Are you an entrepreneur looking to scale your startup but intimidated by the fundraising process? This post will demystify startup funding and show you it is not as complicated as it is often made out to be.Sanjay Shenoy
You have a brilliant idea for a business. You round up a handful of people who believe in that idea. You guys pool in money from your savings and work on building the product around the idea. Your startup is beginning to get some traction now with an ever increasing customer base, which forces you to expand your operations and your team. Before you know it, your startup has captured a significant chunk of the market, is profitable and all poised for an initial public offering (IPO).
I know. This situation for a startup can only exist in an idealistic imagination while the reality can be far more scary, unpredictable, and full of unexpected surprises.
Let’s not take away the credit from amazing entrepreneurs who have actually achieved it. But they belong to a rather small elite minority.
More often than not, startups depend on financial help from the outside to get things moving. The primary reason being is that the journey of a startup is not necessarily as rosy as it has been painted earlier. There is a good chance you might need external help in the form of (mostly) money.
But the problem is that the startup ecosystem has glorified raising money, sometimes more than making money itself. To a point where raising money for your startup itself is seen as a success. And this has inadvertently made raising money look very complicated, hard and only worthy of an elite few. This alone has intimated and demotivated a lot of promising entrepreneurs.
The objective of this post is to demystify the notion that raising money is not as complicated and also shed light on the different options you have as an entrepreneur to raise money, what the procedure is and what might be appropriate for you and your business.
Well, it is evident that any business would have expenses, and someone has to pay for them. Capital, or money, is the most essential requirement for a company to grow. The concept of running your business is that at some point in time, you will make more money than what you have spent.
Without adequate financing for your business, your startup is at the risk of imploding or going nowhere. To solve this problem and limit risks, business owners usually seek financial help from the outside. This can be in the form of debt or by sharing partial ownership of the company.
This, is what “raising money” means. In simple terms, you borrow money from external sources to fund your operations, development and growth of your business.
As discussed before you can raise money for your business in one of two forms: debt and equity.
Debt is basically a loan where you borrow money from an individual or a bank at an agreed upon interest rate. You pay back the borrowed money along with interest on top of it within a predetermined time.
But there is a glaring problem with this one.
If you choose to take this route, you take on 100 percent of the risk yourself, and you have an obligation to pay back the borrowed money. Also, usually, the process to get a loan is tedious and is restricted to businesses that already have a decent cash flow already.
To reduce the risk, some business owners raise money by giving partial ownership of the company, in the form of equity (shares). The investor will get a share of your company for the money he has lent, but you are under no obligation to pay back the money.
Usually, investors prefer to wait it out and cash out their investment with something called an “exit” wherein the investor gets to sell his shares of the company. The exit usually happens when the value of the investor’s share is exponentially higher than what he bought it for.
This is a rather oversimplified but an overarching explanation of how funding for your startup works. Let’s dive a little more to understand all the different options you would have as an entrepreneur to raise capital.
Well, the good news is that this option is available for every entrepreneur. Bootstrapping means building your startup from scratch with your own money and funding the everyday operations with sales of your offering.
Of course, most entrepreneurs reach out to their closed circuit of family and friends to gather some more money, which also comes in the purview of bootstrapping. Usually, this is done not only to diversify risk but also because it is unlikely that your friends and family will be tough on getting the money back.
Until very recently, bootstrapping was the only way to go and still is one of the most preferred ways to start a business. But you need to understand that bootstrapping is not easy.
The entire risk of the business is on the entrepreneur and his team, which can be a double blow since most entrepreneurs dip into their savings. It also affects how fast and how much you can grow. This can sometimes inhibit the way the offering is developed and sold. With bootstrapping, expect to make a lot of sacrifices and compromises.
On the other hand, you as an entrepreneur gets to keep the entire pie; meaning total control of your company. You are likely to focus all your efforts on developing your product and financing it through sales rather than external financing. Since you are not inclined to borrow money, your costs in the form of interest or equity go down considerably, which helps you inch towards positive cash flow.
Considering all of these factors, service companies are more prone to be bootstrapped. Having said that, there are plenty of Indian startups which were bootstrapped and has reached incredible heights of success.
Debt or loan is probably the second most instinctive option most entrepreneurs have. It means you borrow money, usually from a bank, to finance your business and repay the money with interest within a stipulated period.
Debt is yet another attractive option for entrepreneurs because it would give them complete control over the business. Loans can help you finance short terms needs like payroll, working capital and other miscellaneous expenses.
But at the same time, getting a loan from a bank might seem like an arduous task considering all the documentation and strict lending standards banks have. It also means that your expenses are going to increase taking into account the interest you will be paying, which might, in turn, pinch your cash flow.
Before you opt for going into debt, you have to be very clear as to why you will need this. It can be to start your business, to fund everyday expenses, for growth, etc. Depending on that, and at which stage your business is you have various options in debt too:
If you are starting a new business, it is doubtful that you will be able to crack a deal with your local bank. Usually, banks would require you to have some track record and predictable sales to repay the loan. Your startup might take a while to reach this stage, and that’s where credit cards come into the picture.
You can apply for a business credit card, but you can very well do with your personal credit card. Apart from easy eligibility, access to capital, credit cards also have an added advantage of reward points. And if used properly it can be a great tool for building up your credit history.
On the other hand, credit cards are notoriously known for their exorbitant interest rates, as high as 40 percent, which can end up compounding into a monstrous pile of debt. Credit cards have turned out to be a slippery slope for many and its a trap which can be challenging to get out of. So be extremely wary of how much you want to spend and always pay back in full and on time.
As mentioned before, although bank loans can be excruciatingly difficult to get, they offer a lot more flexibility and a much more secure and reliable way for funding more substantial expenses for your business.
Now, this is no credit card application. If you are planning to opt for a bank loan, be prepared for a lot of documentation. The most important prerequisite would be for you to have a detailed business plan. This will allow you to determine how much funds you would need, where you would be utilising them, the current financial position of your business, and the returns you are expecting.
Again, there are different types of business loans out there, and few of the more prominent ones are listed below:
Term loans: A specific loan for a specific period, usually paid back via EMIs
Asset-based loans: Credit against personal or business assets (eg: gold, land etc.)
Invoice discounting: Loans against unpaid invoices, promissory notes etc.
Purchase order financing: Loans to fulfill large purchase orders
Working capital loan: Credit to finance short term expense and cash shortage
Let’s take a hypothetical situation. You might run into a situation, with your startup, where you need Rs 1,00,000. But this expense is not required at one shot; you need it across a period of three months. Considering the lengthy process to acquire a loan, you would rather take a loan of Rs 1,00,000 at one shot rather than take three different loans. But the problem is, the bank is going to charge you interest for the entire Rs 1 lakh irrespective of how you choose to use it.
This is the inherent problem with traditional lending methods. And that’s where line of credit comes into the picture.
With a line of credit, you can apply for a loan amount and need not utilise the entire amount. You can withdraw how much ever you like and keep the rest in the bank. The best part is that interest will be charged only on the amount used and not the entire amount.
In the same example, say you apply for a line of credit of Rs 1,00,000 and you utilise only 30,000 out of it. You will be charged interest only on the Rs 30,000 and the rest of the Rs 70,000 will be available to you at any point you require. This means you will end up spending a lot less as interests.
There are plenty of traditional banks and new online players who offer this service.
Microfinance, as the name suggests, is a small credit given for a short term and is usually serviced by Non-Banking Financial Corporations (NBFCs). Microfinance is traditionally reserved for people with low income or who do not have a formal credit history or maybe do not have access to traditional loans at all.
This means they usually have low eligibility criteria, and you as a new business can have access to vital funds. But mind you, not all NBFCs will be open to funding your business. Certain NBFCs have a particular target group and sometimes a very specific type of loan that they would serve.
The loans and interests are usually very similar to traditional banks, sometimes even higher. A few of the NBFCs also offer a lot of other unconventional services like chit reserves and advances and other banking financial services which might be useful for your business.
Going into debt might not be everybody’s thing. There is a bizarre moral, if not cultural, resistance towards debt. The opposition also comes from the fact that you need a high level of predictability of your own business before you explore debt and let’s not forget the risk involved.
This is where equity comes into the picture. You minimise your risk by sharing part ownership of the company in return for capital. This capital usually comes in the form of “venture capital”, which is money invested in companies with a huge risk but a massive potential for exponential returns. These investors, usually, are aware of the risks they are getting into, but you need to show them exponential results.
But, you might be wondering, how do you determine the worth of the business, so that you can sell a part of it? The answer lies in a concept called “valuation.”
There are plenty of methods to arrive at the valuation of your company, but as a general rule, you can assume five times your annual revenue as the value of your company. For, eg, If you are making one crore in revenue, then you can assume that the value of the company is five crores. Again, this is an oversimplified way to arrive at this valuation, but this should give you a sense.
If you are at the idea stage, with no operations or sales, your valuation will usually be based on future cash flows, which ultimately depends on execution. This is why, investors typically look at the founder’s profile, background and history.
Now depending on which stage you are at with your business, there are various types of funding you can raise from investors. Let me take you through the hypothetical funding journey of your startup.
This is the first leg of your startup journey. You have an idea, you probably have a co-founder, and you guys have gone ahead and built a prototype. You have invested your own money, probably a few of your friends and family have helped fund your idea. But this is only enough to sustain you and your co-founder for a bit.
Usually, the first round of funding is called the seed funding, and it often happens at the idea/prototype stage. Funds from this round are generally used to develop the product, hire key members beyond the funding team and set up the foundation for revenue generation.
At this stage, investors will be looking for signs of product-market fit ( meaning does the market even need your product ), some initial set of customers which probably might drive some revenue. What you should be seeking here is a validation of your idea and the potential to scale. This round is usually led by angel investors ( individuals willing to invest ) who also sometimes don the role of mentors.
Average funding amount: $500,000 (Rs 3.5 crore)
Average company valuation: $1 million - $2 million (Rs 7-15 crore)
Accelerators and incubators come into the picture around the same time. Accelerators and incubators tend to be organisations, usually run by investors and experts, that try to help startups achieve what they are after. Apart from funding them, they also tend to provide startups with additional help in the form of mentorship and resources.
You might notice that the terms "accelerator" and "incubator" are often used interchangeably, but they are not the same thing. There are a few notable differences.
Accelerators tend to help you grow and scale an existing company ( hence the name accelerators), while incubators usually take businesses at the idea stage and seek to mould them into a viable business model.
Accelerators tend to be more like programs with a set time frame, where startups work with a bunch of mentors and other startups, to iron out things and set the foundation for scale. If you were to apply for an accelerator programme, you might be given a small investment and most importantly, access to an extensive mentor network in exchange for equity.
Unlike accelerators, incubators tend to come before accelerators at a much early stage and can also be industry focused. They can offer you office space, help you evolve from the idea stage to the prototype stage, try to get a product-market fit, mentor you to grow from there. Again they usually take a small chunk of your equity in return for their services.
Keep in mind that accelerators and incubators can be incredibly hard to get into. Less than two percent of the applicants go through. Even if you do get in, you might be asked to relocate, even if it's for a short period of time.
Average funding amount: $500,000 (Rs 3.5 crore)
Average company valuation: $1 million - $2 million (Rs 7-15 crore)
Rapid growth: he only metric that you should be looking for at this stage. And this is precisely what your investors will also be looking for. You should also be able to demonstrate a good product-market fit, deep understanding of your ideal customer and how you have grown from your seed stage. Investors tend to look at metrics like ARPA (average revenue per customer) and how you have been increasing your revenue so far.
You should have also identified new channels for growth. At the seed stage, it’s usually taking your business from 0-1. By the time you reach Series A, you should have a clear idea of how to take that from 1-10. This is also where you will be investing a significant amount of the funds in expanding your team, getting office space, among other things.
This is a game usually played by venture capital firms because that kind of rapid growth doesn’t come cheap. It often requires enormous amounts of capital, resources and mentorship. If your angel investors see promising growth and are confident in your execution, they too might participate in this round.
Average funding amount: $5 million (Rs 35 crore)
Average company valuation: $10 million - $20 million ( Rs 70 crore - Rs 150 crore)
Congratulations on raising that massive Series A. Looks like you have grown significantly, hired all the important people, gotten yourself a swanky office, customers seem to recognise your brand, word of mouth is spreading, and you have hit pretty much every agreed upon milestone. This is a significant achievement.
Now comes the next level of growth: scale. This is where you will be judged on how you can take whatever you have done so far and take it to the next level. If you are doing X, how are you going to take it to 10X? A Series B investment usually fuels this kind of growth. This is where the rubber meets the road.
This level of capital infusion will allow you make expansive ( and sometimes expensive ) hires across the board, grow both deep and wide in the market with new product segments and multiple revenue streams and sometimes even buy smaller startups which might put you in strategic advantage.
Average funding amount: $20 million (Rs 140 crore)
Average company valuation: $40 million - $60 million (Rs 300 crore - Rs 450 crore)
You are no longer an underdog. The whole industry is watching you take giant strides and capture more market size on an everyday basis. Your competitors are losing ground; you have a strong, established the brand in the market. Very few startups reach this stage of funding, but at this stage, the risk is much less, you have established yourself in the market, and that sense of the unknown has long disappeared.
You are confident about your startup, the industry you are operating in, and this allows you to go even bigger and raise massive rounds of investment in the form of Series C and above. In essence, you can keep continuing to raise money in the form of Series D, E, F etc. but this privilege is reserved to only breakout companies.
At this stage, you will probably be eyeing new markets, even international if you are ambitious enough. You take branding to a whole new level by sponsoring IPL matches and product placements in the famous Bollywood movies. You enter into strategic partnerships with other companies to further disrupt your industry. You acquire other companies and grow deeper and broader into your market. You would also be looking at making your business profitable to prepare for the next big thing:
Average funding amount: $50 million (Rs 350 crore)
Average company valuation: $200 million - $300 million (Rs 1,500 crore - Rs 2,000 crore)
The Initial Public Offering is the first time you will be offering the shares of your private limited company to the public. So far, you were attracting only institutional investors, but now you go to the public. Now the public can buy and sell your shares at a price determined by the demand and supply of your shares in the share market.
There are approximately 5000 companies, among millions of companies, listed in India’s stock exchanges, which means two things :
This is also where your investors “exit” from your business. They take this opportunity to sell the equity they have in your company and take the money. Usually, at this stage, they tend to get exponential returns on the investments they have made in your company.
An alternative to this is to sell your entire company to another bigger company. This is also one form of exit and a lot of companies take this route rather than the IPO since it may attract a lot of attention and regulators to your business. In both cases, both you and your investors can exit from the business and reap the benefits of your hard work and success.
For you to understand how long it might take for you to raise money from investors, you need to understand the entire process that takes place before the monies hit your bank account :
Assuming that you have identified the investors you want to work with, be it angel investors or VC firms, and they agreed for a meeting, you need to pitch your idea and business. We will go in detail later in this article to understand how to prepare for this.
The Term Sheet is a list of terms which both you and your investor would have mutually negotiated and agreed upon. The terms usually include how much you will be getting and will you be getting it one shot or in tranches (parts) and other conditions. This is not set in stone and usually, have an “expiry date”.
Obviously, when someone is willing to give you a lot of money, they would like to ensure that you are the real deal. The investors carry out rigorous financial and legal due diligence before they move on to the next step.
If everything checks out during due diligence, your investors would like to protect their rights as shareholders. This is usually very detailed and covers a spectrum of details to protect all the shareholders (including yourself) from any disputes arising in the future.
After the SHA is signed off, you can expect the money to hit your bank very shortly. You will also be required to make necessary filings in the Registrar of Companies (RoC) and stay compliant throughout. The entire process might take 3-6 months.
The internet is, indeed, the ultimate equaliser. If nothing, the internet has closed the gap between the business, and it’s customer by eliminating middlemen. There was also a factor of trust which has also been solved to a large extent by various services. Forget about the behavioural change from traditional shopping to online shopping; people are now buying online before the product is even released!
That’s precisely the concept of crowdfunding. Crowdfunding is the polar opposite of the traditional business route. Ideally, you would first build a product, get some traction, raise some money, get more customers and grow from there.
With crowdfunding, usually what happens is that, people “pre-order” your product before you have even started building it, that way you can use the money from your “sales” to actually create the product and ship it to your customers.
So, in essence, with crowdfunding, you can get a small amount of money from a lot of people instead of a lot of money from a limited number of people. You can also choose to part with equity if you would like to or you can purely base it on pre-order. Crowdfunding, as you can imagine, has been hugely successful in raising donations for various causes.
To get your project crowdfunded, you need to first work on a detailed business plan. You need to then set goals, milestones (very important), timelines, and how you will execute and deliver. Also, you need to mention how you are going to deploy the funds. A prototype, even in a design form, would be helpful in describing your product to your audience.
Once you have all of this, you can go to one of the crowdfunding platforms like Wishberry, Indiegogo, Ketto, and more. Please bare in mind that we might have oversimplified the process and also it can be extremely competitive to raise money in these platforms.
Although a bit late, the Government of India has jumped on to the startup bandwagon and its good news for all Indian entrepreneurs. Some would say that not enough is being done, but that’s for another day. To the government’s credit, there are enough programs and most notable of them is the Startup India programme.
Startup India intends to create a conducive environment for startups to thrive in India by setting up incubation centres, relaxed norms, tax exemptions for three years, and most importantly, an Rs 10,000 crore corpus fund managed by Small Industries Development Bank Of India (SIDBI). The government has received a lot of flak for poor execution of the program, but nevertheless, there is some traction for this programme, and the ecosystem as a whole seems to have benefitted from it.
Also, another programme that cannot be ignored is the Pradhan Mantri MUDRA Yojana (PMMY), which seeks to facilitate loans of up to Rs 10 lakh to non-corporates, and non-farm small/micro enterprises. These loans are serviced by most commercial banks and also NBFCs, and you can approach any of these financial institutions or even apply online through their portal.
Also, you might want to check with your own State governments. Although most State governments fall under the purview of the programs mentioned above, States have their own programmes and initiatives too. Kerala State Self Entrepreneur Development Mission (KSSEDM), Maharashtra Centre for Entrepreneurship Development and Rajasthan Startup Fest are good examples of these state-run programmes.
Regardless of what type of funding you might opt for, there are certain things you need to ensure is in order. Here is a quick checklist for you, before you go out to raise some money
Correct legal structure: It is obvious that you can’t give away shares in your company in exchange for capital if you don’t have a legal structure that allows you to do so; in other words a private limited company. Even if you are going for debt funding, having a private limited company is going to help you because of the credibility it carries.
Business plan: You should work out the numbers of your business in detail which includes market size and research, revenue numbers, and most importantly what do you need the money for and how it will be spent
Determine your need: While you are working on the business plan, you will understand how much money you will be needing and what kind of funding to opt for. Overfunding can be equally dangerous as underfunding, so determine exactly how much you will need and in what format.
Market research/size: You need to know who your ideal customers are and how many of them are there and how much they are willing to spend on products like yours. This will help you understand your market and also estimate the size of your industry.
Prototype/MVP: If you are just starting, having a prototype or an MVP (Minimum Viable Product) is essential. Your prototype or MVP is a bare minimum product, enough to demonstrate how it works and the problems it solves.
Product market fit: You need to give enough indicators to show that your target customers actually need it. If it is a brand new category, having a test run on the sales would benefit you in more ways than you can imagine.
Traction: Do you have any customers? This should be a natural progression from the product-market fit. By now, you have validated your product’s need, but you also need to show them that you can keep achieving the same with some growth.
Pitch deck: Your pitch deck should be a summary of all the things mentioned above. Ideally, you need to have about 10-15 slides summarising everything about your business and your future projections. Also work on an elevator pitch, which is a one minute explanation of your business.
This should give you a good start for raising any money and what usually happens is when you work on these aspects, you understand your business in a completely different perspective. So perhaps its a good idea to work on these things even otherwise.
Having said all of this, I would like to remind you of one thing, especially if you are just starting: please don’t be of the misconception that capital is the deciding factor for a startup’s success or for it to even get started. There are plenty of startups which have obtained millions but failed to make it. This is the greatest testament to the fact that there are various other factors in play here.
Does that mean, you just wasted your time reading this guide? Not at all.
Capital is still essential, but what is more important is you need to when and how to deploy it most efficiently to get the most of it. Capital gives you a massive advantage over other players simply because you can scale and capture a large market for yourself in a very short period.
Are you facing problems raising money for your startup? Let us know of your challenges, success stories, tips and feedback in the comments.
Do you have a startup enthusiast friend who might enjoy this guide? I am sure you do so we would appreciate if you could share this article with them.
Sanjay Shenoy is the co-founder of PixelTrack, a digital marketing training and consulting company. He is also trying to put the marketing back into digital marketing through his blog: Sanjay Shenoy. Content is his forte and has left his mark at prominent startups like Thrillophilia and Explara in the past. He is also a TEDx speaker, author, a corporate trainer with clients like Mercedes Benz India and Nikon Lenswear. In his free time, he likes to travel, juggle, learn music, play football and pet his dog, Max.