WEBVTT
00:00:00.400 --> 00:00:01.280
Hello everyone.
00:00:01.600 --> 00:00:07.200
Welcome to another edition of the Timeless Wisdom episode of the Contra Minds podcast.
00:00:08.320 --> 00:00:15.919
In this episode, I'm revisiting my conversation with Sham Shaker, founder and CIO of iThought PMS.
00:00:17.039 --> 00:00:23.359
Sham has over fifteen years of experience in investment management and is also an angel investor.
00:00:24.640 --> 00:00:37.600
His keen eye for identifying potential startup ideas, promising founders, and backing them with patient capital is something that I found different from many investors that I've met and interacted with.
00:00:38.560 --> 00:00:49.119
His views about capital, evaluation, and entrepreneurship are all grounded in reality, which is something that I find as a rarity in many investors I mean.
00:00:50.479 --> 00:00:59.759
In the first part of this episode, Sean specifically focused on the fact that capital is not a fuel to chase, it's a tool to be structured.
00:01:00.960 --> 00:01:11.120
He shares his ideas on the importance of proof of concept thinking to discipline and dilution and cash flow awareness for founders and entrepreneurs.
00:01:12.319 --> 00:01:18.799
This episode offers a first principle lens on how entrepreneurs and founders should approach money.
00:01:19.359 --> 00:01:24.239
Let's dive in and listen to Sham and his thoughts in the Timeless Wisdom episode.
00:01:41.040 --> 00:01:48.079
Hi Sham, thanks a lot, and uh thanks very much for uh giving us time and talking to us on this podcast.
00:01:48.400 --> 00:01:49.280
My pleasure, Sami.
00:01:51.040 --> 00:02:10.080
Um Sham, uh, one of the most important things that I found interesting about what you do today is really a contra view that you have about investments, about portfolios, about the way you go about investing, and that's something that uh you know we found really interesting.
00:02:10.319 --> 00:02:31.840
And uh, you're also an angel investor, you look at startups, you look at how startups get funded, uh, how entrepreneurs need to really look at capital, and you have really uh different views about how normally this gets done in this era and probably how it has to be done from first principles, right?
00:02:35.840 --> 00:02:59.840
So I think the first question uh that I wanted to uh really uh start up this conversation, Sham, is uh, you know, in your in your opinion, if I were an entrepreneur and if I actually were doing a startup, uh how should I understand the word capital that is the most important fuel for a business or an enterprise?
00:03:00.159 --> 00:03:02.240
Typically, entrepreneurs come with ideas.
00:03:02.479 --> 00:03:07.599
So entrepreneurs know that they want to do something, they're very clear that they want to do this.
00:03:08.319 --> 00:03:18.319
Um, but for them to do what they want to do and to prove the idea, what we call as a proof of concept, they need capital first.
00:03:18.560 --> 00:03:27.840
So, capital is something that bridges an idea to a proof of concept, that's the first bridge.
00:03:28.000 --> 00:03:44.400
Okay, so capital for an entrepreneur at the starting point is money that will help him prove that his idea is good, it is scalable, and it can be taken to a next level.
00:03:44.719 --> 00:03:52.719
So, beyond that, at the starting point, an entrepreneur need not unduly worry about uh capital.
00:03:52.800 --> 00:03:53.680
That's the first point.
00:03:53.759 --> 00:03:58.159
Because if you are right, then you there are going to be believers in your idea.
00:03:58.400 --> 00:04:01.120
If you are wrong, you will probably move to the next idea.
00:04:01.199 --> 00:04:15.039
And we also have many entrepreneurs who tried ideas which did not do well, and then they went on to do more ideas which went on to become hugely successful.
00:04:15.280 --> 00:04:22.959
So, capital is merely the bridge between an idea and the proof of concept stage.
00:04:23.759 --> 00:04:24.399
Great.
00:04:28.000 --> 00:04:38.160
So, literally, uh, you know, when you look at this whole uh startup ecosystem that's actually uh you know got a lot of hype nowadays.
00:04:38.399 --> 00:04:55.199
Uh, normally it is said that uh you know equity capital is the most expensive, and uh you know you don't give away uh so much of equity capital at the start, uh, but that does not seem to be the general philosophy nowadays, right?
00:04:55.279 --> 00:05:04.399
So they just go out and say, okay, let me raise as much capital at uh you know whether it's an early stage or whether you are at a seats seed stage.
00:05:04.560 --> 00:05:15.839
So, how is the thinking on equity capital changed over maybe your generation to this uh you know uh Gen Z or millennial generation?
00:05:16.319 --> 00:05:27.519
Firstly, um in the earlier Avatars, equity capital once diluted, could not be reset.
00:05:28.079 --> 00:05:29.519
That is the first point.
00:05:30.560 --> 00:05:46.240
Today, entrepreneurs bring value to companies, which is something which will evolve, it's not set at the dilution stage, it can always be changed subsequently as well.
00:05:47.120 --> 00:06:00.480
But the dilution of equity as a concept has always been a problem area, whether it was in a different era or in the present era, it is always difficult.
00:06:01.040 --> 00:06:06.160
Earlier, we used to see people overdo the dilution.
00:06:06.319 --> 00:06:11.680
If I look at companies which started 9-10 years back, I see that the dilution is excessive.
00:06:12.079 --> 00:06:26.399
You will have a financial investor straight away owning some 30% today, even after multiple dilutions, which is in my view not reasonable, especially if you are just given one-time money, right?
00:06:26.959 --> 00:06:40.879
But today it's the other extreme, you are seeing very low dilution as a result of which a lot of money has already gone into a business and the outcome is not significant.
00:06:41.279 --> 00:06:59.600
So, in the earlier era where there has been higher dilution of the founders, we are seeing cases where the outcomes are better, and in a latter era or in more recent times where there is lesser dilution for more capital going in, the outcomes are really not so great.
00:06:59.839 --> 00:07:09.279
So the difference really is that earlier it was an excess on one extreme, and today it's probably an excess on the other extreme.
00:07:09.439 --> 00:07:24.879
Ideally, there should be a middle ground or somewhere closer to the middle ground, which will make this whole process of diluting capital of a founder, giving them growth capital, and then seeing outcomes more meaningful and productive.
00:07:24.959 --> 00:07:27.519
So, there is still a lot of ground to be covered there.
00:07:27.680 --> 00:07:36.480
Also, one more thing is that uh dilution must be more critically aligned to outcomes.
00:07:36.639 --> 00:07:51.120
I think that would be a better way to manage this because uh, if somebody has shown the outcome or he has exceeded what he has sought to create, then the dilution should be fair to the person who has performed.
00:07:51.360 --> 00:08:04.399
And if somebody has given more capital than he ought to have, and if the performance is lagging, then he needs to be uh penalized or the capital should be adequately priced, appropriately priced.
00:08:04.480 --> 00:08:06.959
So this balance has to happen.
00:08:10.480 --> 00:08:19.040
Okay, so clearly uh you know there are multiple uh uh you know uh ways in which today you can raise capital, right?
00:08:19.199 --> 00:08:27.199
So today you have uh you know uh you know warrants, you have convertible debt, you have uh equity financing.
00:08:27.439 --> 00:08:42.480
So uh if I am a company at a very very early stage, uh how should I look at uh my capital requirements and what are the best forms of early stage capital uh you know fundraise?
00:08:42.639 --> 00:08:48.480
What would you think is fair for uh an early stage startup enterprise?
00:08:48.720 --> 00:08:58.000
I think that would entirely depend on the gestation of the idea, the structure of the business, uh, what is the financial structure of the business?
00:08:58.159 --> 00:09:04.000
Assume that you are in a business where you don't have too much requirement of working capital.
00:09:04.320 --> 00:09:15.840
For example, your customers give you an advance, you deliver a product or a service over a period of time, then you could well be funded by the working capital itself.
00:09:16.320 --> 00:09:16.720
Right?
00:09:16.879 --> 00:09:19.360
So you have to understand the structure of the business.
00:09:19.519 --> 00:09:25.600
You also have to explore whether the business you are going to do can be done differently from conventional base.
00:09:25.919 --> 00:09:27.519
So, give me some example.
00:09:27.840 --> 00:09:37.440
There are businesses where you deliver a service and then you collect the money at the end of delivery of the service.
00:09:37.840 --> 00:09:40.879
Let's say you are giving a one-year service to somebody.
00:09:41.120 --> 00:09:43.840
Today you have digital payments.
00:09:44.559 --> 00:09:49.600
Can you change the terms of contract where they always just give you one month payment in advance?
00:09:51.360 --> 00:09:56.639
Okay, as you deliver, they pay almost.
00:09:56.799 --> 00:10:10.720
Okay, so if the structure of the business can be changed, let us say you incentivize the person, it's like newspapers collect three year subscription in advance, it's capital, right?
00:10:11.200 --> 00:10:15.120
Similarly, digital media can also do it, it's capital, right?
00:10:15.279 --> 00:10:24.879
So for every business, there will be an alternate way which we have not explored, which can become a source of capital.
00:10:25.600 --> 00:10:34.559
So if we can change the way we do business, that itself can also change the way we structure our capital.
00:10:36.480 --> 00:10:42.000
So effectively, we should look at ways of doing business first.
00:10:42.159 --> 00:10:44.799
Is this the most optimal way to do business?
00:10:45.039 --> 00:10:46.960
Can we do it better?
00:10:47.200 --> 00:10:55.759
And once we are arrived at the most optimal way to do the business we want to do, then we estimate how much capital we require.
00:10:57.200 --> 00:11:02.240
Then we understand whether we will be needing that capital permanently.
00:11:02.399 --> 00:11:03.519
That is the next question.
00:11:03.600 --> 00:11:15.600
Suppose I am going to do a business where in three years I will scale myself so much that after that cash flows will be sufficient to run my business and my business will give cash back to me.
00:11:16.000 --> 00:11:32.320
Then should I go for excess dilution of equity or should I have some optionally convertible equity with a reasonable horizon where I give the investor cover of debt and then decide whether it should become equity or be returned.
00:11:33.039 --> 00:11:47.679
So all this structuring should be done, keeping in mind the nature of the business, my expectations of when the business will become self-sufficient, and whether I really require permanent capital.
00:11:50.159 --> 00:11:57.360
I think once we understand these things, then we decide what is the best financial structure for the company.
00:11:58.240 --> 00:11:59.919
Brilliant, brilliant.
00:12:02.000 --> 00:12:13.519
Blindly raising money because it's available may not be a smart thing because somebody who understands your business better than you may actually overpay in the near term to take a higher stake.
00:12:14.399 --> 00:12:22.720
And you will realize this after three, four years, and there is no comeback after that.
00:12:24.720 --> 00:12:36.799
In a number of businesses which don't require capital after they stabilize in two, three years, you see that the damage of dilution is done at the early stage itself.
00:12:39.600 --> 00:12:46.879
Okay, so therefore, we should have a very clear understanding of the financial structure of the business.
00:12:47.360 --> 00:12:52.960
Be sure that you are doing business the right way and in the best or most optimal way.
00:12:53.120 --> 00:12:55.440
Is there a better way of doing your business?
00:12:55.840 --> 00:12:58.639
Uh is there a new way to do the same old business?
00:12:58.799 --> 00:13:03.200
Because that is also something that has created a lot of opportunities for many startups.
00:13:03.600 --> 00:13:07.919
And then you figure out what is the capital structure.
00:13:08.320 --> 00:13:14.240
ContraMinds is a podcast dedicated to decoding people, minds, strategy, and culture.
00:13:14.559 --> 00:13:22.159
We interview and learn from high performers so that you can apply these lessons on your journey to becoming the knowledge worker athlete you were meant to be.
00:13:22.320 --> 00:13:26.000
The Contraminds Podcast is available on all leading podcast players.
00:13:26.080 --> 00:13:35.440
And if you are interested in revisiting past episodes or taking a look at our show notes from this episode, please visit us at www.contraminds.com.
00:13:35.759 --> 00:13:38.080
And now back to the show.
00:13:40.879 --> 00:14:08.320
So one of the key questions then which comes up next, Sham, is that uh today is a day where uh you know you're almost uh in this period, five people come together to start up a company, and you know they may be friends in college or they may be working somewhere else, they have an idea, they come together, and literally this discussion around uh you know how do you distribute a founder's equity?
00:14:08.480 --> 00:14:12.399
Okay, is a very touchy topic because you know, do I bring in the strength?
00:14:12.639 --> 00:14:14.159
Do you bring in the strength?
00:14:14.399 --> 00:14:23.120
And this is something that is discussed discussed to death uh by Y Combinator to you know lots of uh you know great investors.
00:14:23.279 --> 00:14:40.639
So uh so if I'm really looking at uh distributing equity between startup founders, what do you think are the basic principles around which you distribute it so that you know you're building something whether for instant gratification for various things that you mentioned in the past?
00:14:40.720 --> 00:14:49.679
Uh so how do you really look at distribution of equity amongst founders and what are the best practices and principles that you believe we should follow?
00:14:50.799 --> 00:14:56.159
I think when you say five people, I am immediately going back to the Mahavartha and reminder to the Pandavas.
00:14:56.639 --> 00:15:04.399
But uh, it's a difficult question because when you start as five people, I'm giving an example because I've seen one example.
00:15:04.559 --> 00:15:28.559
The natural tendency is to start with everybody being equal because it's a very easy decision to arrive at at the starting point, but that decision may not stand the test of time because over time you start realizing that a few people are more important to the organization, or a few people are not as important as others.
00:15:28.799 --> 00:15:41.600
So then what happens is the motivation levels of those who are more important tends to be less than the others, or tends to be less than what it ought to be.
00:15:41.919 --> 00:15:57.039
This is like equally true of family businesses where there are multiple stakeholders, and my lesson comes from there because I have operated in that environment as well.
00:15:57.600 --> 00:16:02.240
I think that this is a very, very difficult area.
00:16:02.399 --> 00:16:22.720
There are no simple solutions to this because when you start a venture, I think that to have a fair conversation about who is going to bring what and who should be given a better position in the venture is not easy, but we need to find that answer.
00:16:23.679 --> 00:16:28.639
Basically, I think that setting it correctly in the beginning is very, very critical.
00:16:28.799 --> 00:16:34.559
Taking this idealist approach of all five are equal is not going to work.
00:16:34.879 --> 00:16:35.200
Okay.
00:16:37.039 --> 00:16:53.919
I think that you should have a separate pool from which the contributors will be rewarded subsequently, and there should be well-established metrics of how these rewards are going to happen instead of simply taking all five are equal approach.
00:16:54.399 --> 00:17:01.919
Same at the same time, I think that we should not make it too lopsided either.
00:17:02.240 --> 00:17:13.519
So I think that having an approach to evaluate this fairly and get it accepted by everybody is critical to organizations where there are multiple founders.
00:17:14.240 --> 00:17:30.559
So I think that you should have some mechanism to do this with people who are impartial and objective to help you along the way to you know carry this decision fairly and to take it forward.
00:17:31.119 --> 00:17:34.240
You should not get stuck after making a decision.
00:17:34.400 --> 00:17:35.920
That's very, very critical.
00:17:36.480 --> 00:17:57.359
We should have a mechanism to not only start the process but also to run the process of stake distribution among founders until it reaches a steady state, and to ensure that you reach that steady state with a feeling of fairness, that is very important.
00:17:57.599 --> 00:18:05.119
Only then they will stay together, otherwise, we are going to see things dissipate or move away from each other.
00:18:08.400 --> 00:18:31.039
So uh Sham, uh, when you're really talking about uh you know angel investing, when you're talking about putting money in companies, uh the current uh trend is let me raise money uh for my business because money is available versus my business really needs money.
00:18:31.279 --> 00:18:35.119
Okay uh we seem to be seeing more of the first trend.
00:18:35.680 --> 00:18:56.480
Uh so therefore, how does it uh affect businesses and uh therefore uh you know when should I really trigger my fundraise and how should I uh how should I look at it uh from uh enough cash in my bank versus what cash my business needs?
00:18:56.640 --> 00:19:01.359
How do you really balance this and what what mistakes are people making today?
00:19:02.000 --> 00:19:12.079
I think that when people raise money which they don't need, I have seen one universal trade, it tends to get squandered.
00:19:13.599 --> 00:19:25.599
The second point is that when you raise too much money at that point, you think that you are diluting less.
00:19:26.880 --> 00:19:50.480
But you are taking away the right to dilute in future because if you dilute at a valuation which is unreasonable, people will hesitate to again give you capital even when the valuation becomes more reason because they see that you have not handled the capital well.
00:19:51.519 --> 00:19:54.960
So there is a problem you are setting yourself up for.
00:19:55.039 --> 00:20:06.720
So it's very important that when you raise money, you raise money which you really need and money on which you are reasonably sure of delivery.
00:20:07.200 --> 00:20:54.240
Yes, you have the option of raising some more money, you can raise a little more than what you require if you want a slightly longer runway, but don't raise too much money just because money is available, because the risk of capital going into unproductive areas and leading to destruction of capital is very high, and this has happened time and again whenever I have seen companies which are in the listed space raise money when capital is easily available, whether it was the 94 GDR rush or even the current VC-driven raising of huge sums of money by the unicorns.
00:20:55.039 --> 00:21:17.359
I am seeing that after raising so many millions of dollars, within 12 months the company is again coming and trying to raise venture debt because it is not able to raise equity at the same valuation it has raised last time, and it's still hungry for capital because that capital has been misallocated.
00:21:17.599 --> 00:21:22.400
We are seeing that happen in multiple Indian unicorns today.
00:21:24.799 --> 00:21:31.440
Now, this is a road to destruction clearly.
00:21:31.759 --> 00:21:46.160
So, how you raise money is not just about that one race, it sets the context and trajectory for the future of your entrepreneurial journey itself and the future of your enterprise.
00:21:46.400 --> 00:21:59.759
So it's very important that you are going to think of a scenario when things may become difficult, and you should be able to raise money at that point if the need be.
00:22:00.799 --> 00:22:19.359
Raise money now, or whenever you raise money, remember that you should always maintain that optionality to raise another round, and you should be reasonable enough to be accepted by investors at that time.
00:22:19.680 --> 00:22:27.440
If you do unreasonable things, then later you are not going to get acceptability.
00:22:27.839 --> 00:22:32.720
In fact, people may actually not reach out to you at all.
00:22:32.799 --> 00:22:40.559
So, in the sense, you will isolate yourself, and that is a risk which one should never run in this entrepreneurial life.
00:22:40.720 --> 00:22:46.559
Things may go right, wrong, but people should be again willing to come and give you their trusted capital.
00:22:46.799 --> 00:22:52.000
So, whenever you raise capital, think about this that is there another time.
00:22:52.319 --> 00:23:00.799
Don't act as if this is the last time, it's never going to be a now or never situation.
00:23:01.440 --> 00:23:12.000
And if you think it is now or never, you are going to set yourself up for a never-again situation where you will never be able to do it again.
00:23:12.079 --> 00:23:14.960
So that is something which is a real risk today.
00:23:15.119 --> 00:23:23.440
I know the last two years have been very lucky for a lot of people, but from here I think that we are again reverting to mean or moving in that direction.
00:23:23.519 --> 00:23:25.359
So one should be very, very careful.
00:23:28.799 --> 00:23:31.119
Thanks for listening to this episode.
00:23:31.359 --> 00:23:38.079
For selected links and detailed show notes, visit www.contramines.com.
00:23:38.240 --> 00:23:43.839
Follow Contraminds on social media and let us know who you would like to see next on the podcast.
00:23:44.079 --> 00:23:49.359
If you are listening to Contramines on Apple Podcasts, do share your comments and give us a rating.
00:23:49.599 --> 00:23:51.599
We are keen to know what you're thinking.
00:23:51.920 --> 00:23:54.480
Contramines is also on YouTube.
00:23:54.960 --> 00:24:01.599
If you are listening to the podcast on YouTube, hit the subscribe button and stay up to date on all our releases.
00:24:01.920 --> 00:24:04.319
Thanks for listening and stay safe.
00:00:00.400 --> 00:00:01.280
Hello everyone.
00:00:01.600 --> 00:00:07.200
Welcome to another edition of the Timeless Wisdom episode of the Contra Minds podcast.
00:00:08.320 --> 00:00:15.919
In this episode, I'm revisiting my conversation with Sham Shaker, founder and CIO of iThought PMS.
00:00:17.039 --> 00:00:23.359
Sham has over fifteen years of experience in investment management and is also an angel investor.
00:00:24.640 --> 00:00:37.600
His keen eye for identifying potential startup ideas, promising founders, and backing them with patient capital is something that I found different from many investors that I've met and interacted with.
00:00:38.560 --> 00:00:49.119
His views about capital, evaluation, and entrepreneurship are all grounded in reality, which is something that I find as a rarity in many investors I mean.
00:00:50.479 --> 00:00:59.759
In the first part of this episode, Sean specifically focused on the fact that capital is not a fuel to chase, it's a tool to be structured.
00:01:00.960 --> 00:01:11.120
He shares his ideas on the importance of proof of concept thinking to discipline and dilution and cash flow awareness for founders and entrepreneurs.
00:01:12.319 --> 00:01:18.799
This episode offers a first principle lens on how entrepreneurs and founders should approach money.
00:01:19.359 --> 00:01:24.239
Let's dive in and listen to Sham and his thoughts in the Timeless Wisdom episode.
00:01:41.040 --> 00:01:48.079
Hi Sham, thanks a lot, and uh thanks very much for uh giving us time and talking to us on this podcast.
00:01:48.400 --> 00:01:49.280
My pleasure, Sami.
00:01:51.040 --> 00:02:10.080
Um Sham, uh, one of the most important things that I found interesting about what you do today is really a contra view that you have about investments, about portfolios, about the way you go about investing, and that's something that uh you know we found really interesting.
00:02:10.319 --> 00:02:31.840
And uh, you're also an angel investor, you look at startups, you look at how startups get funded, uh, how entrepreneurs need to really look at capital, and you have really uh different views about how normally this gets done in this era and probably how it has to be done from first principles, right?
00:02:35.840 --> 00:02:59.840
So I think the first question uh that I wanted to uh really uh start up this conversation, Sham, is uh, you know, in your in your opinion, if I were an entrepreneur and if I actually were doing a startup, uh how should I understand the word capital that is the most important fuel for a business or an enterprise?
00:03:00.159 --> 00:03:02.240
Typically, entrepreneurs come with ideas.
00:03:02.479 --> 00:03:07.599
So entrepreneurs know that they want to do something, they're very clear that they want to do this.
00:03:08.319 --> 00:03:18.319
Um, but for them to do what they want to do and to prove the idea, what we call as a proof of concept, they need capital first.
00:03:18.560 --> 00:03:27.840
So, capital is something that bridges an idea to a proof of concept, that's the first bridge.
00:03:28.000 --> 00:03:44.400
Okay, so capital for an entrepreneur at the starting point is money that will help him prove that his idea is good, it is scalable, and it can be taken to a next level.
00:03:44.719 --> 00:03:52.719
So, beyond that, at the starting point, an entrepreneur need not unduly worry about uh capital.
00:03:52.800 --> 00:03:53.680
That's the first point.
00:03:53.759 --> 00:03:58.159
Because if you are right, then you there are going to be believers in your idea.
00:03:58.400 --> 00:04:01.120
If you are wrong, you will probably move to the next idea.
00:04:01.199 --> 00:04:15.039
And we also have many entrepreneurs who tried ideas which did not do well, and then they went on to do more ideas which went on to become hugely successful.
00:04:15.280 --> 00:04:22.959
So, capital is merely the bridge between an idea and the proof of concept stage.
00:04:23.759 --> 00:04:24.399
Great.
00:04:28.000 --> 00:04:38.160
So, literally, uh, you know, when you look at this whole uh startup ecosystem that's actually uh you know got a lot of hype nowadays.
00:04:38.399 --> 00:04:55.199
Uh, normally it is said that uh you know equity capital is the most expensive, and uh you know you don't give away uh so much of equity capital at the start, uh, but that does not seem to be the general philosophy nowadays, right?
00:04:55.279 --> 00:05:04.399
So they just go out and say, okay, let me raise as much capital at uh you know whether it's an early stage or whether you are at a seats seed stage.
00:05:04.560 --> 00:05:15.839
So, how is the thinking on equity capital changed over maybe your generation to this uh you know uh Gen Z or millennial generation?
00:05:16.319 --> 00:05:27.519
Firstly, um in the earlier Avatars, equity capital once diluted, could not be reset.
00:05:28.079 --> 00:05:29.519
That is the first point.
00:05:30.560 --> 00:05:46.240
Today, entrepreneurs bring value to companies, which is something which will evolve, it's not set at the dilution stage, it can always be changed subsequently as well.
00:05:47.120 --> 00:06:00.480
But the dilution of equity as a concept has always been a problem area, whether it was in a different era or in the present era, it is always difficult.
00:06:01.040 --> 00:06:06.160
Earlier, we used to see people overdo the dilution.
00:06:06.319 --> 00:06:11.680
If I look at companies which started 9-10 years back, I see that the dilution is excessive.
00:06:12.079 --> 00:06:26.399
You will have a financial investor straight away owning some 30% today, even after multiple dilutions, which is in my view not reasonable, especially if you are just given one-time money, right?
00:06:26.959 --> 00:06:40.879
But today it's the other extreme, you are seeing very low dilution as a result of which a lot of money has already gone into a business and the outcome is not significant.
00:06:41.279 --> 00:06:59.600
So, in the earlier era where there has been higher dilution of the founders, we are seeing cases where the outcomes are better, and in a latter era or in more recent times where there is lesser dilution for more capital going in, the outcomes are really not so great.
00:06:59.839 --> 00:07:09.279
So the difference really is that earlier it was an excess on one extreme, and today it's probably an excess on the other extreme.
00:07:09.439 --> 00:07:24.879
Ideally, there should be a middle ground or somewhere closer to the middle ground, which will make this whole process of diluting capital of a founder, giving them growth capital, and then seeing outcomes more meaningful and productive.
00:07:24.959 --> 00:07:27.519
So, there is still a lot of ground to be covered there.
00:07:27.680 --> 00:07:36.480
Also, one more thing is that uh dilution must be more critically aligned to outcomes.
00:07:36.639 --> 00:07:51.120
I think that would be a better way to manage this because uh, if somebody has shown the outcome or he has exceeded what he has sought to create, then the dilution should be fair to the person who has performed.
00:07:51.360 --> 00:08:04.399
And if somebody has given more capital than he ought to have, and if the performance is lagging, then he needs to be uh penalized or the capital should be adequately priced, appropriately priced.
00:08:04.480 --> 00:08:06.959
So this balance has to happen.
00:08:10.480 --> 00:08:19.040
Okay, so clearly uh you know there are multiple uh uh you know uh ways in which today you can raise capital, right?
00:08:19.199 --> 00:08:27.199
So today you have uh you know uh you know warrants, you have convertible debt, you have uh equity financing.
00:08:27.439 --> 00:08:42.480
So uh if I am a company at a very very early stage, uh how should I look at uh my capital requirements and what are the best forms of early stage capital uh you know fundraise?
00:08:42.639 --> 00:08:48.480
What would you think is fair for uh an early stage startup enterprise?
00:08:48.720 --> 00:08:58.000
I think that would entirely depend on the gestation of the idea, the structure of the business, uh, what is the financial structure of the business?
00:08:58.159 --> 00:09:04.000
Assume that you are in a business where you don't have too much requirement of working capital.
00:09:04.320 --> 00:09:15.840
For example, your customers give you an advance, you deliver a product or a service over a period of time, then you could well be funded by the working capital itself.
00:09:16.320 --> 00:09:16.720
Right?
00:09:16.879 --> 00:09:19.360
So you have to understand the structure of the business.
00:09:19.519 --> 00:09:25.600
You also have to explore whether the business you are going to do can be done differently from conventional base.
00:09:25.919 --> 00:09:27.519
So, give me some example.
00:09:27.840 --> 00:09:37.440
There are businesses where you deliver a service and then you collect the money at the end of delivery of the service.
00:09:37.840 --> 00:09:40.879
Let's say you are giving a one-year service to somebody.
00:09:41.120 --> 00:09:43.840
Today you have digital payments.
00:09:44.559 --> 00:09:49.600
Can you change the terms of contract where they always just give you one month payment in advance?
00:09:51.360 --> 00:09:56.639
Okay, as you deliver, they pay almost.
00:09:56.799 --> 00:10:10.720
Okay, so if the structure of the business can be changed, let us say you incentivize the person, it's like newspapers collect three year subscription in advance, it's capital, right?
00:10:11.200 --> 00:10:15.120
Similarly, digital media can also do it, it's capital, right?
00:10:15.279 --> 00:10:24.879
So for every business, there will be an alternate way which we have not explored, which can become a source of capital.
00:10:25.600 --> 00:10:34.559
So if we can change the way we do business, that itself can also change the way we structure our capital.
00:10:36.480 --> 00:10:42.000
So effectively, we should look at ways of doing business first.
00:10:42.159 --> 00:10:44.799
Is this the most optimal way to do business?
00:10:45.039 --> 00:10:46.960
Can we do it better?
00:10:47.200 --> 00:10:55.759
And once we are arrived at the most optimal way to do the business we want to do, then we estimate how much capital we require.
00:10:57.200 --> 00:11:02.240
Then we understand whether we will be needing that capital permanently.
00:11:02.399 --> 00:11:03.519
That is the next question.
00:11:03.600 --> 00:11:15.600
Suppose I am going to do a business where in three years I will scale myself so much that after that cash flows will be sufficient to run my business and my business will give cash back to me.
00:11:16.000 --> 00:11:32.320
Then should I go for excess dilution of equity or should I have some optionally convertible equity with a reasonable horizon where I give the investor cover of debt and then decide whether it should become equity or be returned.
00:11:33.039 --> 00:11:47.679
So all this structuring should be done, keeping in mind the nature of the business, my expectations of when the business will become self-sufficient, and whether I really require permanent capital.
00:11:50.159 --> 00:11:57.360
I think once we understand these things, then we decide what is the best financial structure for the company.
00:11:58.240 --> 00:11:59.919
Brilliant, brilliant.
00:12:02.000 --> 00:12:13.519
Blindly raising money because it's available may not be a smart thing because somebody who understands your business better than you may actually overpay in the near term to take a higher stake.
00:12:14.399 --> 00:12:22.720
And you will realize this after three, four years, and there is no comeback after that.
00:12:24.720 --> 00:12:36.799
In a number of businesses which don't require capital after they stabilize in two, three years, you see that the damage of dilution is done at the early stage itself.
00:12:39.600 --> 00:12:46.879
Okay, so therefore, we should have a very clear understanding of the financial structure of the business.
00:12:47.360 --> 00:12:52.960
Be sure that you are doing business the right way and in the best or most optimal way.
00:12:53.120 --> 00:12:55.440
Is there a better way of doing your business?
00:12:55.840 --> 00:12:58.639
Uh is there a new way to do the same old business?
00:12:58.799 --> 00:13:03.200
Because that is also something that has created a lot of opportunities for many startups.
00:13:03.600 --> 00:13:07.919
And then you figure out what is the capital structure.
00:13:08.320 --> 00:13:14.240
ContraMinds is a podcast dedicated to decoding people, minds, strategy, and culture.
00:13:14.559 --> 00:13:22.159
We interview and learn from high performers so that you can apply these lessons on your journey to becoming the knowledge worker athlete you were meant to be.
00:13:22.320 --> 00:13:26.000
The Contraminds Podcast is available on all leading podcast players.
00:13:26.080 --> 00:13:35.440
And if you are interested in revisiting past episodes or taking a look at our show notes from this episode, please visit us at www.contraminds.com.
00:13:35.759 --> 00:13:38.080
And now back to the show.
00:13:40.879 --> 00:14:08.320
So one of the key questions then which comes up next, Sham, is that uh today is a day where uh you know you're almost uh in this period, five people come together to start up a company, and you know they may be friends in college or they may be working somewhere else, they have an idea, they come together, and literally this discussion around uh you know how do you distribute a founder's equity?
00:14:08.480 --> 00:14:12.399
Okay, is a very touchy topic because you know, do I bring in the strength?
00:14:12.639 --> 00:14:14.159
Do you bring in the strength?
00:14:14.399 --> 00:14:23.120
And this is something that is discussed discussed to death uh by Y Combinator to you know lots of uh you know great investors.
00:14:23.279 --> 00:14:40.639
So uh so if I'm really looking at uh distributing equity between startup founders, what do you think are the basic principles around which you distribute it so that you know you're building something whether for instant gratification for various things that you mentioned in the past?
00:14:40.720 --> 00:14:49.679
Uh so how do you really look at distribution of equity amongst founders and what are the best practices and principles that you believe we should follow?
00:14:50.799 --> 00:14:56.159
I think when you say five people, I am immediately going back to the Mahavartha and reminder to the Pandavas.
00:14:56.639 --> 00:15:04.399
But uh, it's a difficult question because when you start as five people, I'm giving an example because I've seen one example.
00:15:04.559 --> 00:15:28.559
The natural tendency is to start with everybody being equal because it's a very easy decision to arrive at at the starting point, but that decision may not stand the test of time because over time you start realizing that a few people are more important to the organization, or a few people are not as important as others.
00:15:28.799 --> 00:15:41.600
So then what happens is the motivation levels of those who are more important tends to be less than the others, or tends to be less than what it ought to be.
00:15:41.919 --> 00:15:57.039
This is like equally true of family businesses where there are multiple stakeholders, and my lesson comes from there because I have operated in that environment as well.
00:15:57.600 --> 00:16:02.240
I think that this is a very, very difficult area.
00:16:02.399 --> 00:16:22.720
There are no simple solutions to this because when you start a venture, I think that to have a fair conversation about who is going to bring what and who should be given a better position in the venture is not easy, but we need to find that answer.
00:16:23.679 --> 00:16:28.639
Basically, I think that setting it correctly in the beginning is very, very critical.
00:16:28.799 --> 00:16:34.559
Taking this idealist approach of all five are equal is not going to work.
00:16:34.879 --> 00:16:35.200
Okay.
00:16:37.039 --> 00:16:53.919
I think that you should have a separate pool from which the contributors will be rewarded subsequently, and there should be well-established metrics of how these rewards are going to happen instead of simply taking all five are equal approach.
00:16:54.399 --> 00:17:01.919
Same at the same time, I think that we should not make it too lopsided either.
00:17:02.240 --> 00:17:13.519
So I think that having an approach to evaluate this fairly and get it accepted by everybody is critical to organizations where there are multiple founders.
00:17:14.240 --> 00:17:30.559
So I think that you should have some mechanism to do this with people who are impartial and objective to help you along the way to you know carry this decision fairly and to take it forward.
00:17:31.119 --> 00:17:34.240
You should not get stuck after making a decision.
00:17:34.400 --> 00:17:35.920
That's very, very critical.
00:17:36.480 --> 00:17:57.359
We should have a mechanism to not only start the process but also to run the process of stake distribution among founders until it reaches a steady state, and to ensure that you reach that steady state with a feeling of fairness, that is very important.
00:17:57.599 --> 00:18:05.119
Only then they will stay together, otherwise, we are going to see things dissipate or move away from each other.
00:18:08.400 --> 00:18:31.039
So uh Sham, uh, when you're really talking about uh you know angel investing, when you're talking about putting money in companies, uh the current uh trend is let me raise money uh for my business because money is available versus my business really needs money.
00:18:31.279 --> 00:18:35.119
Okay uh we seem to be seeing more of the first trend.
00:18:35.680 --> 00:18:56.480
Uh so therefore, how does it uh affect businesses and uh therefore uh you know when should I really trigger my fundraise and how should I uh how should I look at it uh from uh enough cash in my bank versus what cash my business needs?
00:18:56.640 --> 00:19:01.359
How do you really balance this and what what mistakes are people making today?
00:19:02.000 --> 00:19:12.079
I think that when people raise money which they don't need, I have seen one universal trade, it tends to get squandered.
00:19:13.599 --> 00:19:25.599
The second point is that when you raise too much money at that point, you think that you are diluting less.
00:19:26.880 --> 00:19:50.480
But you are taking away the right to dilute in future because if you dilute at a valuation which is unreasonable, people will hesitate to again give you capital even when the valuation becomes more reason because they see that you have not handled the capital well.
00:19:51.519 --> 00:19:54.960
So there is a problem you are setting yourself up for.
00:19:55.039 --> 00:20:06.720
So it's very important that when you raise money, you raise money which you really need and money on which you are reasonably sure of delivery.
00:20:07.200 --> 00:20:54.240
Yes, you have the option of raising some more money, you can raise a little more than what you require if you want a slightly longer runway, but don't raise too much money just because money is available, because the risk of capital going into unproductive areas and leading to destruction of capital is very high, and this has happened time and again whenever I have seen companies which are in the listed space raise money when capital is easily available, whether it was the 94 GDR rush or even the current VC-driven raising of huge sums of money by the unicorns.
00:20:55.039 --> 00:21:17.359
I am seeing that after raising so many millions of dollars, within 12 months the company is again coming and trying to raise venture debt because it is not able to raise equity at the same valuation it has raised last time, and it's still hungry for capital because that capital has been misallocated.
00:21:17.599 --> 00:21:22.400
We are seeing that happen in multiple Indian unicorns today.
00:21:24.799 --> 00:21:31.440
Now, this is a road to destruction clearly.
00:21:31.759 --> 00:21:46.160
So, how you raise money is not just about that one race, it sets the context and trajectory for the future of your entrepreneurial journey itself and the future of your enterprise.
00:21:46.400 --> 00:21:59.759
So it's very important that you are going to think of a scenario when things may become difficult, and you should be able to raise money at that point if the need be.
00:22:00.799 --> 00:22:19.359
Raise money now, or whenever you raise money, remember that you should always maintain that optionality to raise another round, and you should be reasonable enough to be accepted by investors at that time.
00:22:19.680 --> 00:22:27.440
If you do unreasonable things, then later you are not going to get acceptability.
00:22:27.839 --> 00:22:32.720
In fact, people may actually not reach out to you at all.
00:22:32.799 --> 00:22:40.559
So, in the sense, you will isolate yourself, and that is a risk which one should never run in this entrepreneurial life.
00:22:40.720 --> 00:22:46.559
Things may go right, wrong, but people should be again willing to come and give you their trusted capital.
00:22:46.799 --> 00:22:52.000
So, whenever you raise capital, think about this that is there another time.
00:22:52.319 --> 00:23:00.799
Don't act as if this is the last time, it's never going to be a now or never situation.
00:23:01.440 --> 00:23:12.000
And if you think it is now or never, you are going to set yourself up for a never-again situation where you will never be able to do it again.
00:23:12.079 --> 00:23:14.960
So that is something which is a real risk today.
00:23:15.119 --> 00:23:23.440
I know the last two years have been very lucky for a lot of people, but from here I think that we are again reverting to mean or moving in that direction.
00:23:23.519 --> 00:23:25.359
So one should be very, very careful.
00:23:28.799 --> 00:23:31.119
Thanks for listening to this episode.
00:23:31.359 --> 00:23:38.079
For selected links and detailed show notes, visit www.contramines.com.
00:23:38.240 --> 00:23:43.839
Follow Contraminds on social media and let us know who you would like to see next on the podcast.
00:23:44.079 --> 00:23:49.359
If you are listening to Contramines on Apple Podcasts, do share your comments and give us a rating.
00:23:49.599 --> 00:23:51.599
We are keen to know what you're thinking.
00:23:51.920 --> 00:23:54.480
Contramines is also on YouTube.
00:23:54.960 --> 00:24:01.599
If you are listening to the podcast on YouTube, hit the subscribe button and stay up to date on all our releases.
00:24:01.920 --> 00:24:04.319
Thanks for listening and stay safe.
