How the fine print in VC funding can ruin a startup’s dreams - The Ken
29/08/23, 11:48 AM
How the fine print in VC funding can
ruin a startup’s dreams
Chicago-based Guild Capital’s unusual investment
terms lead to founder resignations and legal troubles
for early stage startups MegaExams and Wink &
Nod among others
Arundhati Ramanathan
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In October 2022, Prasanth Parameswaran, the founder of MegaExams (an
online-exam software run by Phio Technologies) received an email
carrying a petition filed against him in the Bombay High Court. Guild
Capital—a venture-capital firm that had invested in Parameswaran’s seedstage edtech valued at US$1.3 million—had moved court to seek seizure
and attachment of Parameswaran’s personal assets.
The notice was not a surprise to Parameswaran, as the relationship
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between MegaExams and Guild had been deteriorating for some time.
In April 2022, the Chicago-based VC had sent a 'put' notice to
MegaExams, demanding that the edtech company return the entire
US$300,000 that Guild had invested in it. This meant that the edtech had
to buy back all of the shares at the same valuation at which Guild had
invested, and also pay an additional 18% interest from the day of the
investment in January 2019.
The reason for this demand was a claim for GST (goods and services tax)
dues worth Rs 800,000 (US$11,000) in 2017-18, as well as allegations
against Parameswaran of tax evasion and failure to maintain the books.
With Parameswaran no longer running the company, Guild-run
MegaExams paid the fee, but called this mismanagement, and sent
Parameswaran a notice.
The characters in this case may look insignificant and quite ordinary, but
the events are not. They hold important lessons that any startup seeking
funding would ignore at its own peril.
Guild Capital is an early investor in India that has put in about US$10
million across a dozen companies over the last two years. The 13-year-old
fund has made over 35 investments globally, investing an average of US$1
million, and has an overall fund size of over US$550 million.
In addition to MegaExams, Guild has also invested in small startups such
as Wink & Nod, a firm that sells mattresses and other sleep-focussed
products; Nursery Live, an online gardening supplies company; and it
nearly invested in MobiChemist, an online medicine-delivery startup.
According to people close to these companies, all these startups have had
to deal with unusual investing terms from Guild. They were required to pay
board fees to investors, which is rare for venture capital firms to request.
They were also made to hire senior consultants at high salaries, and even
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had to pay the investor for assisting with these hires.
Multiple people mentioned in the story declined to be named as they
didn’t want to be seen publicly commenting on their companies and rivals.
As a result of meeting some of these terms, founders of companies like
MegaExams ended up quitting or selling their companies. If few knew
about these companies when they were around, even fewer know that
they are now gone.
It is not uncommon for startups to fail, with over 90% not surviving for
various reasons such as lack of funding, poor product-market fit, or
founder conflicts. However, it is rare for startups to fail at an early stage
due to tussles with investors. This is a reflection of a time when startups
are scrounging for money and will take whatever they can get, overlooking
the terms and conditions attached to the money.
Clean exit
One of Guild’s successful exits in India was the $200 million sale of its
portfolio company Pickrr to logistics startup Shiprocket in 2022
Seeds of desperation
In 2017, when 26-year-old Parameswaran set up a platform for offline
coaching classes to be able to conduct digital exams, edtech giant Byju’s
was a year away from becoming a unicorn and ‘edtech’ was not yet a
buzzword.
A college dropout who was supporting himself through various side-gigs,
Parameswaran initially chose to bootstrap his company. This meant
crashing at a friend’s apartment to save on rent, eating cheap meals from
Swiggy financed by cashback rewards, and doing side jobs to fund his
small team of three.
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Since small companies have small teams and goals, they tend to reach
breakeven quickly. However, when more competition arises there is
pressure to grow and companies invariably go the venture capital route to
expand.
According to a person close to MegaExams, Parameswaran reached out to
40-50 venture-capital funds and only received responses from four to five
of them. One of these was Guild Capital, which made an offer of
US$300,000 for a 33% stake in the company, while other funds only
offered commitments of US$150,000. This was in 2019, the same year
that MegaExams’ bigger rival, ClassPlus, received over US$1 million in
funding during a pre-series A round.
MegaExams was one of Guild’s first investments in India, and
Parameswaran had little information about their track record. But in the
US, Guild had achieved success by backing startups like meal-kit
company HomeChef, which was acquired by supermarket chain Kroger for
US$200 million in 2018 and became a US$1 billion brand within the
American retailer.
In Indian companies such as MegaExams, Guild included some odd
conditions in the term sheet for their investment. These included requiring
the team to move to the Guild office in India’s western city of Pune for the
first 90 days, as this allowed Guild greater oversight on the companies
they invested in. A former Guild employee said: “The amount of
commitment they showed towards their investments was very high.” He
added, “That level of involvement is unheard of. Guild behaved more like a
private-equity firm.”
Other unusual conditions included committing to closing a critical hire
approved by Guild. “Lead investors usually have the right to approve roles
to be hired above a certain salary,” said the founder of a Series C-funded
startup. “But that they must approve the hire itself is unusual.”
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Guild’s shareholder agreement also stated that the startup must seek their
permission before making any critical business decisions and pay board
fees of US$1,000 per sitting. They typically have at least one board
member in the company they invest in.
Some of these conditions are considered red flags by some, as they are
highly unusual. “If you take this you either are naïve or you didn’t get
anything else,” said the founder of a mid-stage startup.
Despite these concerns, it was difficult for those like MegaExams to walk
away from the investment opportunity after spending close to three
months in this process. However, it didn’t take long for these conditions to
turn into a threat.
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Professional hit
As part of the “critical hire” condition that Guild required, it insisted that
these hires come from consulting firms such as McKinsey, Bain, and BCG,
also known as ‘MBB’.
This is because Guild believes that these consultants have a wide range of
expertise and have solved business problems across various sectors. Both
Iain Shovlin, the founder and managing partner of Guild Fund, and the
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current India head, Apoorv Gautam, are former Bain and McKinsey
consultants. “If the right talent gets hired early, the return on investment is
multifold,” said a person associated with Guild.
But many associated with Guild-funded startups said that hiring these
consultants was difficult. Several of them did not have on-the-ground
sales experience, and were not eager to join a no-name startup. Despite
this, the startups had to make these hires because Guild insisted on it.
According to the person close to MegaExams, the startup paid a salary
three times what its founder was earning at the time to hire a sales head.
Another Guild-funded startup received multiple profiles of people from
business schools like Indian Institutes of Management and even Wharton
or Harvard at a salary of US$150,000 even after hiring a senior consultant
recommended by Argyle, a headhunting firm that is owned by Guild.
“This was a constant distraction,” said the founder of a startup funded by
Guild in the last two years. “These were unreasonable demands.”
MegaExams too ended up hiring a second person with an MBBbackground when it raised a bridge round from Guild.
In some cases, Guild even insisted that startups make these hires before
receiving their investment. For example, e-pharmacy startup MobiChemist
received a term sheet from Guild in 2018, but before receiving the
US$200,000 investment, Guild insisted that the startup hire a chief
operating officer (COO), according to a person close to MobiChemist.
However, Guild ultimately did not invest in MobiChemist and the company
had to sell its stake to competitors such as 1mg in order to just pay
salaries.
Portfolio services
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Another atypical characteristic of Guild is that it seems to generate
revenue from firms in which it invests. It runs a set of companies called
Atidiv, Argyle, Houndstooth, Harlequin—which offer services like customer
support, headhunting, marketing communication, accounting services,
respectively, to its portfolio companies. These companies came up
between 2013 and 2017.
Even though Guild does not insist on their use, most startups end up using
these firms to gain approval of Guild for their operations. For instance,
there’s pressure to close a hire of “Argyle quality.”
“In reviews, we would be nudged to take these services,” said the person
close to MegaExams, adding that the pressure to increase “organic traffic”
would drive the startup to take the services of Houndstooth, which
provides design, content, and strategy services.
Some of these are crucial services, offered by other VCs as well. For
instance, Blume Ventures has a search arm called Metamorph, which it
established five years after the fund was founded, and also offers
financial- and legal-compliance services through an independent entity
called Constellation Blu. While it charges portfolio companies for these
services, it runs them as a non-profit entity to avoid any conflict of
interest. A founder from a Blume portfolio company said it does not
mandate that portfolio companies hire from Blume or have a say in hiring
decisions. The VC firm Sequoia offers some of these services to their
portfolio companies free of cost.
Guild believes that its services set it apart from other VCs. According to
the person associated with Guild, “capital is commodity,” and offering
additional resources to early stage founders can be helpful in the early
stages of a company’s development.
They added that the company charges for these services in order to
ensure they are provided to a high standard, and are not simply a side
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project. “We spend a lot of time on it, so there is a cost to it,” they said.
Many of Guild’s partners, such as Shovlin and Gautam, also work for
Argyle.
There is a flipside to this close association. A person close to Wink & Nod
claimed that Guild held back on the final tranche of investment in 2019
and adjusted the startups’ bills for its services. This meant the company
did not receive the full amount of funding it was expecting. This modus
operandi also took away startup’s agency to schedule payments as they
saw fit.
Scuttled deals and severed ties
By the end of 2019, MegaExams’ revenue was still growing 18% month on
month, but it had just five months of runway left, according to the person
close to MegaExams.
So in December 2019, when Classplus made an offer to acquire
MegaExams for US$2.5 million in a stock and cash deal—a ~5X revenue
multiple, it came as a lifeline. But Guild reportedly did not approve the
deal, and instead demanded a better offer.
In 2020, Wink & Nod, which was then low on cash, secured a deal with
SAR group—the maker of water purifiers under the Livpure brand—albeit
at a low valuation. But the deal fell through after Guild allowed it to expire,
said a person associated with Wink & Nod.
These events led to the resignations of the founders of MegaExams and
Wink & Nod—the former in January 2021 and latter in May 2020.
But the ordeal was still not over, especially for Parameswaran, who is
battling Guild in court to save his personal assets.
MobiChemist, which waited six months to receive their investment, had to
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shut down after the investment was withdrawn. “The founder’s burn had
increased so much that to pay salaries, he had to withdraw from his PF,”
said a person close to MobiChemist.
In response to an email with the allegations, Guild said it cannot comment
till the legal proceedings conclude. MegaExams, Wink & Nod,
MobiChemist, and Parameswaran declined to comment.
These experiences have left some of these founders introspecting about
their role in this. “I’m wary about my capabilities to pick the right investor
again. It was foolish, but I’m responsible for this,” said a founder of one of
the Guild-funded startups.
The founder of the series C-funded company quoted earlier said: “I’d
rather not start a company than be in a position to take this money.”
Sometimes early stage and young founders get excited about just landing
a term sheet. One such founder from the Guild portfolio had some sage
advice: “Talk to other portfolio founders before taking on an investor. Do
your due diligence on your investor.”
Image credit: Loic Leray/Unsplash
AUTHOR
Arundhati Ramanathan
Arundhati is interested in how people use money in the digital age and
how new economies will take shape based on that interaction. She writes
the newsletter Ka-Ching! every Thursday. She lives in Bengaluru and has
spent 14 years reporting and writing on various subjects.
View Full Profile
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