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Doing due diligence on startups

Due diligence is the process of researching and analyzing a potential investment before making a decision. The process can include reviewing financial documents, assessing market trends, evaluating management teams and a lot more. Essentially, due diligence is all about doing your homework to make an informed investment decision. When it comes to investing in startups at very early stages, due diligence can be more art than science.

Investing without proper due diligence can lead to disastrous financial losses, missed opportunities, and frayed relationships.

On the other hand, conducting thorough due diligence, though often time consuming, can help an investor make better informed investment decisions that align with their financial goals, risk tolerance and investment horizon. By conducting proper due diligence, an investor can gain a deeper understanding of the investment, evaluate its potential returns and risks and make a decision that is right for them.

However, it is equally important to balance thoroughness with speed. Many times, there are very few or no financials and legal documents for an investor to review and make decisions on. This is especially true at the pre-seed and seed stages of many tech startups. At Saka, we look at diligence a little differently. We believe the usual diligence is required but we also believe it doesn’t have to be a very long or complicated process for the founders. 

At Saka Ventures, we try to balance speed of decision making with as much data to back up a decision. After a meeting or two, we can confidently tell if a company, and the founders, are onto something that requires more time or the startup just isn’t a fit for us. If we eventually move to a conditional, yes, we start our diligence process.

Here are some key steps we employ in conducting due diligence when evaluating a potential investment:We start by reviewing the company’s financial statements, including income statements, balance sheets, cash flow statements, KPIs and other metrics. This gives us a sense of the company’s financial health, growth potential and profitability. We try to look for consistency and accuracy in financial data and projections, as well as, a clear and viable revenue model. A startup’s financials should reflect a good understanding of the market and the expense projections are a good indication of that understanding. 

In India, we have seen that, often, founders start working on an idea well before incorporating a company and sometimes, the incorporation can take a significant amount of time. Hence, very often, there aren’t any financial or legal documents to review. In such instances, we ask for three to six months of bank statements to review. If these don’t exist, we ask the founders to share financial projections for the next one to two years. We believe that most financial projections for early-stage startups are a waste of time but the expense projections are an incredible indicator of how the founders are thinking about their business. 

We look for an efficient use of capital and realistic assumptions about the market and growth. We also look for potential risks, such as legal liabilities or debt obligations, such as repaying a relative for their help before the company was setup. When investing in a market like India where, frequently, there are complex structures used, it’s critical to understand how the finances flow from investor to operations, customer to operations and, eventually, where is value being created. We want to make sure that we are investing in the entity where the value creation is occurring.

In assessing the market where a startup operates, we research the market speaking with other investors, founders and our advisors and mentors, many of whom have been entrepreneurs and operators in cross-border startups straddling the US and India. We also examine industry trends and direct and indirect competitors in the space. Many times, we pass on investment opportunities because it’s a market we don’t have enough information or just haven’t formed an opinion on.

In our opinion, the most important part of investing in pre-seed and seed stage companies is to assess the founding team. We look into the company’s founders, including their experience, track record building companies and products as well as selling them. In India, over the past decade, we’ve seen a massive surge in the number of high quality operators across the spectrum needed to scale a young startup. We try to assess a founder’s past contributions and what they’ve been able to accomplish. Unfortunately, this is sometimes quite opaque and requires much more than reference checks. We don’t rush this process. We take our time getting to know the founders and understand how they think and act. Building a relationship can take a lot of time and effort. Some times, we will pass on an investment opportunity because we haven’t yet been able to establish a working relationship that we can build on over the next ten to fifteen years it takes to build a successful startup. 

Some key documents we request early on in addition to financial, legal and operational due diligence, are a cap table showing the ownership structure of the startup and details the percentage of ownership for each investor, the articles of incorporation which outline the legal structure of the startup and its key provisions, such as the number of shares authorized, the board of directors and the initial shareholders, shareholder agreements which detail the rights and obligations of the company’s shareholders and outline procedures for important decisions, such as the sale of the company or issuance of new shares and, finally, the employment agreements which detail the terms and conditions of employment for key executives and employees.

We like to ensure that the startup has a strong legal foundation, with a clear ownership structure and contracts that protect the company’s assets.

Investing in startups is not a one-size-fits-all approach and taking the time to conduct data driven and human due diligence can help mitigate the chance of investing in the wrong company or people but since startups are high-growth and have high failure rates, it still may not prevent financial losses.

If you’d like to hear more, I did a short video on this topic a few years ago.

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This post was originally published on the Saka Ventures blog.

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Early-Stage Startup Deal Terms in India 2020

There was a recent thread on Twitter about how even in 2020 angels and VCs in India continue to put ridiculously onerous terms into early-stage deals.

I recently invested in an Indian startup that closed a pre-series A round and the documents were more than 100 pages. When I was at 500 Startups, with the help of BMR Legal, we modified the 500 Startups KISS Agreement for India and open sourced the documents in the hopes that it would simplify early-stage documentation and reduce the amount of time to close a deal and the cost of doing early-stage deals in India, much like Series Seed docs and the SAFE have done in the US.

Here’s a presentation I gave in January 2020 at CIE-IIIT Hyderabad on some of the deal terms in India to watch out for. Unfortunately, there’s no video of the actual presentation I gave so I recorded a voice over for you.

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If there are additional terms you have questions about or terms you’ve come across that are onerous, please leave a comment on the YouTube video and I will respond. Hopefully, other founders will benefit from it as well.

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Off the Beaten Path: Wall Street to Startup Investor – A Fireside Chat with Me!

Who is “Pankaj Jain” besides being the founder of Invest Stream and Founder Craft What came before? 

If you’ve followed my erratic writing over the years, you might have some idea. I’ve been a risk manager at the largest hedge fund in the world, Long-Term Capital Management (LTCM), operator, product manager, entrepreneur, community builder at BarCamp Delhi, co-founder of HeadStart Network Foundation and Startup Weekend India

I’ve been a venture capitalist at TLabs and 500 Startups, advisor to startups, funds and platforms like AngelList India and most recently, a dabbler in startup and venture capital related video content

My friend and former colleague, Ritesh Bansal, suggested interviewing me on the show to bring out more about who I am and what my journey has been. Naturally, I couldn’t refuse an invitation to be on my own show. Get ready for a frank and open discussion between an old friend and I. This is going to be Ritesh’s first time being visible on any social media channel, so please be gentle with him. It’s an #AMA so feel free to ask me anything.

I’m looking forward to seeing you for the AMA-style chat on July 28th, 2020 at 9:30am PDT / 12:30pm EDT and 10:00pm IST. If you’d like to RSVP and have a calendar invite, click the button. Otherwise, head over to YouTube with your questions.

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The Rise of Indian Venture Capital

Over the last twenty years, India has seen a tremendous amount of economic activity in the tech arena. The startup and venture capital ecosystems were a bit slow to pick-up, partly due to low Internet penetration until just a few years ago. That, however, didn’t prevent the creation of unicorns like Flipkart, Snapdeal and others. Since 2017, India has seen numerous new venture capital firms being launched with domestic and foreign capital. Japanese and Chinese investors have poured billions of dollars into Indian tech startups and venture capital firms over the last 5 years.

In the next Invest Stream Live, we’re going to chat with Ankita Vashistha, founder of the Saha Fund and Rahul Chandra, founder of Arkam Ventures. Both Ankita and Rahul have been active investors in India and both of them have very unique fund strategies. We will discuss broad trends they are seeing in India right now, what drove them to formulate such unique theses for their respective funds and what they see in store for Indian startups and other VC firms over the next year.

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Twelve Years of Indian Startups – Part II

After landing in India, I realized the bureaucracy was going to make it really difficult to get started. I won’t bore you with the details but it took me eight months from the day I landed in India to having all of the required papers in place in order to setup a Private Limited company (or corporation). I’m sure the process is much easier today to set up a company but it is definitely not easy to shutdown a company in India.

The view from my balcony

Once I got the company registered, I started looking to hire a few people. I used headhunters, job boards, and, of course, asking people I had been meeting in Delhi. I tried pretty much everything under the sun that I could think of. I hired two interns, one of which was the younger brother of another founder I had met. A few weeks went by and I hired my first full-time hire.

To be honest, though my long-term vision for a reverse auction platform serving the labor force in India was something clear, I had no idea what the magnitude of the problem was and the kind of people I needed to hire. I thought I needed developers so that’s what I tried to hire before anything else.

I interviewed anyone that was desperate enough to to work at a startup (in 2007 working at a startup was definitely not where the cool kids were). Finally, I found another developer who was a Microsoft dev and didn’t quite have the technical background in LAMP technologies. I made a bunch of mistakes in the interview. I should have asked more in-depth technical questions but, instead, I was satisfied with theoretical answers to my questions. I wound up letting this developer go on their first day, partly because of my own mistakes in interviewing and hiring and, in part, because the developer only had theoretical knowledge and wouldn’t be able to contribute to building the product for a long time.

A few months later (probably around April 2008), I was out of town for a funeral. The two interns were working on an important piece of the project. Unexpectedly, I got an email that they were both quitting. Together. Effective immediately.

Most interns didn’t get paid in India back then. I was paying them from day one and relative to what other recent college graduates were getting paid, these college students were getting paid very well. Needless to say, I was furious and shocked at the lack of professionalism by these two interns. They quit right in the middle of an important deadline with an email while I was out of town. I have the email they sent me and my response. Perhaps I will redact some of the emails and share them.

At this stage, I was completely and utterly dejected. I had no idea what I was doing. I was beaten down and there wasn’t a day that went by where I didn’t want to throw in the towel and head back home, to New York City.

I Kinda felt like this truck…or what was left of it.

I still had enough money left to continue bootstrapping this small company, so I continued to push ahead (completely uncertain in which direction I was actually going). The same acquaintance whose younger brother bailed on me was working out of small incubator in Okhla, Delhi. I went to check it out and see if I can get some space. I moved in with my sole developer. I was more confused than ever about how to build out a team that could build the product I needed. I dusted off the cobwebs and started teaching myself PHP while looking for a designer to join us. Eventually, I found a designer and hired him. He wasn’t too thrilled about using Gimp instead of Photoshop but I wanted to see what he could do before spending the money for a product no one else knew how to use. I never really got the chance to find out. After multiple absences during his first week of work (on one instance, his mother called to tell me he wasn’t feeling well), I had to fire him as well.

I’m a little hazy on the time lines now but somewhere around the middle of 2008, I got involved with organizing BarCamp Delhi and that eventually led me to co-founding the HeadStart Network and launching Startup Saturday Delhi. My initial reason for getting involved was to broaden my network and find good people to hire. Also, around this time, I met two people from IAN (Indian Angel Network). They both wanted me to come and pitch IAN but I wasn’t ready to raise money. I viewed raising money from outsiders as something I should do only after I figure out the basics of building this business.

I can’t find any screenshots but we did a soft launch of Semblr in August of 2009. It was a rough and rocky road getting there but we got there. Building a two sided market was much harder than I thought. I quickly found that not having background checks in India was going to be a problem and scaling the process of doing “police verifications” across the city was going to cost a lot of money.

By December, I was almost out of money and I decided to start doing some services to generate a little cash to pay my employees (I had hired a few folks again). That didn’t work out so well. Our first client didn’t pay me for the work we did and instead, hired away my employee that was working with them.

That was pretty much the end of Teknatus Solutions. More or less, that day, I decided to shut it down. I told my last employee (also my first full-time hire) that I would help him find another job but I was done. He was the last person to walk out of the office and turn off the lights. I still try to see him whenever I’m in the same city.

Running a startup in India was an incredibly difficult and it forced me to reexamine a lot of what I had learned about doing business and running operations over the previous 10-15 years. It was more importantly, extremely adventurous, exciting, and educational experience. I wouldn’t trade it in for anything. I learned a lot more about doing business in India than I ever would have in a MBA program or at a job. The experiences gave me a lot to digest and learn about myself which I may not have had the chance to learn had I not taken the leap. The opportunity for introspection that “failing” in a startup gave me has been invaluable but most of all, the people I met and the relationships I built over the last twelve years is something I will always cherish.