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Investing In A Start-Up? Check If It's Taking These 6 Crucial Steps

10/05/2016 6:36 PM IST | Updated 15/07/2016 8:26 AM IST
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Start-ups interest me, especially since I have been involved with one that my friend founded. I helped him with his investor pitch documents and was part of a group of friends that provided him bridge funding. When he had to raise working capital, I helped set up meetings for him with some venture funds and intermediaries. Discussions with my friend, his colleagues, and investors and intermediaries helped me develop my own perspective in managing, and more importantly, measuring start-ups. If you are thinking of investing in a start-up, then you might check if your investee company is looking at the points enumerated below.

Retaining the right clients, dropping the wrong ones


Your investee start-up, just like many before it, has probably felt tempted to go for the "easy-to-acquire" clients, as it gave the initial momentum to operations and helped attain scale in client count. But such clients come with their own risk, the most important being them delaying their payments. After all, there is a reason why they were easy to acquire in the first place. The resultant cash flow issues end up causing frequent calls for fresh capital, despite adding to the clients served. A start-up needs to find a common thread between such clients based on their profile, background, size, solvency and management's attitudes. Such clients need to be dropped, since even the lure of repeat business amounts to nought.

A start-up needs to analyze its clients to identify a common thread amongst those who do give their payments on time... It should re-focus on such clients.

Conversely, a start-up needs to analyze its clients to identify a common thread amongst those who do give their payments on time, or where the delay was not intentional. It should re-focus on such clients since they mean fewer cash flow worries--even if this means lower client numbers. This may include re-setting the target clients to those willing to pay advance, or at least a portion upfront. Such clients are better for long-term profitable growth, since the advance locks in the client's interest plus the upfront cash helps the start-up meet part of its own financing needs internally.

Cash-flow is important since several start-ups have lost cash for investors for years despite promises of reaching break-even, and now the focus of early-stage investors has moved acutely to profitability and cash management. An exception to dropping delaying clients will be if such a client introduced/referred the start-up to further departments/companies for fresh business. In such cases, your start-up needs to take a call if that client's referrals are worth enough to retain it.

Tracking project-wise cost and profitability


Your start-up started its journey by doing a whole lot of projects as the priority was to build credentials. Nonetheless, every project may not have been profitable. But how does one gauge that? After all, unprofitable projects would eventually have to be told a polite "no". The start-up should be putting in place a tracker of costs (salary and opex) as per the "average time spent in an average month" across various projects. Such an activity-based costing is one of the easier methods to roughly gauge estimated profitability per project.

The start-up should be putting in place a tracker of costs (salary and opex) as per the "average time spent in an average month" across various projects.

If your start-up has a threshold margin in mind, then it can see which projects crossed that. It will also give an indication of where, and which, costs have to be cut. Otherwise, an across-the-board cost-cutting would only reduce the output and motivation of those working on the profitable projects, which would be disastrous. Hence, it needs to cherry-pick for specific areas where costs need to be rationalized. In situations where costs cannot be controlled further, the only way is to increase revenue through higher value projects. Hence, the start-up would need to refocus its USP and pitch to garner such higher value business.

Cementing appropriate partnerships


It is not just about selling to the end-client. Rather, it is also about getting into the value-chain of an existing large enterprise or a supplier in a B2B/sub-contract relationship. Your start-up should be looking to get into an arrangement with a supplier such that it becomes its front-end, and their combination becomes a one-stop solution to the end-client. In such a situation, the supplier may also be agreeable to extend his material on credit for a time period, which would benefit your start-up. Without such a relationship, the start-up would need to cough up adequate cash to pay for the material upon supply. That, in itself, would take care of working capital to some extent.

There could also be partnerships with those who would give funding to retail end-clients to buy the start-up's products by boosting purchasing power (for example, loan companies).

Alternatively, your start-up should be looking to get into a partnership with similar players in other geographical regions for reciprocal work in each other's regions. This way, it can source and add projects to its portfolio in new regions, without the need to invest in offices. Partnerships also include getting a piece of work from the value-chain of a large player through sub-contracting arrangements, as that would give it a chance to participate in larger projects and build relationships with the big boys. There could also be partnerships with those who would give funding to retail end-clients to buy the start-up's products by boosting purchasing power (for example, loan companies).

Adding big banners periodically to the portfolio


Names matter, and brand names matter even more! Your start-up may be doing several small projects or working with several small clients; but it should start targeting at least one or two big projects/clients in a quarter. Let the quarter be the target, as only then will it be achieved in a half-year.

This has two advantages:

(1) It will add larger projects and clients to its portfolio.

(2) Investors and corporate clients will pay more attention once it says it works on the big names.

This may mean saying "no" to smaller clients once in a while, but one needs to remember that profitability almost always comes from the larger clients due to economies of scale. Hence, your start-up has to start thinking big in terms of adding projects and clients.

Communicating the big picture, and its strategy to grab it


Your start-up needs to reasonably quantify the industry opportunity and current penetration that exists in its sector. That may mean working on making reasonable assumptions and estimates. Showing the industry opportunity will communicate the big picture in the minds of the investors from whom it will raise subsequent rounds of funding. This should also come out in its communication collaterals as well as in discussions during investor meetings/con-calls.

Your start-up needs to reasonably quantify the industry opportunity and current penetration that exists in its sector.

What would also interest investors from whom it would raise subsequent rounds of funding, is how the start-up's management are making strategic changes to improve the company's performance and how it expects those changes to make a measurable impact. Even if such changes are yet to be implemented, conveying the management's thought process on them is important. The start-up may also release regular newsletters in concise bullet-points which summarizes the incremental work done towards its strategic changes. In most sectors, there are already too many companies vying for prospective investors' mindshare, and such communications would help keep its brand name in the memory of investors.

Taking time out to introspect regularly


One common issue most start-ups face is that all its founders/leadership are involved hands-on operationally. This leaves very little time to actually sit back and analyze the projects, clients, profitability, prospects, etc (which relates to the above 5 points). Hence, the senior team of your start-up should be making a concerted effort to meet at least once a week, solely to discuss and analyze where the enterprise has reached and where it aims to be, rather than doing only operations 24X7. This time may also be somewhere out of office since a change of environment often works wonders in making people think afresh.

In conclusion, these points are part of the bigger goal of ensuring your start-up succeeds and delivers the returns to you as an investor. Unfortunately, many often put these points on the back-burner in their earnestness to work on daily operations. But these are critical things each start-up must do eventually.

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