integration calls for integration with parallels. Then you can have a merger, where you merge with a company. Or alternatively, you can have an acquisition, where a larger company takes over a smaller one and acqui-hires certain teams from the one they’re acquiring.
  • Acquisition by Competitors
    This usually happens through aggressive competition between companies in the same market. This can be extremely fruitful or an absolute disaster. 
  • Funding by VCs & Senior Investors
    This happens through a series of funding, where the company switches hands multiple times. Here the main motivation is to ensure the valuation of the company is higher every round and then it gives an exit to investors.
  • IPO
    This is super new. In 2019, the Government announced a Startup exchange. Here you can invest and exit the startup through the IPO. Paresh says that this is very optimistic news for investors. 

As with most things business, numbers are crucial. Keep track of your business expenses and incomes.

Paresh then spoke about valuations best explained through this image:

In a hypothetical situation, say you were being asked for $1M. If you were to look for an exit at the 5 year mark, and assuming you have a 10% stake in the company and they made $20M in that year, you will get about $2M. However, say if at exit your company is worth about $30M, if the ROI you want is at about 10x, then the required valuation of your stake will need to be $10M. With some quick math, the % of the company you will want is about 33%- to get you the $10M. And so to get here, your pre-money valuation will be about $2M.

After this, Paresh spent the next quarter of an hour answering questions that the audience had. Both sessions were very engaging and saw very positive feedback from all those that attended it.

Contributed by:
Sanskriti Bhatnagar
Headstart Network Foundation