Start-ups and their funding process
With the increasing number of start-ups in India, the funding requirement has also seen a tremendous growth line. Investors are looking out for start-ups that will create value for them as well as the society in the coming years. Start-ups usually need funding in order to convert their idea into an actual selling product or service. This process of conversion requires a lot of patience, compliance and confidence on part of the team handling the start-up or their advisors.
A start-up usually requires funds for various reason ranging from capital investment to operational needs. It is important to be clear as to why the funds are being raised. A detailed business plan and financial model before approaching an investor for funding. Funding can be used for:
1. Product development
- Team Hiring
- Working Capital requirements
- Marketing and Sales
Types of Funding:
- Equity Finance:
Equity finance is the source of finance wherein the start-up agrees to give up a certain percentage of shares of the business to the investor in return for the funds being provided. This is considered to be the primary sources of investment. Here, there is no obligation of repayment of the fund, but there may be certain covenants imposed by the investor such as expected revenue or net profit to ensure their return on investment. The risk factor for an investor is high as there is no guaranteed return on their investment. Players that provide equity finance are angel investors, venture capitalist, self funding, family and friends etc.
- Debt Finance:
As the name suggests, financing the start-up through debt. Debt doesn’t confine only to loan from banks, it widens towards loan from other sources as well. Here, no share of the business is to be provided however there might be time limit as to by when the principal along with the interest will be paid back to the investor. Risk factor for the investor is comparatively lower as there is guaranteed interest payment as well as principal amount to be recovered in the stipulated time. This is the more or less uncommon in start-ups as this creates a pressure on them to repay the funding by the due date.
Stages of funding:
Stage 1: Pre-seed (Idea)
This stage is a starting point for a start-up. Their idea is getting fruition in the minds of the entrepreneur. The sources in this stage include self-financing, friends and family. This is also the stage when the entrepreneur should start preparing pitch deck, business plan (financial model) and valuation report.
Stage 2: Seed Stage
This is the stepping stone for the start-up. Here they have a chance to provide a proof of concept i.e. prove their product or service in front of a group of investors. They will have to conduct tests, surveys, sampling and customer reviews in order to gain funding. The sources at this stage are incubators, government grants or schemes, angel investors and crowd funding.
Stage 3: Series A Round
This is the first stage of growth for a start-up. Here, the start-up is starting to see traction and demand for their business. The need for further funds can be to satisfy the demand, increase their customer base, etc. The sources include venture capitalist, banks and NBFCs, institutional investors.
Stage 4: Series B Round
The stage is for scaling and faster growth in the market. Here, the start-up will see competitors draw up in the market and they are looking to beat them. They experience faster revenue growth, increase in market share and demand. The sources are mostly large venture capitalists, private equity and investment firms.
Note: After Series A and B rounds, if the funds are not enough to satisfy the growth of the start-ups they may go further for round C and D.
Stage 5: IPO
Finally, the start-up has been converted into a full-fledged business with a large customer base, constant demand and revenue growth. They may decide to go public by getting listed on stock exchanges for further financing through IPO.
How to raise funds?
Start-ups usually lack the skills and knowledge required to gather funding. They are and should be more focused on their business and the product they are willing to sell. There are many advisors that provide these services. The process involves assessing the needs, investment plan, pitch deck, business plan, valuation report, investor targeting and screening and due diligence.