Startup Swaraj: Is VC the correct source of capital for you?

I recently read "Hind Swaraj" - a foundational text written by Mahatma Gandhi in 1909 on a Ship journey between London and Durban, that explains Gandhi Ji's world view. Swaraj is a Hindi word that translates to Self-rule. "Hind Swaraj" translates to "Indian self-rule", a thought from Mahatma where he articulates what Indian independence meant to him. Mahatma makes largely 2 points: one is his critique of modern civilisation (and I have now heard this from multiple other people lately, but more on this some other time); the second is the definition of self-rule, and the means and process to achieve it. He argues that mere transfer of power from British hands to Indian hands would not lead to self-rule, instead the individuals have to learn to rule themselves and that will be the true Swaraj. Effectively, he makes the case of looking into one's own behaviour and actions that causes an outcome, rather than blaming others for their miseries - thereby avoiding falling into victim mentality.

One of the challenges of growing up is that you seldom agree or disagree with someone completely. In the same spirit, I also do not agree with many of the points brought up in the book (including the practicality of it in the modern world) but I found it to be a fascinating read and also gives a glimpse of the maturity of the thought process of Mahatma Gandhi when he was just 40.

Mahatma's thoughts were more in the context of the Independence movement, but I have found it applicable in many other context too, including "problems of the newly rich, of finding purpose and happiness in life" - a scenario I find more and more common amongst people I interact with mostly. I also see and hear a very similar conflict between Founders of Startups and VCs - where both blame the other party for many of their miseries. Given my experience now on being both sides of the table, I thought to write in my thoughts to address some of the more common questions I have heard in the eco-system. In the spirit of self-rule, but without claiming a maturity anywhere close to that of Mahatma, I will also try a writing-style same as Hind Swaraj.

Reader: There is a Startup wave passing all over the country, and VCs are a very important stakeholder in the ecosystem. Yet, they are looked at by multiple Founders as "other party", even though they occupy the same cap-table. How do you look at that, given you have been in both capacities in your professional career?

Editor: There are 2 ways to think about the question you posed: the first point to understand is if VCs are the right source of capital for your company; and the second point is that why do they behave different from the Founders even though they are on the same cap-table as a shareholder. I feel that there is general lack of understanding in the ecosystem on the subject, and that makes both parties feel that the other party needs greater maturity. But if you look carefully, the companies who become successful and the VCs who have invested in those companies are generally lot more aligned and happy with each other, and you hear much less (if at all) about these problems from them. In my experience, if you hear complaints mostly from people in the case of failures, it is usually NOT because of the actions of the other party but because of the lack of understanding of the other party.

Reader: I don't like you answering a question with another question. Why don't you address the questions directly. Perhaps you can explain what you meant when you asked to consider if VC is the right source of capital.

Editor: We are talking about a swaraj (self-rule) here, so it is important to understand the motivation of both parties as they try to get into a partnerships. Not understanding the motivation of the other party will always cause mis-alignment, particularly when these relations are long-term relationships.

Look at the 2*2 matrix I drew and attached below. X-axis is about your/Founder motivation, which is defined by Desired Exit Duration. On one side are the Founders who look at this business as long-term commitment (X+). Remember that it takes ~10 years in India to create a real business, X- side represents smart individuals (most commonly, serial entrepreneurs) who will want to create rapid value in relatively shorter-term of 3-5 years and then move to their next gig. Y axis talks about the differentiation and strength of value-proposition (product, market-access, growth-rate) of the company. Is this a company with significant differentiated offering (Y+), or will have a more democratic market presence (Y-).

You will have to be very clear and honest about which quadrant your company and you belong to. A startup which tries to beat an incumbent by just competing on the cost, or by solving a problem in the incumbent and creating a new business out of that is usually not solid enough differentiation. Remember, the significant differentiation in value proposition comes from your strengths, and not someone else's weakness. Strengths are difficult to copy, weaknesses are easier to fix and don't usually provide structural advantages. Once you know which quadrant you / your company falls into, try looking for that capital provider. If you try finding another source of capital, you will have a tough time exciting them and will be disappointed more often than not. And even if you are able to sell a story there, it will be difficult to repeat that in the next round and it usually ends up badly. This, my friend, is the cause of the misalignment that you are talking about.

Reader: Interesting. So you are telling me that the problem is in me? And not the Investor.

Editor: Swaraj says that you have to look internally to solve your problems, and not blame the other party. Since you are asking the question, I am talking about you. If an Investor asked me this question, I would have spoken about them.

I am highlighting that VC is a market-share game. For a VC to make money from your business, it has to reach a high scale. In the time-frame that a VC operates in our country, high market-share is a necessity for that to happen. And that does require a company to grow much more aggressively than what is considered normal in usual environment, and that only happens when the value-proposition of the product you are offering is significantly stronger than the alternatives that a customer has.

Reader: I understand. I see that you recommend me to not look at VC as source of capital, if my value-proposition is at least not an order of magnitude stronger from other alternatives (mass-usage) a customer has. I notice that you have labeled the quadrants A to D written in the Founder-Investor-Partnership evolution graph above. What is that?

Editor: I like that you are asking questions without getting upset now. The quadrants are labeled A to D, because that is how I have seen most companies evolve in an eco-system. When I first started seeing start-ups, I thought most companies were in A and B quadrant - the differentiation in the value proposition wasn't very high. Most companies didn't understand the real product differentiation, or couldn't execute keeping the differentiation intact. In addition, there was some entitlement in some of the Founders who felt that they could create strong value in a very small time without enough structural differentiation, and burnt out when that did not happen. But I don't see too many companies in quadrant A now, in fact I see fresh college graduates also understand this. This is a very encouraging development. You will notice that the Founders who fall in C usually don't have a problem of misalignment from a capital source perspective. The big problem is in B, and that is what the Founders need to understand and evolve. From a capital perspective, if you are in B, you are in No-man's-land for quite sometime.

Reader: Tell me more. I like the evolution graph. Will you tell me why is D after C in evolution graph? I thought highest maturity is when someone wants to create a large value and is committed for a long time, and hence C should have been the last stage.

Editor: Yes, this is true. It usually happens when you have few large companies created who are very happy to acquire smaller companies to fill some of their product or market gaps. There are some very smart entrepreneurs who spot these opportunities and create companies in very short period of time and are able to sell their companies to one of the acquirers. Silicon Valley is now full of such companies, and my conversations with a few VCs from Silicon Valley shows this to be an issue they have to deal with and also take advantage of. I think India will also see this, but we are perhaps couple of years away from that. Whether it is a good development or not is topic for another day, but that's how it has evolved today.

Reader: Okay, can you now address your 2nd point - why do VCs behave differently from the Founders even though they are on the same cap-table as a shareholder.

Editor: My dear Reader, I can try copying Mahatma's writing style, I do not have the capability to think like him. I will need another day to charge my energies. Besides another day, a response to this post will act as the source of energy for a potential next post ;-)

P.S: My reading of Hind Swaraj was a part of the short course "The Making of Contemporary India: History and Political Theory" by Professor Khilnani that I am currently doing. An English version of "Hind Swaraj" is also available here. Highly recommended read :-)