The world of investment in startups for family offices and Angel Investors is a nascent one in India. We, at 100X.VC, conducted an exploration of the merits of iSAFE Notes and why they are the preferred mode of investing.
Though there are 6000+ Angel Investors all over India, looking at the deals, one can see that there are only about 2,000 active Angel Investors. We gave listeners a list of qualities in the founders they might want to back, including a rockstar tech team, massive market opportunity, key partners, market validated business model, hunger for resources, an investment to grow, an unfair advantage to make profits, skin in the game, and the X factor with communication skills; along with a weighted score for each quality with the main focus being on the management team.
As an aid in the process of constructing a portfolio, we shared portfolio construction math. This included investment horizon period as minimum five years, required exit potential as 10X-50X, asset allocation not more than 5-15% of the total assets, and advised the audience to be ready for two rounds of investments in a company, although not mandatory. We split the next set of information into two groups: For Angels and family offices.
For Angels, the capital required per year is 10-50 lacs, investments per year are 2-3, and cheque size per instalment is 5-25 lacs.
For Family Offices, capital needed per year is 1-2.5 crores, investments per year are 4-5, and cheque size per investment is 25-50 lacs.
I firmly believe that an exit strategy is essential to develop while diving into the world of startup investment. Financial exit occurs when a financial investor buys out the Angel investor/family office equity making it an excellent return that is a double-digit exit. A strategic exit occurs when an acquisition happens, resulting in the investor’s stake being bought over. This leads to an average exit, wherein cash returns that are limited are to be expected.
I further explained that an AcquiHire exit occurs when a startup is failing, and a coerced merger happens with an equity swap to halt the erosion of capital. Here, the best-case scenario is capital protection.
I also detailed exit triggers and indicative timelines, explaining that 1-3X typically takes 1 to 3 years, 5-20X takes 4-5 years, 30-100X could take eight years or more based on luck, and 100=X will take 10 to 15 years considering immense luck and patience.
The reasons for the failure of a startup may include lack of market cash, running out of cash, lack of the right team, getting out-funded or outcompeted, etc.
The Angel investment landscape in India has significantly changed over the last decade with the number of deals and the average ticket size improving tremendously. Angel investors/family offices are now more closely evaluating startups as an emerging asset class. Many Angel investors are entrepreneurs with domain experience who do not possess skills related to the various clauses in long drawn agreements.
To understand iSAFE, we must start first by discussing the full expansion - India Simple Agreement for Future Equity. iSAFE is a simple agreement where founders promise future equity to investors instead of investments. iSAFE is relevant and suitable for early-stage investing.
Why iSAFE Notes?
A three-point explanation to this question may be - Valuations; Execution where speed is of the essence with little to negotiate; and Costs, as funds are needed for business and not compliance. iSAFE notes allow for high-resolution fundraising as startups can close with an investor as soon as both parties are ready to sign. iSafe notes also provide a flexible one document security without many terms to negotiate.
iSAFE notes were introduced in India for the first time in 2019 by 100X.VC. To expound on the use of iSAFE to Angel investors, a few benefits can be stated- such as no dilution till the priced round, the ability to negotiate a discount to the next round with founders, and the opportunity to beat other Angels to enter the right company by closing the deal quickly. Founders mostly feel more comfortable dealing with Angel investors who invest through iSAFE.
There are four different types of Sequel iSAFE: Valuation Cap no Discount, Discount no Valuation Cap, Valuation count, and Discount MFN without Cap or Valuation Discount. The source of these documents is available at www.100X.VC/isafe. When iSAFE is compared with early-stage standard CCPS term sheets based on Post money valuation, Board seat, SHA, Consent rights/reserved matters, ESOP Pool, Voting rights, Investor consent, commitment and non-compete clause and founders’ equity vesting and lock-in period, iSAFE emerges very clearly as the better alternative.
There is no better way to explain how an iSAFE works rather than by stating numbers. In a spreadsheet that compared the Cap table before and after iSAFE, after investor X(if CCPS) and Post conversion Cap table (Final), the numbers give Angel Investors/family offices that are ready to invest through iSAFE the edge over other alternatives.
Few Commonly Asked Questions answered by me:
1) How will an investment in iSAFE happen?
The investor and founders agree on the investment amount, mutually sign an iSAFE agreement, and the investor transfers the investment amount post-completion of applicable secretarial formalities.
2) Do iSAFE noteholders have liquidity preference over Equity holders/Promoters/Founders?
Yes, iSAFE noteholders do have liquidity preference to the extent of their invested capital.
3) Do first iSAFE noteholders have liquidity preference over subsequent iSAFE noteholders/investors?
First, iSAFE noteholders will have pari-passu rights with subsequent iSAFE noteholders/investors.
4) How will the iSAFE note be reflected in the startup’s financials, and will the company’s authorised and paid-up capital go up; and if so, by how much?
iSAFE investment will be reflected as CCPS in the company’s financial statements. Yes, the authorised share capital will have to be increased to the extent of face value multiplied by the quantity of CCPS issued. Rest of the amount will be credited in the reserves as share premium.