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Funding refers to the money required to start and run a business. It is a financial investment in a company for product development, manufacturing, expansion, sales and marketing, office spaces, and inventory. Many startups choose to not raise funding from third parties and are funded by their founders only (to prevent debts and equity dilution). However, most startups do raise funding, especially as they grow larger and scale their operations. This page shall be your virtual guide to Startup funding.
| Working Capital | Equity Financing | Debt Financing | Grants |
|---|---|---|---|
| Brief | Equity financing involves selling a portion of a company's equity in return for capital. | Debt financing involves the borrowing of money and paying it back with interest. | A grant is an award, usually financial, given by an entity to a company to facilitate a goal or incentivize performance. |
| Nature | There is no component of repayment of the invested funds. | Invested Funds to be repaid within a stipulated time frame with interest | There is no component of repayment of the invested funds |
| Risk | Financer: There is no guarantee against his investment. Startup: Startups need to give up a portion of their ownership to shareholders. | Financer: The lender has no control over the business's operations. Startup: You may need to provide a business asset as collateral. | Financer: There is a risk of the startup not meeting the goal or objective for which the grant has been provided. Startup: There is a risk of the startup not receiving a portion of the grant due to several reasons. |
| Threshold of Commitment | While startups are under lesser pressure to adhere to a repayment timeline, investors are constantly trying to achieve growth targets. | Startups need to constantly adhere to the repayment timeline, which results in more efforts to generate cash flows to meet interest repayments. | Grants are distributed in different tranches w.r.t the fulfilment of the corresponding milestone. Thus, a startup is constantly working to achieve the milestones laid down. |
| Return to Investor | Capital growth for investors | Interest payments | No Return |
| Involvement in Decisions | Equity Investors usually prefer to involve themselves in the decision-making process. | Debt Fund has very less involvement in decision-making. | No direct involvement in decision-making. |
| Sources | Angel Investors, Self-financing, Family and Friends, Venture Capitalists, Crowd Funding, Incubators/Accelerators | Banks, Non-Banking Financial Institutions, Government Loan Schemes | Central Government, State Governments, Corporate Challenges, Grant Programs of Private Entities |
The entrepreneur must be willing to put in the effort and have the patience that a successful fund-raising round requires. The fund-raising process can be broken down into the following steps
The startup needs to assess why the funding is required, and the right amount to be raised. The startup should develop a milestone-based plan with clear timelines regarding what the startup wishes to do in the next 2, 4, and 10 years. A financial forecast is a carefully constructed projection of company development over a given time period, taking into consideration projected sales data, as well as market and economic indicators. The cost of Production, Prototype Development, Research, Manufacturing, etc should be planned well. Basis this, the startup can decide what the next round of investment will be for.
While it is important to identify the requirement of funding, it is also equally important to understand if the startup is ready to raise funds. Any investor will take you seriously if they are convinced about your revenue projections and their returns. Investors are generally looking for the following in potential investee startups:
The offering of any startup should be differentiated to solve a unique customer problem or to meet specific customer needs. Ideas or products that are patented show high growth potential for investors.
The passion, experience, and skills of the founders as well as the management team to drive the company forward are equally crucial in addition to all the factors mentioned above.
Market size, obtainable market share, product adoption rate, historical and forecasted market growth rates, macroeconomic drivers for the market your plans to target.
Startups should showcase the potential to scale in the near future, along with a sustainable and stable business plan. They should also consider barriers to entry, imitation costs, growth rate, and expansion plans.
Clear identification of your buyers and suppliers. Consider customer relationships, stickiness to your product, vendor terms as well as existing vendors.
Consider the number of players in a market, the market share, obtainable share in the near future, product mapping to highlight similarities as well as differences between different competitor offerings.
No matter how good your product or service may be, if it does not find any end-use, it is no good. Consider things like a sales forecast, targeted audiences, product mix, conversion and retention ratio, etc.
A detailed financial business model that showcases cash inflows over the years, investments required key milestones, break-even points, and growth rates. Assumptions used at this stage should be reasonable and clearly mentioned.
A startup showcasing potential future acquirers or alliance partners becomes a valuable decision parameter for the investor. Initial public offerings, acquisitions, subsequent rounds of funding are all examples of exit options.
Investors essentially buy a piece of the company with their investment. They are putting down capital, in exchange for equity: a portion of ownership in the startup and rights to its potential future profits. Investors form a partnership with the startups they choose to invest in – if the company turns a profit, investors make returns proportionate to their amount of equity in the startup; if the startup fails, the investors lose the money they’ve invested.
Investors realize their return on investment from startups through various means of exit. Ideally, the VC firm and the entrepreneur should discuss the various exit options at the beginning of investment negotiations. A well-performing, high-growth startup that also has excellent management and organizational processes is more likely of being exit-ready earlier than other startups. Venture Capital and Private Equity funds must exit all their investments before the end of the fund’s life.
The investor may decide to sell the portfolio company to another company in the market. In essence, it entails one company combining with another, either by acquiring it (or part of it) or by being acquired (in whole or in part).
Initial Public Offering is the first time that the stock of a private company is offered to the public. Issued by private companies seeking capital to expand. It is one of the most preferred methods by investors to exit a startup organization.
Investors may sell their equity or shares to other venture capital or private equity firms.
Under financially stressed times for a startup company, the investors may decide to sell the business to another company or financial institution.
Founders of the startup may also buy back their shares from the fund/investors if they have liquid assets to make the purchase and wish to regain control of their company.
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