Challenges faced by first gen entrepreneurs in raising seed capital

We did In-Depth Interviews (IDIs) with select first generation entrepreneurs (in India). Some of them were successful in raising capital for their pre-revenue companies outside of FFF (Friends and Family Funds). We used an open questionnaire to help in the IDIs. Below is the summary of challenges expressed by these entrepreneurs:

  • Investors are buying more time to make an investment decision, so they can see the developments before they can invest.
  • Investors are funding start-ups whose technology applications or business models are proven to be successful overseas (outside of India).
  • Many a times investors are not able to grasp the technology behind the products, thereby, doubting the potential benefits of the new technology.
  • One of the most successful entrepreneurs felt that majority of the investors have no qualifications of an experienced management consultant and opined that the investors go by some unwritten procedures that are blindly followed across the industry in India.
  • Investors tend to evaluate more based on numbers and back out when they do not understand the technology, which, many start-ups may not be willing to disclose.

In my next post, I’ll explore the possibility of implementing the two Islamic equity contracts viz., Mudarabah and Musharakah, in India by identifying a set of covenants in these contracts that could potentially address some of the above challenges.

Before we conclude, a comparison of Debt vs Equity based financing explained through the Islamic equity contract - Musharakah:

Debt-based financing:

  1. A fixed rate of return on a loan advanced by the financier is predetermined irrespective of the profit earned or loss suffered by the debtor.
  2. The financier cannot suffer loss.
  3. Results in injustice either to the creditor or to the debtor.
  4. If the debtor suffers a loss, it is unjust on the part of the creditor to claim a fixed rate of profit.
  5. If the debtor earns a very high rate of profit, it is injustice to the creditor to give him only a small proportion of the profit leaving the rest for the debtor.

Equity-based financing explained through Musharakah:

  1. Rate of return cannot be fixed. The return is based on the actual profit earned by the joint venture.
  2. The financier can suffer loss, if the joint venture fails to produce a profit.
  3. The returns of the creditor are tied up with the actual profits accrued through the enterprise.
  4. The greater the profits of the enterprise, the higher the rate of return to the creditor.