Is it Ever too Early to Fundraise?

This is the first blog of my series. I chose this startup because its fundraising journey was clean and simple compared to other complicated ones which shall feature in later blogs. So far, the startup has raised a $2.5m Seed round followed by a $13m Series A. However, what’s interesting is how quickly after its date of incorporation it managed to close its seed funding round which was no paltry sum.

What did the investors see in the investment opportunity? It was definitely not traction in the form of revenues which most investors nowadays seem to consider as an important ingredient in a recipe for a successful early-stage investment!

So let’s see how the startup’s fundraising journey unfolded:

The startup was incorporated on 26th Feb 2020. According to its corporate filings: “the startup is engaged in the business of trading of fruits and vegetables on a wholesale basis to its B2B customers.”

The most common process by which startups tend to raise funding is through a private placement offer (“PPO”) pursuant to section 42 of the Companies Act 2013. Under the rules, there are 2 very important documents that the company needs to file with the MCA:

Form PAS-4 (Offer Letter) and Form PAS-5 (Record of the Offer).

So according to the company’s offer letter, a board meeting was held on 03 May 2020 where the offer was approved by the board, and then a general meeting was called for the shareholders to pass a special resolution to approve the offer so it could be circulated to prospective investors.

Initially, 5884 Compulsory Convertible Preference Shares (CCPS) were offered by the startup to prospective investors for a total sum of Rs 2,32,92,284.72 (≈$312,000).

On 4 May 2020, shares were offered to 2 lead investors. Subsequently, on 10 May, 3864 CCPS were offered to 16 investors mostly individual angel investors.

The round was subscribed to quite quickly and shares were allotted to the investors in the following manner:

18 May 2020 – 2020 shares to 2 investors (Lead Investor)

28 May 2020 – 3196 shares to 12 investors

02 Jun 2020 – 668 shares to 4 investors

However, the funding round continued, and a new PPO was made which was authorised by a board meeting held on 06 June 2020 and approved by a shareholder meeting on 10 June.

The new PPO consisted of an offer of 40,877 CCPS + 10 equity shares for Rs 16,18,54,460.46 (≈$2.16 million) and was circulated to investors on 10 June.

Again, the round was subscribed to quite quickly and shares were allotted to the investors in the following manner:

18 June 2020 – 40,333 shares were allotted to the lead investor (i.e from the first round) and 1 new institutional investor joined the round.

24 July 2020 – 544 CCPS + 10 equity shares were allotted to 3 new investors.

As you can see the startup initially set off with a PPO of Rs 2.32 crores ($312,000) but very soon managed to hustle its lead investor to invest more funds and also bring in an institutional co-investor to join the round to increase the round size by an additional Rs 16.18 crores ($2.16 million).

Maybe the angel investors who joined the cap table helped convince the lead investor to increase the size of the round and also pull in the co-investor?

So all in all, the founders diluted around 28% equity (which included an allocation for ESOPs) in their startup in return for Rs 18 crores ($2.5 million) in investment which gave it a post-money valuation of about Rs 64 crores ($8.5 million). So, let’s see how do you come up with a valuation for a company that is 3 months old presumably which hasn’t started trading and has zero revenues. For this, we take a look at the startup’s valuation report which is required to be submitted along with the PPO to the prospective investors.

The registered valuer was appointed on 25 Feb 2020 which was before the company was even legally incorporated that is on 26 Feb 2020.

This is an odd one, nevertheless, maybe the instructions to carry out the valuation was given when the company incorporation was in process. Anyway, the reference date for the valuation of the startup is taken as 29 Feb 2020 (i.e. when the startup was 3 days old) and the report was submitted by the valuer on 24 April 2020.

As the startup was newly incorporated the valuer had no choice but to base their assessment on the projected P&L statements provided by the startup. Nevertheless, the valuer decided to carry out a DCF valuation. So let’s have a look at these projected financials:

So based on these figures, it was estimated that the startup would make a loss of Rs 7.6 crores ($1 million) in the first financial year and become profitable in the third financial year with a profit of Rs 26.3 crores ($3.5 million) then growing to a profit of Rs 100 crores ($13.3 million) in the fourth and Rs 275 crores ($36.8 million) in the fifth year.

Imagine the kind of revenues the startup would have to generate to post profits of Rs 275 crores in a highly low-margin business of fruit & veg trading. If we make a conservative estimate that the startup would be making a 10% profit margin that would mean it would be clocking revenues of around Rs 2,750 crores ($368 million) by its fifth year.

The valuer estimated the Enterprise Value of the startup to be Rs 64 crores ($8.57 million)?but then adjusted it to Rs 38 crores ($5 million). Thus, the fair market value of the startup’s shares was estimated to be Rs 3,311 per share.

It seems the startup founders did well as they managed to negotiate a higher price per share of Rs 3,958 compared to that of the valuer's estimate of Rs 3,311. So, something must have happened between 29 Feb 2020 and 04 May 2020 when the first PPO was circulated to the lead investor to have increased the price by Rs 647 per share.?Or it was simply just some good negotiation!

So let’s give the startup the benefit of the doubt – maybe they had something groundbreaking up their sleeves and their investors saw a lot of promise in them. But let’s see what the startup ended up doing with the funding they received as demonstrated by their FY 20-21 audited financial statements:

So by 31 March 2021, 8 months from the close of their Seed funding round (24 July 2020) the startup managed to earn a revenue of Rs 11.82 crores ($1.58 million) but spent Rs 16.61 crores ($2.22 million) to achieve it resulting in a loss of Rs 4.79 crores ($642,000).

Let’s dive into the details of these figures:

The revenue from operations was reported as Rs 11.80 crores ($1.58 million) and the COGS was reported as Rs 12.54 crores ($1.68 million). This suggests that the startup traded at a negative gross margin of (-) 6%. This definitely must have put a dent on the claim of the startup to trade fruit & veg in an efficient manner with the use of technology through e-commerce.

Next, let’s have a closer look at the operational expenses:

A closer analysis of the COGS shows that actually, the purchases in itself of the fruit & veg amounted to Rs 10.47 crores ($1.40 million) which suggest that the startup was getting a positive 11% gross margin on its trades. However, the high spend on inward freight, packing materials, grading charges, labour expenses, and stock wastages is what took its gross margin into negative territory.

The question then is – does the use of sophisticated technology while trading fruit & veg really make it efficient and cost-effective?

Let’s look at the next big expense human resources:

So the startup ended up spending Rs 2.64 crores ($354,000) on employee salaries and benefits which amounts to 22% of its revenues. Again, I would give the benefit of the doubt to the startup as the F&V supply chain business is an operationally heavy business model and you need to have sufficient boots on the ground. However, if you’re spending 22% of your revenues on employees you need to be playing in positive gross margins otherwise you’ll be burning cash at an unstainable rate.

Finally, let’s look at the other expenses – I call this the pandora’s box for startups:

The noteworthy line item here is the Consulting Expenses of Rs 58 lacs ($78,000). You could let your imagination run wild regarding what this pertains to. In total the startup spent Rs 1.45 crores ($194,000) on other operating expenses which amounted to 12% of its revenues.

So after raising ≈ Rs 18.5 crores the startup posted a net loss of Rs 4.79 crores?($642,000). You may say, fair enough it’s only the first year of operations and this is expected because the startup is estimated to hit a topline of Rs 2750 crores ($368 million) in 5 years’ time and all will be forgiven then.

You would imagine they haven’t been too reckless as they still have around Rs 12-13 crores ($1.6 - $1.7 million) of the fundraise available to cover next year’s payroll and operating expenses or maybe not?

Let’s have a look at the startup’s cashflow statement for more insights:

Financing activities?

We can see here that Rs 18.51 crores ($2.5 million) came in from the fundraise.

Operating activities?

Here we can see that the startup ended up burning Rs 6.04 crores ($809,000) in relation to its operating activities.

Investing activities?

Now, this is interesting – the startup invested Rs 12.15 crores ($1.63 million) in mutual funds and even managed to make around 2 lacs ($2680) in profit from the sale of the mutual funds. But what this investment in mutual funds resulted in was that the startup was left with only Rs 14.68 lacs ($19,677) in the bank.

Now if you have a Rs 2 crore ($268,000) payroll liability to cover for the coming year, working capital needs and funds for other operating expenses and you have only Rs 14 lacs ($19,677) ?left in the bank what would you do? Liquidate your mutual fund investments or raise more funds?

Raise more funds!

That’s exactly what the startup did. So let’s delve into its $13m Series A fundraise.

A board meeting was called for 29 June 2021 and a new PPO was approved on 09 July 2021 for 20 equity shares + 62,247 Series A CCPS for Rs 97,65,07,208.86 ($13 million).

In this round, 2 new Series A investors took the lead and 6 existing investors joined the round.

The round was subscribed to super quickly and shares were allotted to the investors in the following manner:

31 July 2021 – 20 Equity + 45,064 Series A CCPS allotted to the 2 new lead investors for Rs 70,70,33,436 ($9.48 million)

05 Aug 2021 – 17,183 Series A CCPS alloted to 6 existing investors for Rs 26,94,73,772.14 ($3.61 million).

So, this time around the founders diluted a further 20% equity in return for Rs 97 crores ($13 million) in investment which gives a post-money valuation of about 485 crores ($65 million). So, let’s have a look at the valuation report that was used to support the fundraise this time around:

The valuation date chosen by the valuer was 31 Mar 2021. Any guesses why :)

Last time as the company was newly formed and didn’t have any financial history thus only projected financials were used to determine the value, however, this time there were provisional financial statements up to 31 March 2021 available. As we have seen above these were later adopted as audited financials.

Good ol’ DCF was chosen as the valuation methodology again - no surprise.

So let’s have a look at the projected financials:

This time around the valuer actually had some previous financial history to base their projection figures. Now, these are really interesting estimates. Ok maybe the startup didn’t have the final revenue numbers for the previous financial year but I’m sure they would have a basic idea of what they might be – let’s assume the valuer had knowledge that the startup earned revenues of about Rs 11.80 crores ($1.58 million)?in FY 20-21 (i.e. up to 31 March 2021). To estimate that it would 4x its revenues to Rs 45.5 crores ($6 million) the next year and in 5 years’ time it would be clocking revenues of 1350 crores ($181 million) seems a bit on the optimistic side.

The EBIT estimates are wow – especially the transition from FY 22-23 to FY 23-24 going from a loss of Rs (-) 7.1. crores ($0.95 million) to a profit of Rs 91.3 crores ($12.23 million) is the stuff dreams are made of!

The valuer estimated the Enterprise Value of the startup to be 273 crores ($36.58 million) but then adjusted it to 191 crores ($25.59 million). Consequently, the fair market value of the startup’s shares was estimated to be Rs 11,761.86 per share. If you notice the line item – “investments not for business purpose” of Rs 12.15 crores ($1.63 million) these are the mutual fund investments, we saw earlier.

It seems the startup founders did well again as they managed to negotiate a higher price per share of Rs 15,672.58 with the Series A investors compared to that of the valuer’s estimate of Rs 11,761.86.

The valuer’s report was dated 25 June 2021 which was 4 days before the startup conducted a board meeting to recommend the offer and issue of the Series A funding to the existing shareholders.

Again, the question is whether the founders did a brilliant job negotiating a 5x increase in the valuation of their startup with the Series A investors? Or did they get help from their Seed-stage investors to hook the Series A investors?

On paper, the Seed investors have scored a great result by substantially increasing the value of their investment in one year's time. But now let's see whether the Series A investors will be able to score a similar result by hooking a Series B investor in the future!

In conclusion, to all of the above analysis, if you’re an agritech startup founder it is possible to raise investment if you have zero revenues and you can also 5x your valuation in one year’s time even if you made a loss equivalent to 40% of your total revenues. Finally, it's a good idea to invest some of your fundraise in mutual funds.

So, keep your chin up and keep going! ?        

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