India is the youngest startup nation and, in recent years, the startup ecosystem has become mainstream driven by factors like growing technology, the mushrooming domestic market and, last but not least, massive funding. The numbers became clear when NASSCOM revealed that India has moved up to the third position among the five largest startup communities in the world, with the number of startups in India crossing 4,200 by the end of 2015.
With startups taking the lead, setting up a new business in India has become a hot trend. So if you have a fabulous idea to start a business, the next step involves sourcing money. Here comes the biggest dilemma: how to raise money for your startup? No matter how brilliant your idea, it is crucial to find the right source of funding to build a sustainable business.
Planning to fund your startup
Every entrepreneur that believes his idea to be the next billion-dollar proposition often decides to ‘bootstrap’ it before accepting venture capital or other funding. In other words, an entrepreneur uses limited capital (usually his own) to start a self-sustaining business, and promotes and nurtures it without any financial backing by venture capital firms or angel investors. This has proven to be a successful model for early stage companies and businesses by serial entrepreneurs. Because the entrepreneurs work with their own money, operating the business is usually cheaper and they remain answerable only to themselves, stay hyper-focused on what they do best, enjoy flexibility to innovate or pivot, and maintain full control of their business. Many successful companies that we see today like Dell Computers, Facebook, Apple, Clorox, Microsoft, eBay, and Cisco Systems, to name a few, had modest beginnings as a bootstrapped enterprise.
Unfortunately, problems with bootstrapping arise when a company doesn't generate enough capital to enhance its product or fund expansion. After a certain point, a niggling lack of revenue makes bootstrapped companies bite the dust. And as they yearn for greater traction and faster progress, they sometimes make the mistake of adopting strategies or growth models that weren't necessarily part of their original plan and prove unfavourable down the road.
Raising money from institutional lenders
Venture capitalists (VCs) and well-connected angel investors can introduce startups to the right people, facilitate valuable partnerships, and open up crucial markets with improved visibility. The absence of an external investor can disturb the company's credibility in the beginning, whereas backing by credible investors instills confidence in potential customers to buy in. Flipkart, Amazon, Uber, Ola, and Zomato are a few examples of startups that became successful because of institutional backing.
For a startup enthusiast, getting hold of the best financing model isn't a luxury, but a necessity! This often means choosing between one of two funding options: venture capital or angel investors. Angel investors can be a better fit for many startups because they are generally more accessible and faster in financing a lump sum.
Benefits of venture debt
Start-ups undeniably need a lot of capital and typically have to sell some of their equity to VCs or angel investors to raise funds. For those facing cash flow issues, relying on VC funding in the short term may seem like a good idea but is not ideal for every situation. For entrepreneurs looking for additional cash without diluting their equity in the business, venture debt may be a better alternative for businesses that need capital to finance product development, hire more staff, invest in equipment, or drive other critical growth activities.
Venture debt is not an ideal solution for companies who are at an early stage, as having to make debt payments could essentially put them out of business. But it holds enormous potential for mid to growth stage companies, as it enables them to hit their next business milestone by stretching their financial runway. Venture debt can also result in improved valuations of the company in its next round of equity funding or get businesses to the stage where they do not require any capital infusion. Although still a lesser-known concept, it is rapidly gaining attention from startups and investors in India. But be warned: while there may not be any dilution of equity, the fact remains that venture debt is very much like a loan in that it has to be repaid.
The perils of fundraising
Venture capitalists have expectations of a higher rate of return and may or may not make "follow-up" investments – these facts make it a risky proposition for startups. On the other hand, VCs have deeper pockets and, as mentioned earlier, offer startups access to business guidance from experienced people. Moreover, as VCs have a vested interest in a startup's success, they usually offer the best help for startups. However, when it comes to investment returns, their expectations are much bigger than a typical angel investor. Therefore, startup founders who are low on patience may find VC investments extremely frustrating as they can take months to a year before deciding to invest in a firm. Also, once the investments are made, VCs may force owners to give up a larger equity stake than they would like. And if the startup fails to build something sustainable, the VC can be the first to turn its back on it. There are also higher chances of a company getting overvalued, which can affect its image and funding in later rounds. In 2015, USD 9 billion of venture was invested in Indian startups. This rush to invest in the newest El Dorado of tech startups has created its fair share of unreasonable enthusiasm. Tiny Owl, Grofers, Spoonjoy, and DoneByNone were some of the half-baked business models that received VC funding with negligible attention to ground realities.
Crowdfunding as a funding catalyst
Crowdfunding can help businesses raise smaller amounts of money from multiple backers. Not only does it save time and money, but also it can help a startup to establish a customer base, organize multiple marketing campaigns, and maintain control over how to reward shareholders. However, while it can prove effective to get through the first trial of a business product, it is not a viable long-term option for funding and it does not work for complex businesses or startups with large capital requirements. Moreover, it is usually ideal for hardware – i.e. a product consumers can touch and feel – as opposed to a pure digital or service play. And unlike developed economies where crowdfunding is swelling the ranks of early-stage entrepreneurs with platforms like Kickstarter and Indigogo, the crowdfunding path in developing economies like India remains largely untraded.
Choose the right path
Raising money for new businesses has conventionally been one of the most difficult steps in building an innovative idea from the ground up. However, the advent of advanced technologies along with new age algorithms and digital platforms has given entrepreneurs massive scope to start a company and the means to get it funded. At the end of the day, every startup has its own unique needs. One startup might be best suited for crowdfunding, another would need the backing of an institutional investor, and a third may be better suited for angels. No matter what kind of funding option you choose, make sure that there is a foolproof plan for utilising the money, so that you can select or attract the right investor for your company.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)