The nuanced & often difficult aspect of gauging ‘real’ founder ambition
Evaluating how ambitious the founder is & when they would be likely to take an acquisition offer.
A key attribute of a good founder is their vision. What sets them apart is ambition and the quintessential fire in the belly to build a large business. The extent of motivation and the drive to grow are critical factors that chart the course of a startup.
As early stage investors, one of the more nuanced decisions for us is to figure out how ambitious the founder is and at what point in time would they be likely to want to check out and take an acquisition offer. This decision of founders is often driven by their mindset and ambition can critically impact a VC fund’s fortune.
Of course, there is no right or wrong here. It is a relative perspective that matters particularly for exits that happen early in the lifecycle of a business, say, within 2–4 years.
For a founding team that has a $20mn to $50mn acquisition offer, suppose the founders hold 70% stake, this would mean it is a $14mn to $35mn outcome. This is a fairly large outcome — and in the current economic conditions, can be life changing for the individuals involved.
However, for an early stage fund that has, say, invested at a $5 to $8mn valuation, this means a 5x-8x outcome. While this is decent for a fund, it is not the outcome that they wanted out of the ace team they were backing in the first place.
Hence, there is a period of misalignment between founders and early stage investors on taking the acquisition offer. If I have to put a number to it, it’s all the way from an enterprise value of $10mn to a $75mn value. Once this threshold is broken, the enterprise value & resulting multiples start to make sense for the early stage investors too.
Of course, this is mostly true in the context of acquisitions that happen in the first 2–4 years after a seed fund’s investment. If these offers come after 8–10 years of the fund’s investment, chances are that the fund may be fine with this kind of a valuation, because the story has not played out positively and real scale has not been achieved. In such a scenario, getting an exit for the investors becomes more important than the quantum/quality of exit. So, at that time, this scenario is still good news and both the founders and investors are aligned on the outcome.
But let’s go back to the misalignment that exists at the earlier stage and discuss how as investors, we can try and gauge founder ambition and the intent & staying power of founders to build a large outcome for themselves and all other stakeholders.
What investors need to know and do:
- Building a crude way to get into the founders’ heads and understanding different drivers of their ambition is essential. It is important for investors to understand if there are drivers other than just wealth such as impact, respect, fame, ego, and so on. Each of these can be powerful drivers that ensure that founders will not take early acquisitions.
- A 2019 Pilot Survey on the Indian Startup Sector by the RBI revealed that most Indian founders were motivated by opportunity, and a substantial lot was driven by social causes. An interesting finding of this survey was that only ~24% of them were looking to get acquired, only 10% respondents aimed to exit, and nearly 58% had plans to get listed on the stock exchange. Of course, some of this is the natural response in a survey. The key is to get into their heads beyond what people state!
- Moreover, investors must understand that sophistication (i.e., awareness of exit routes, ability to engineer exits, relationships in the ecosystem, etc.) may not be directly proportionate to ambition; in fact, we have seen enough to believe maybe there is a negative correlation between the two. Not enough data to statistically substantiate this but willing to stick my neck out here! (This follows the old adage in India that if you get too educated, you may not take enough risks.)
- While some degree of inflexibility and stubbornness are often regarded as negative traits by investors, these qualities may actually have a slight positive correlation with the drive to succeed and build a large business.
- Another aspect investors may need to factor in is founder background. For example, in Tier 2/3 cities, founders are typically more grounded, hungrier and eager to prove themselves, and know how to run a business with fewer resources. The availability of tech talent is also rising (read more on my perspective regarding this here) and you could have big tech businesses built out of these Tier 2 towns. Also, while their motivation is also wealth creation, there are also other powerful drivers. Again, not enough data to substantiate this, but at Arali, we do pay attention to this dimension.
Take the example Jugnoo originating from Chandigarh. The team got an investment offer from Flipkart and denied it. They later went on to raise $5mn in series-A and formed a strategic partnership with PayTm. TeaPost from Rajkot also makes for a stellar story of founder ambition, which grew to 29 cities and has more than 70 outlets since 2013. Am sure you folks reading it will probably know of and resonate with many such examples!
- Additionally, a comparison between US and Indian entrepreneurs revealed that most Indian founders were more driven towards solving “problems” and creating a large impact.
So, here is what we have started doing at Arali:
We map the nature of business with the founder’s ambition using a classic 2–2 matrix approach illustrated below.
This helps us demarcate true very large outcomes vs. outcomes that could generate middling returns for us. And hey, middling returns are not bad for us seed VC investors as long as you align with founders on the same, and ensure that it happens within a finite timeframe without too much further raise of capital & dilution of ownership.
We think founders too can help out investors in this scenario. Here is what I think they can do:
- Founders can be more expressive about what they want out of the business they are building. It also make senses for all the founders to discuss among themselves each one’s expectation and if they are aligned on this. One of our portfolio companies did a good job on the same. They had aligned on an acceptable outcome range in the very early stage itself.
- Founders also need to have open conversations with investors on their motivations and allow themselves to be discovered by investors, more as individuals rather than as founders/entrepreneurs. This will also create greater transparency & trust in the relationship.
- Founders need to know the market & landscape very well. They also need to be able to articulate this to their investors with conviction.
At Arali, we come from the school of thought that founders know their business & market the best. If they believe it’s time to take an exit, they probably know best. However, if investors do not have conviction in their founders’ knowledge of their market, this would be a driver of dissonance.
If you’re a founder with unbounded ambition in the early stage enterprise tech biz, reach out to us and we’ll be happy to support you.
Arali Ventures is a pre-seed, seed-stage VC from India, investing in entrepreneurs building enterprise-tech solutions for the world. We help shape their journeys through product-market-fit and beyond and scale the offerings to greater heights.
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