Startups, Innovate while securing funding, think co-investment

Let me not make this article a tutorial and try to be as informative yet interesting as possible. The whole fund raising process is like huge water filter with multiple layers of filtration process. Some of the investors pull out initially itself since they do not find the industry worth pursuing. Most typically pull out at the time of initial discussion between investors and promoters. Reasons could vary from serious to silly. The ones that finally come on board are the ones who indulge in active dialogue and due-diligence and manage to present a term sheet. Term sheets are like engagement ceremonies – “if all goes well, we will get married in a few months”. Most do, some don’t. In most occasions we have seen that an investor presenting the term sheet is not necessarily funding the entire fund raise. There is a gap. Now, this gap could remain open and the equity round could be closed else the investor and the promoter could agree on inviting another investor on board on their agreed terms and conditions. Such a scenario when 2 or more investors agree to invest on the same terms and conditions is called “Co-investment”.

“Co-investment” could happen at any stage of the fund raise. In most casse a “co-investor” springs into action at the time of signing of the term sheet. Question arises on why “co-investment” arises? Here are a few reasons for the same:

1. Ensuring completion of the fund raise: Nobody likes a half-baked chicken (For vegetarians – “nobody likes a half-baked cauliflower…hmmm…doesn’t sound that great for vegetarians). The whole idea of doing a fund raise is to ensure that you gallop ahead. What is the point of the whole exercise if you could just run? An incomplete round also sends out a negative signal to the investor community who will be sure to remember the performance of the last equity round of the company. So, if you find 2 or 3 investors willing to ensure closure of the fund raise be sure to nod your head in affirmative.
2. Investment thresholds:Most investors, though sector agnostic, have investment thresholds. Their investment guidelines do not allow them to invest in a company beyond a certain amount. As much as they are excited about their business and it prospects, they may never be able to fund the entire fund raise given their internal guidelines. Be sure to partner such investors as they will not only believe in you but also bring a co-investor on board.
3. Saves time and effort: There are a lot of investors who have a small fund and tend to be frugal about their costs of investment. They follow investors who would take the lead in their due-diligence on the company. It will be wrong to say that they follow herd mentality because they do indulge in active dialogue and framing of legal documents. It is just that their involvement in running the investment process is limited given the constraints around their costs.
4. Value addition: I have said it many times earlier as well that at times while micro managing their business, a promoter misses the bigger picture. Striving towards achieving an unachievable vision is equally important as achieving your next year’s target. At times the zeal for pursuing the vision with passion is lost. Having more than one investor on board tends to ensure that you remain focused on the overarching goal of the business. Some investors with their investee companies or with their contacts tend to further the interests of your business as well. We have also seen that some promoters also tend to approach additional investors to act as marquee investors. “Marquee investors” are investors with a significant corporate pedigree that enhance the overall image of the company. It helps in future rounds of equity as well. In nut shell more than one investor at times adds significant tangible and intangible value to the company.
5. Risk mitigation for one investor: While ranking risk capital, private equity comes at a reasonably high rank. However, there are investors who despite having the necessary capital to fund the entire equity round tend to play safe. They typically bring in another set of investor(s) to complete the equity round as part of their risk mitigating strategy. This happens quite often when 2 investors with similar investment profile look to manage risks of their overall investment by co-investing.

Co-investment is definitely not a norm while fund raising but is a good option to have up your sleeve. But it is really not as rosy and as easy as it seems. While most co-investment happens at the same valuation, the rights of the investors might be different. This disconnect may not be apparent at the time of investment but can result in avoidable squabbles in the board room as time goes on.

The other day my seven year old nephew boasted about his relationship status to me, “Mama, I have 2 girlfriends”. I replied, “Buddy, if you are still enjoying life then you have a bright future managing multiple private equity players in your firm.”