In my attempts to engage in angel financing, I have seen the typical concerns that potential angel investors have. Many of these have to do with the investment parameters, and figuring out how investors can get their money back (or returns) – especially given the inherent immaturity of these businesses in being able to outline an exit potential. Investment then gets limited to businesses where investors perceive a high probability of creating a breakout business. Many other diamonds remain in the rough. I have been thinking of ways of addressing this issue so that seed financing is available to a larger base of startups. This should allow for great businesses to “emerge” rather than being “envisioned”.
To start, I am sharing some thoughts on a potential investment structure that should allow this to happen. There are several other elements to making this successful, besides the investment structure, and I will talk about some of those over next few weeks. In the meanwhile, comments and critiques are welcome on this – both from entrepreneurs and angel investors!
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Deepak,
There is nothing called `unsecured’ working capital finance based on `relationships’ issued by PSB’s that go strictly by Basle norms (previously Tandon committee recommendations). The principal document that binds the arrangement is a “Deed of Hypothecation” (of receivables or inventory or WIP) that creates a firm charge on the underlying assets. This applies even for temporary overdraft facility. Unless the borrower has a steady cash flow from repeat business customers of verifiable credit standing (as appraised by their bankers), the norms do not permit working capital gap to be financed.
One extra covenant: if the company finds debt at a lower rate, and the company will take that debt to prepay the loan – the debt holder/investor HAS to allow that debt on the books (i.e. cannot deny that debt regardless of equity holding) , or lower his interest rate to match.
Funda is at high interest rates it may become a lifestyle business for the investor – or if the company wants to go down the lifestyle route for the founder, the right way is to pay out the debt.
Alok: Good point about lifestyle business exit strategy and credit cards having recourse to promoter’s other assets while angel debt is on the company instead.
WCTLs and Bill discounting are different from the unsecured wc finance I was speaking of – which I’ve seen happen from PSBs to service businesses also based on relationships. Typically this is a line of credit or overdraft facility ANd Im speakign startups with no real fixed assets – one I knew needed it for a couple month mismatch between billing cycles and payroll, for instancce.
I’m not complaining of the RoI – it can be anything, really, because there is no other source or that the conversion is at a reasonable premium. For instance if I could get a 50L debt that converts at a 4cr. valuation in a year, I might be happy to pay 50% fixed rate if I’m confident enough.
Deepak,
You say “banks give lower for working cap lending even when unsecured”.
Not quite. Both Working Capital Term Loan (WCTL) and Working Capital assistance by way of Cash Credit/Bill Discounting/Packing Credit are “secured” by a first charge on receivables and inventory of finished goods/Work in Progress and for added comfort, by a second charge on fixed assets with NoC from the first charge holder, if any. This is a product that is available to companies that have a regular manufacturing/sales cycle and come with limits (that get exhausted and replenished cyclically) that can be enhanced/reduced by the lenders from time to time depending upon their realization experience.
In the context of seed stage, angel funded startups that we discuss here, WC assistance has little relevance.
The debt extended by an angel investor will always be unsecured with a mere service of interest / principal repayment obligation upon the seed stage founders until conversion clause is triggered. It will be based purely upon the angel’s perception of the likelihood of the venture getting past the gate and no more. That explains the higher asking RoI.
Deepak – my impression is that in absence of a good track record of seed investments working and companies scaling up fast enough, the debt piece provides a good way of getting basic minimum return in case some of these companies land up becoming lifestyle businesses. Credit card default rates are nowhere close to startup failure rates – credit card funded startups fall back on promoter guarantee in effect, which is not the proposal here,