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Incubator Funds in India: Legal & Financial Structuring?

Posted on Wednesday, Nov 14th 2007

Judging by the kinds of questions that show up in various entrepreneurship related blogs and forums, financial structuring, otherwise known as the Cap Table, is something entrepreneurs often need help with.

Here’s a quote from Alex Osadzinski on the overall philosophy of a good term sheet:

“And, I can’t stress enough that a fair deal for the entrepreneur and the VC is vitally important. All of the byzantine deal structure tools that VCs use should be employed primarily to do two things:

1. If the company has a subscale outcome, the VCs should get their money back before the operating team makes a big return. And you should absolutely avoid the situation that we’ve all seen when a team exits prematurely because the structure allows them to take a (small) fortune off the table and the VCs don’t even get their money back.

2. More important, if the outcome is good, the operating team should make a big fortune, as well as the VCs.”

The real issue here is “fairness”. What I am gathering from the Indian side is that the “fairness” factor is missing from the equation in many deal structures, causing angst and heartburn. Unfortunately, this can be quite true in Silicon Valley as well, especially for first-time entrepreneurs. Nonetheless, Angel investors asking for 50% of your company for a $50,000 investment isn’t a deal one should even contemplate accepting, however desperate the situation may be.

My take on an incubator’s deal structuring methodology would be to create a framework that fits (a) the types of deals and the scale of returns expected (b) how the proceeds are to be split between operating teams and VCs in the event of varying degrees of success assumptions. I cannot present the framework here, since that would depend on fund size, ROI expectations of the Limited Partners, compensation structure of the Incubator Management team, etc. Some of these I will visit in detail in the next few posts.

In terms of Legal Structuring, of course, there are decisions to be made like where do you put the company HQ. For example, a company that’s a Domestic producer – Domestic consumer model, would, obviously, be headquartered in India, and also expect to exit in India. A company that is a more export-oriented business model (e.g. SaaS for the US Market) needs to be headquartered in the US, with an Indian subsidiary.

There are many decisions that fall in the general umbrella of Legal and Financial which typically entrepreneurs would not have experience dealing with. The incubator management needs to provide guidance and best practices on all these issues.

Again, while it may not be possible for the individual companies to hire sophisticated legal and financial counsel, it is possible for the incubator to do so and amortize across the portfolio.

This segment is a part in the series : Incubator Funds in India

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This is getting interesting by the post.
I see that you are creating a working template for a Startup.

Indeed, ‘templates’ made mortgage widespread and accessible to larger section of people. Template as a complexity control mechanism is well illustrated in the financial sector. Venture Capital as part of financial sector can do well with borrowing techniques from less glamorous counterparts.

Templating needs scale. Can someone set out with a mission like 1000 incubators in 4-5 years? And execute well? That is belling the cat.

That is a worthy mission to ‘Follow the leader’

-Balaji S.

Balaji Sowmyanarayan Wednesday, November 14, 2007 at 11:49 AM PT

Yes, I am creating a Template.

However, don’t expect 1000 incubators.

There is a very critical piece in this framework, which is people. Each incubator needs to be run by a group of highly motivated, talented, creative, effective people.

I don’t see how we can find 1000 teams like that.

I would be very happy if we can find 1 team to begin with, 10 teams, then 25 teams over the next 3 years.

But yes, I am trying to create a scalable template / framework / formula / equation – whatever you call it.

Something repeatable.

Something that can unblock the entrepreneurship chokepoints in India.

Sramana

Sramana Mitra Wednesday, November 14, 2007 at 11:55 AM PT

I agree with this point.

Finance, Legal and Human Resource Management (HRM focussed on building mgmt team) … are areas where an incubator can add tremendous value to early stage ventures.

It is typical for first time entrepreneurial teams to have limited knowledge of the end game in these functions … yet those can create a shaky foundation for the long term viability of the venture, if handled poorly.

Most failed start ups can trace back their demise to poor cash management, bad contracts or inability to build the right management team to take it to the next level.

An incubator with the team composition and philosophy you describe and add tremendous value here by helping lay a scalable foundation for the venture.

Most of the above are not very operational in nature … if done right … and will allow the incubator to support multiple ventures at the same time. Hence it is fairly practical to sign up for those.

Sridhar Turaga Wednesday, November 14, 2007 at 11:53 PM PT

[…] Incubator Funds in India: Legal & Financial Structuring? […]

Early Stage Technology Entrepreneurship and Incubators in India |Indian startups, India Business Monday, November 19, 2007 at 5:29 AM PT

I chanced upon this post just now. Am late, but still….

I completely agree that entreprenuers do need this help. But the sad part is, most entrepreneurs seek legal help ONLY when things go wrong.

As an attorney, I have seen enterpreneurs sign contracts, without understanding the legal nuances, and I wonder why….

Why is legal not a part of ‘solution based counselling’?

Sharda Balaji Saturday, February 2, 2008 at 4:39 AM PT