There are several reasons for NRIs to invest in India the major three being (i) to build up a strong financial security when they return to their homeland for good (ii) contribute to creating employment opportunities and (iii) contribute to economic growth of the country. Though NRI now have become a major segment of investors into India and many of them are successful, some of them have faced failures because of various reasons, including being duped by the promoters. In this article, I try to highlight a few points that an investor should look into before they conclude the investment deals.
- Know your Industry
Before investing into a venture, it is really important to do a market study of the sector and understand the industry. It is often seen that NRIs are introduced to a concept or a business idea and are taken to a fictitious world of imagination of the promoters, in which everything is perfect with high returns and no provisions for plan B or contingencies are provided. Before investing, it is important to view the initiative in the most realistic way and identify all issues of the particular industry, so that a solution strategy, if deciding to invest, can be worked out.
A market study by an independent agency can help the investor in obtaining a SWOT analysis (Strengths, Weaknesses, Opportunities and Threats) of the industry into which he is investing.
- Project Feasibility Report:
Project reports form a crucial part in evaluating any business. Technical, operational and financial aspects must be studied in depth while evaluating any deal.
Where the investment is made into a new venture or into a new idea, the investor should take care to review the project report in depth and the same should be analyzed and critically approached by a subject/ technical expert. The promoters should be able to provide a proper financial road map and convince the investor that the cash burn is justified and the revenue targets are achievable.
- Valuing the business:
The pace at which technology has grown in the recent years can be understood from the fact that investments are now made on an idea of a person (promoter), and not on a product as it once used to be. Many a times it is difficult to put a proper value for the idea due to its uniqueness and lack of comparable data. Valuing a business helps in understanding the estimated worth of the company as well as the percentage of equity stake an investor can acquire in the company.
There are different ways to value a business such as discounted cash flow method, comparable transaction method, multiples method, net assets method, etc. A financial model is built choosing one of these valuation methods which can aid the investor in understanding many financial indicators such as return on investment, break-even point etc. Choosing a method would depend on several factors including the nature and stage of the business, type of industry etc. In many cases valuation using different methods are taken and decision is made on a best judgment. While the above methods are acceptable methods of valuation, it is important for the investor to sit with his team to analyze the assumptions and figures of the financial model to ensure that they are correct and achievable.
- Due Diligence
Where the investment is made into an existing business, it is advisable to do a due diligence of the business by an independent authority directly reporting to the investor. Due Diligence helps an investor to assess the performance of the entity in the preceding years, details regarding unsettled disputes, unsettled outside & statutory liabilities etc. Due Diligence further helps the investor to compare the information gathered against that provided by the promoters and assess the genuineness of the business.
A proper Memorandum of Understanding (MoU) should be entered into between the promoters and investors that clearly states the amount of investment, the terms and conditions of investment. The MoU should also list down the various tranches in which the investments will be made and the milestones that the promoters should achieve before each tranche. It would also be advisable to review the MoU by a competent legal authority to ensure that interest of the investor is safeguarded.
In addition to the MoU, shareholder agreement, term sheet, byelaws of the company etc all form an important part of documentation.
- Know your Promoters
Ensure that the promoters of the venture is trust worthy and reliable. The investor should do a proper back ground check of the promoters. It is the promoters that carries out the day to day business of the entity and their complete involvement in the project is critical to its success.
- Portfolio Management
It is always wise to diversify the investment rather than investing the entire amount into one idea. Such an approach reduces the risk the investor is exposed to. Risk-averse investors should also consider the options of introducing the fund as debt or preference shares. The method of investing should be selected after understanding the risk and return parameters.
- Exit Strategy
It is ideal to have an understanding on the exit strategy as well. Even though it may seem odd to be discussing about exit strategy at the commencement of a business, there should be an alignment of interests between the investors and the founders and planning is required in advance. For example, if the company plans to get listed in stock market, they might prefer to follow some accounting regulations from initial stage.
- Governance Report
Once an investment is made, monitoring is necessary to ensure that the promoters are on track with the idea development and the cash burn are as budgeted. As the investor is not involved in the day-to-day management of the entity, he will not be able to monitor the performance of the entity. A monthly or quarterly governance report is a solution. The report can either be a summarized dash board with major findings on the performance of the company or a detailed internal audit report. To ensure reliability, the governance report should be prepared by an independent agency.
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