Updated: Dec 14, 2020
“You should RULE your money, Money shouldn't RULE your Life.”
― Hyacil Han, Investing Made Easy: 50 Extremely Beneficial Business that are Undeniable Cash Cows
2019 witnessed the rise of more than 1300 startups including 8 unicorns (startups with a valuation of over $1 billion) in India. In 2020, we are seeing investors getting bolder and entrepreneurs getting more enterprising. Investments in 2020 map sectors like Edutech, Telecom, Entertainment, Healthcare among others while three-fourths of the investments in 2019 were purely in the tech industry.
It is an often stated statistic that 95% of the start-ups fail in the first five years. In a large number of such cases, it’s due to a lack of appropriate funding. The right kind of funds at the right stage can prove a gamechanger for any worthy startup.
But raising funds as a startup isn’t a cakewalk. It requires meticulous research backed by the brilliance of the billion-dollar idea.
Sources for funding for startups
The initial funding is the biggest hurdle any new startup would come across followed by networking issues, learning opportunities, and mediocre growth strategies. Investors turn their backs often on startups that overlook such issues. Different needs require different kinds of funds. Let’s test out the functionalities of different sources available :
Personal sources such as savings and credit cards, friends and family: Making funds available to your business in your own personal capacity is called bootstrapping. Such funds assure flexibility in interest and repayment terms. Any friend or relative supportive of the idea can pitch in funds into the business. Credit cards, on the other hand, allow for a repayment period of 30-45 days.
Loan or credit: A bank provides funds for collateral. Banks grant loans based on the applicant’s credit rating and not on the attractiveness of any business idea. The repayment terms and interest rates are fixed, and documentation is required along with time and effort on the entrepreneur’s part.
Funding through equity: This kind of funding asks for a share in the ownership of the business through the transfer of equity shares. The entrepreneur has to share the ownership with family or friends ( in case of a private company) or sell shares through IPOs( Initial Public Offerings).
Venture capital: It is lent by professional investors who are aware of the high risk involved in financing new or existing startups. Venture capitalists invest in high-risk and high-growth potential companies knowing well the long gestation period involved. Venture capital is a popular mode of financing for startups since traditional modes hardly serve the purpose. In return for the investment, such investors expect higher returns plus a share in the company’s ownership.
Angel investors: They are the acquaintances or people who support the entrepreneur’s startup idea that invest money in the company and influence its decision-making. India has a full-fledged network of angel investors ready to invest in promising startups.
Crowdfunding: This is an alternative form of finance and is fast emerging as the preferred medium for many entrepreneurs. A third party moderates the collection of funds that involves the entrepreneur or the initiator and other such people who support the idea.
Government funding: Another source that is available to a selected few, such as small industries and proprietorship businesses, subject to certain conditions. Mudra Loan is one such example.
Funding vs Bootstrapping for Startups
“It is much easier to put existing resources to better use than to develop resources where they do not exist.” ― George Soros
Whether to finance your startup via bootstrapping or via venture funding shouldn’t be a trial and error exercise. A lot of careful thought should go into determining the type of funds, depending on several factors such as:
Type of industry
Magnitude and purpose of operations
Amount and type( fixed or working) of capital required
Risk-averse or Risk-taker personality
Let’s take a look at Investopedia’s definition for bootstrapping - ”Bootstrapping is the process of building a business from the ground up with personal savings, and with luck, the first sales.” Bootstrapping allows for complete control over the ownership for founders. Usually, no external funds are involved. This limits the availability of funds and hampers growth. The entire risk falls on the owners who have to manage every aspect of the business from production to promotion. It involves the following pros and cons:
Greater flexibility and freedom
Opportunity to experiment
Complete exposure to risk
Limited funds available
No specialisation available
Restricted growth opportunity
Venture capital, on the contrary, offers vast opportunities for growth and expansion to the business at the cost of transfer of ownership. The founders have to attract potential investors into investing in their startups through appropriate traction. Venture capital, when provided through a single investor in the early stages of the business, is called angel investing. Owing to high risks and uncertainty, startups find it difficult to find investors and hence the name ‘angel’ investors for such saviors. It has the following pros and cons:
Ample growth and expansion opportunity
Lesser restrictions on funding
Considerable reduction in risk
Greater specialization available
More focus on core areas
Diluted Ownership control
Difficulty in acquiring funding
Lesser freedom with experimentation
The requirement for an exit plan and provable traction
SIgnificant Stages in Funding
The first stage is essentially self-funding or funding from family or friends. The idea, at first, has to take shape through the initial investment of the founder. Even investors have an affinity towards projects in which the founder has sufficient financial stakes. The founder should keep in mind not to part with too much equity at this stage. The cap on equity that can be given to others should not exceed 5%.
This is the preliminary stage where external sources of capital can be sought before the business can generate funds of its own or till further investments are received. Preliminary expenses such as research and product development might be funded in the seed stage through these funds. Investors at this stage include angel investors primarily but might also include venture capital funding, crowdfunding, or government funding.
The early stages of growth have certain rounds that are funded through private equity investors, venture capitalists and crowdfunding :
Series A round:
After the seed round is successful, the business model starts to generate some revenue. More capital is needed to employ economies of scale, improve distribution systems, and hire experienced executives to the board. Series A round is the first major round of funding after the preliminary stages. The preceding stages and this stage is riskier for the investors.
Series B Round:
The business, in this stage, has advanced and has garnered a higher valuation. The product and the business model are already established. This stage is all about scaling up towards broader markets. The investors pay a higher price in this stage and in return, prefer convertible preferred stock to preferred stock.
Series C Round:
This stage is all about expansion on a large scale and growth of markets, even internationally. The company has attained full maturation with an optimal business model. The company has superb management, increasing profitability and posits potential for bigger markets.
At this stage, the venture capitalist likely reaches their investment goal and may look forward to fructifying an exit strategy. While the startup company may go on to raise funds through higher stages of D, E and beyond or opt for IPOs (Initial Public Offering).
Investors and investing networks conduct in-depth scrutiny of the startup before they finally consider it worthy of an equity deal. Due diligence on the past decisions or any potential controversies for the startup may be conducted. The credentials and background of the founders and team are verified. The investors seek to ensure that the claims of growth and success numbers mentioned by the founders are genuine. Hence, it becomes pertinent on part of the founders to put in substantial effort into forming pitch desks and reading term sheets that would be presented before the investors and received from them, respectively. Market research to shortlist the target investors is essential to the task of funding as well.
A pitch deck is a detailed presentation about the startup outlining all important aspects of the startup. Pitch decks are basically the resume of the startup presented before the investors. Founders pitch in their ideas and business aims through a quick overview in the deck. The most important job founders have to do is to gain the attention of probable investors.
Pitch decks, therefore, are an essential step in fundraising and must contain these 12 components:
3. The problem which the startup is trying to solve
4. The advantages of why your product/service is the right alternative
5. The solutions your business has come up with
6. The product/service
7. Market Traction
8. Predicted Market size and distribution
9. Competition to your startup
10. Business Model
11. Investment Necessities
12. Contact Details
There is no set pattern as such that founders have to comply with while writing their pitch decks.
A term sheet contains the terms of the investment and collateral, presented by the investors to the founders once their nod is received for investing in the startup. It contains in detail what is being offered and what can the founders expect in return. There are further guidelines as to how both parties should protect the investment. Like Pitch decks, term sheets have no set pattern. The terms and conditions of the investment deal must be read thoroughly and carefully understood. It is considered good practice to not include the following in a term sheet:
Debt financing and convertible note terms that are adverse to the startup and can even lead to bankruptcy.
A clause disallowing any further fundraising
The requirement of holding a large controlling stake in the startup by the investor. This might result in the replacement or eviction of the founder from his own dream business.
Unrealistic expectations of growth
The Indian investment scenario has gone global with foreign direct investments and other kinds of off-shore investments, making their way into domestically nurtured ventures. The startups have to back their business idea with substantial planning and presentation so as to appease the investors.
Times are favorable for small businesses and startups and post-COVID, this trend may continue to show further bullish signs. A digital-first business accelerator like the Founders Club, an initiative by The Circle, is one such program for innovative startups deserving of mentorship and support. The Founders Club was formed with an objective to assist and nourish early-stage startups via focused mentoring, shared business services, funding support, key business collaborations, and global access. To know more, head over to the Founders Club website.