Building an Investable Company

Mar 11, 2022

While there is a lot of discussion on building an investable business, today we would like to discuss on ‘Building an Investable Company’.

While there is a lot of discussion on building an investable business, today we would like to discuss on ‘Building an Investable Company’. 

What's the difference??

Business is the sum of underlying Product/Service, Operations, Marketing, Team and other functional aspects while company is a subset of business. 

Company is the legal entity.

Many times while building the business, entrepreneurs pay less attention towards maintaining the hygiene of the company which later comes as a challenge by making the company uninvestable for the investors. 

How does it begin??

The journey to making the company uninvestable begins from the Founding Team Dynamics (This case is most relevant for Single Founder Companies).

Founders begin the journey with an idea, ability and a desire to be an entrepreneur. 

At the outset, founders spend less time thinking on the executionary requirements in the longer run but short term goals like building the product and fundraising. Given today’s time we observe the key goal has become fundraising and even the product has taken a back seat.

During the early days of Startup culture the question was: Startup founders don't think about revenues, how are they going to scale and the answer was ‘Product’, today the answer has changed to ‘Fundraise’.

Keeping Fundraise as the focal point of our discussion, let see how the flow of events can render a company uninvestable. 

For the initial fundraise many founders rely on Angel Investor Networks. As they raise the money they start investing in the product. Within a year they seek investment from micro VCs where they face the first Headwind - Single Founder Company.

To mitigate this, founders allot ESOP to core team members and bring one or more of them onboard as co-founder. Herein, they face the next challenge of Skewed Shareholding amongst the founders. 

With one founder holding a majority of stake while another holding stake in single digits (that too allotted out of the ESOP) at the seed stage does not make an impactful narrative for an institutional Investor for Founder’s Skin in the Game.

In such scenarios the founders approach more networks and micro VC’s to raise a bridge round and in line with the feedback from the Tier 1 Institutional Investors they allot more ESOP to the founder with minority stake or bring an external co-founder by further allotting ESOPs

Post the raise, money is deployed towards Growth Hacking.

Given the regular trajectory, in under an year the founders are yet again in the market for fund raise, at this time there are 2 outcomes: 

  1. Where Institutional Investors agree to Invest - If the business has scaled well and the product is generating traction, Institutional Investors consider investing but for the same require the founders to create additional ESOP pool or increase the founder pool which leads to dilution of the existing and a pushback from the same.

  1. Where the founders raise more capital from Angel Investors and Micro VCs - The cap table gets crowded, often with 100’s of shareholders individually holding decimal point shareholding and demanding critical rights in the company. 

In scenario 1, there is a high likelihood that the existing investors will not be content, there will be multiple rounds of discussions, negotiations & iterations. This would lead to delay in execution and frequent that the incoming investor may retract. 

Observing this time consuming flow of events, many tier-1 VCs may choose to stay away from companies having following characteristics:

  1. Single Founder

  2. Too many individual investors holding miniscule stake

In scenario 2 as the cap table becomes more and more crowded, lesser it would attract tier-1 VCs. 

Thus leading to an uninvestable company.

It's interesting to note, the outcome is independent of the underlying business. The basic hygiene here is the key. 

However good the business & team may be, having an optimum and efficient corporate structure is must right from the early stage to ensure the investability of the company. Structural inconsistencies can be hard to rectify in future.

Hygiene to consider

  1. Always have a dynamic & cross functional founding team - Always remember there is a difference between an employee, Key Managerial Person and Founder. 

  1. Skin in the game - Just having shares does not provide grounds to justify skin in the game. A threshold needs to be maintained in terms of stake and the ownership should be reflected in roles & responsibility. 

  1. Choosing the Investor - Many times in the haste to raise funds for Growth Capital, there is a tendency amongst founders to ignore the demographics of the investors being onboarded.It is elementary that the founders choose the investors they would like to onboard.

    At the outset of Startup Investing, Angel Investors were typically onboarded from the perspective of a strategic investor, where the stake may be low but the contribution to business was high.

    Today for many, Angel Investing is another Asset Class for Investing and many Companies opt for Angel Investors as a mainstream source of fund raise.

    This leads to crowding of the cap table with numerous investors holding miniscule stakes and providing no value add to the company.

  1. Managing the cap table and investor rights - It is crucial that at the time of fundraising founders manage the investor rights keeping in consideration, both new and old money is equally important.

    There are rights which are elementary and rights which are of strategic importance to the company (Stay tuned for a detailed blog on Investor Rights)

While assigning rights amongst the investors, founders should incorporate thresholds with respect to the investor stake. Rights of Strategic Importance must be offered to limited investors. This enables efficiency (Time+Efforts) in decision making for the company going forward.
Further, the majority of elementary rights are covered under statutory rights and available to all shareholders. Thus, Contractual Rights must be drafted with utmost care.  

What can be the approach - Building an Investable Company

  • Founder’s responsibility is like an ocean, thus re-emphasising on the need of the Founding Team over Single Founder and employees with ESOP. 

  • Founders must ensure onboarding the right investors who either bring in substantial capital or strategic advantage. Onboarding investors who are not contributing to either is detrimental to the growth of the company in the longer run and should be limited. 

  • Having strategic investors is important in having constructive advice, feedback and also a sandbox for ideation.

Author(s) :
Karan Gupta