Incubator Funds in India: Legal & Financial Structuring?

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