The Angel or the Venture Capitalist - a dilemma

Contributed by: Prof. Radha Iyer, K. J. Somaiya Institute of Management Studies & Research, Mumbai

Customer future Twenty three year old Sanjeev ’s dream of Customer future had fructified after forty-four months of tremendous effort and innovation. Since September 2003 he had been laboring with Customer future. During this journey, his initial team had deserted him. Customer future had been bootstrapped with the Rupees two lakhs of prize money received at an International Business plan competition in Singapore. Customer future started from his home at Hiranandani, Powai a suburb in Central Mumbai. Initial days were spent on the floor with a few rugs and laptops, the luxury later included, hiring of chairs and tables at Rupees Ten per piece per month from a nearby supplier of hired furniture. He had left a lucrative offer of a fellowship and a job too earlier on to pursue Customer future. As a practice when Sanjeev had made his decision, he never regretted it. He knew that both sides of the coin existed. Nurturing and growing Customer future to a great organization seemed to be a joint vision of both Sanjeev and his partner Rajendra. Creating an organization seemed more on their radar along with being profitable as a secondary goal. Rajendra and his partner Sanjeev shared the equity at 50% each, which they diluted as they went along. Customer future wanted to be in seven products at least by the end of next year, in the sectors of apparels, books and hypermarket. The product The new offering was a product built on RFID technology for the growing retail industry. Till date RFID was used instead of a bar code for inventory management in the retail industry. Customer forecast’s unique application included using RFID to map customer preferences based on business analytics, by analyzing customer needs. The product would be coupled with the store loyalty programme cards. Till date the customer swiped his loyalty card at the end of his purchases at the check out. Instead Customer forecast’s technology would require the customer to swipe the card when he walked in to the store. Once this was done, the customer would get a hard copy print out. This would contain offers that are available on various products, based on the customer preferences captured in the past on the loyalty card. The benefits would be manifold, focused purchasing for the customer which in turn would lead to customer satisfaction. The main purpose of retaining the brand loyalty of customers would be achieved. The same technology could be used for all retail applications, like bookstores, music stores, and cellular companies’ mobile for phone caller id downloads and ring tone downloads amongst others. To illustrate, in a bookstore if a customer in the past has bought fiction which is a murder mystery, all new titles in this category will be messaged to him on his mobile when he walks into the bookstore. Their product would be used on various operating systems for various organizational applications. The industry The Indian retail sector has had a 46.64 percent three-year Compounded Annual Growth Rate (CAGR). With a US$ 245 billion market and an anticipated US$ 385 billion mark by the next five years the industry is set to grow. New shopping malls, the likes of superstores, shopping plazas,
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supermarkets and brand label stores are taking over the traditional market places. The Indian customer is able to experience shopping like international markets. By 2010, it is anticipated to become an Rs 12.5 trillion market. The share of organized retailing is supposed to jump to about 10 per cent from the existing three per cent. 1 As of the year 2007, Customer Forecast wanted to be in seven products at least by the end of next year by 2008, in apparels, books, and hypermarket amongst others. As an engineering student, Sanjeev and his classmate had developed a product, which was used for touch screen application in the engineering industry. Sanjeev was an engineer from Meerut in North India and had come to IIT Mumbai to further his education. Sanjeev’s Customer future journey began with the article Sanjeev wrote on the innovative use of R.F.I.D. for the retail industry in an international journal. Many people had read it. He had queries from people in Singapore, Dubai, Brazil amongst others. His plans for the future included working in the domestic markets providing solutions in both the retail and airlines industry, as both were high growth industries. His near future roadmap included global expansion. The team The Customer forecast team consisted of twelve full time and eight part time employees. All of them were well educated. They included two PhDs two M. Tech and five B. Tech, One B.Com MBA and one B.Com with MBA in Finance. His mentors included two people of high caliber, R Sriram, Ex. CEO of Crossword and Rajeev Karwal who was earlier CEO of Electrolux and worked with various organizations like Phillips and Onida amongst others. He was a Band of angels’ member too. Since the past one-year they were incubated at IIT Mumbai – SINE. Sine had 4% equity (Rupees Fifteen lakhs in value terms) in Customer future with a clause of 2% revenue sharing for the first three years from the day Customer future started making revenues. Growth and expansion: funding Customer future needed funds for its growth and expansion. Attracting good People Resources, infrastructure and space were Sanjeev’s key concerns. They had received an offer from both, a well-known Venture Capitalist and an angel investor in March 2007. Their good relationship with the Venture capitalist had been for the past three years, if they refuse the deal, the relationship may fail and the entrepreneur would not like that to happen. Sanjeev knew that, “The relationship with the Venture Capitalist was never pure commerce, it went beyond that”. If not Customer future, the Venture capitalist would probably fund someone in the same line of business. The Venture Capitalist wanted a 30% stake in the equity organization for an investment of Rupees Two crore and twenty lakhs. The Venture capitalist had started a new fund specially aimed at start-ups and Customer future was one of the first few organizations they had made an offer to fund. They were aware that an opportunity existed and were keen to close the deal. Sanjeev knew that in the worst case scenario, the minimum the Venture capitalist would expect is two times the investment in four years with a 18 % IRR if Customer future was not going for an IPO. In the event of an IPO, they would require a minimum of ten times of their investment. The clauses of tag along, drag along etc were also doing the rounds in Sanjeev’s mind at Customer future In December 2006, at the Pan IT conference Sanjeev met with an alumnus of IIT Mumbai. He was part of a group of angels, who invested together. This alumnus had shown an interest in funding Customer future. There were many others too who had seemed keen at that time. After reading the three articles on Customer future in the media this angel made an offer in March 2007, that was twenty percent higher than the Venture Capitalist for equity of fifteen percent. The angel investor was a second/ third generation entrepreneur with interests in real estate, p v c hoses, and medical diagnostics like M.R.I and C.T. scan centers, Eye hospital and hospitals. The
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three diagnostic centers had state of the art facilities and latest equipments. The eye hospital too had excellent facility. The angels were interested in investing without seeing the product. Only their technical design team had viewed the product. Sanjeev believed that this investment was more like “faith money”. The entrepreneur had discussed the dilemma with, his mentors, a Professor at IIT Mumbai, and two other seniors from IIT who have been through the process of start-ups. The advice had been mixed. The seniors mentioned that it didn’t matter so long as Customer future got the funds. They believed that it was the entrepreneur’s skill that mattered finally, and they mentioned that Customer future had a world-class product. He had discussed this with his partner, his team members. Both of them preferred the partnership with the Angel investor. During this meeting Sanjeev had drawn their attention to the fact that if you had a Venture capitalist funding, “All the calls need not be taken by Customer future alone.” Unlike other investors, the team knew that the angel would not regulate salaries. It was also known that Entrepreneurial Operating freedom would be higher with the angel investment. Rajendra commented that, ”Tying up with the venture capitalist would certainly bring with it good networking possibilities for growing the business”. Simultaneously he had done a due diligence of the angel by meeting their investees and had looked at the businesses that they have invested in, in the past. He believed that they had invested in good people, the best doctors, the best designers amongst others. Their revenues/turnover in the PVC hose business was Rupees twenty million dollars p.a., where their investment was one million dollars. The team at the Venture Capital was from Cornell and Stanford. Also it was one of the big brand names. The advantage of doing the deal with the Venture Capitalist for early stage funding was that for the Round two, it would be much easier for Consumer Vision to raise money. The venture capitalist was keen to fund start-ups as they had a fund for the same. Sanjeev’s homework included discussions with various young entrepreneurs’ funded by Venture capitalists. Start up organization A’s founder Ranjan spoke of their limited strengths in systems. They were a group of Engineering and technology experts. This was taken care by the adherence to corporate governance that the Venture capitalist put in place. Ranjan commented that, “The checks and balances help you to stay on track”. Mohit, CEO of another technology start up mentioned that they were clueless about recruitment and compensation at the CTO level. He mentioned that the Venture capitalist helped in the entire process, providing them a huge relief. Recruiting new employees at decision making levels into the organization was also a challenge as typically these people were ex IIT or Computer Science and had eight to ten years of experience with good organizations. They were satisfied with the money that they had earned and saved with divesting their ESOP (Employee Stock Options). Hence many of them were joining start ups on the promise of a small equity. Lastly, Sanjeev had read the Insead case of angel investing written by Insead Professor Patrick Turner on Meritrac, founded by Madan Padaki.

Discussion Questions 1. What should Sanjeev do? 2. Go with the Venture Capitalist or the Angel?

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Teaching Note - The angel or the Venture Capitalist - The dilemma

Case summary The angel or the Venture Capitalist - The dilemma, could be used in the middle of an entrepreneurship course before the session on resource assembly / sources of funds available for entrepreneurs. It helps students empathize with decisions that an entrepreneur needs to take as he goes along in his journey of growth. It also brings to the fore that technology entrepreneurs also need to look at the challenges from a CEO’s perspective and make decisions for the long term. The learning objectives The objective of the case is to get students to appreciate the analysis a young entrepreneur goes through to make decisions on his sources of funds. This

Pedagogical overview The main objective is to understand the decision making process regarding obtaining sources of funds. The sub objectives would be to understand, • Why the CEO (Rohit Nalwade) wants to keep the equity of the organization limited to the founders? • What is role of the team, employees and partner in decision making? • What should Rohit Nalwade do now?

Assignment questions 1. What are the different sources of funds available for a start up? 2. What have been the different sources of funds available for Consumer Vision as a start up? 3. What are the advantages and disadvantages of each of the different sources of funds? 4. If you were the CEO of Consumer Vision what would you choose the angel or the venture capitalist? Provide rationale for your response

Analysis - The students are expected to understand that decisions are unstructured and also that the outcome of could be subjective and non- recurring. - Another focus area would be uncertainty and risk in decision making - Additionally, the role of Experimentation, Experience and Research & analysis in decision making could be addressed. Teaching method 1. Case analysis ( 80 minutes) • The case could be taught as a class discussion with the students, reading the case as a home assignment, preparing for the assignment questions individually and arrive in class. • Introduction of the case. (5 minutes) • They could later be broken in groups of 4/ 6 members each and given fifteen minutes for discussion within the group. (15 minutes) • Then it could be opened up for discussion where the Facilitator uses the board plan mentioned earlier. ( 60 minutes)

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Blackboard plan 1. The left hand side top corner should have a list of all the sources of funds available for a start up entrepreneur 2. The right hand side corner should have sources of funds obtained by Consumer Vision 3. Middle of the board should be divided into two parts and further sub divided into two parts with the following headings (Headings need not be written earlier) • Advantages of obtaining funds from Venture Capitalist • Disadvantages of obtaining funds from Venture Capitalist • Advantages of obtaining funds from angel investor • Disadvantages of obtaining funds from angel investor 4. Role of the partner, team and others in decision making 5. Comparison of the different types of funding available and the market development life cycle could be made. (Ref.the article Moore, G., Darwin and the Demon , Harvard Business Review, July – August 2004 )

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