Unable to understand why early stage startups or growth stage startups need to raise finance? We know how hard it can be to select the right channels for raising funds- So we’ve broken it down for you.
Firstly, it’s important to understand why startups need to raise finance. Most startups need to raise finance to scale their business or gather funds for future growth. Some people fail to realize there is more to raising funds than just financial aid such as capital or revenue expenditure. Raising finance helps firms gain credibility. When a startup is able to raise finance by venture capitalists or angel investors, they show that field experts see the potential in their idea. These channels of raising funds also provide guidance, mentorship and most importantly, an access to a larger network; furthering opportunities for your startup.
Another factor to consider is the right time to raise funds for your startup. Your initial round of funding should be just after your ideation phase when you have a clear idea of how much funding you require. Funding at this stage should usually be done through bootstrapping. Another round of funding, usually with external investors should be done right before launching your product to the market. It still may be confusing which channel of finance will suit you best, but don’t worry, we’ve broken it down for you.
With the rise of online crowdfunding platforms such as Kickstarter, it’s become easier than ever for startups to pitch their ideas online to generate small funds from individuals. The largest crowdfunding platforms in India as of now are Milaap, Ketto and Impact Guru.
There are mainly 4 types of crowdfunding;
Donation-based crowdfunding: A way of asking a large number of people for small amounts of money without any return from the company. Companies can usually expect to raise anywhere between $1000-$10,000.
Reward-based crowdfunding: A way of earning larger sums of money in return for some kind of reward or investment in the company. Companies can usually expect to raise anywhere between $5000-$50,000.
Debt-based crowdfunding: Allows companies to raise funds in the form of a loan from a large number of investors which need to be paid back at a later date. Companies can usually expect to raise up to $1 million.
Equity-based crowdfunding: Allows companies to raise funds from a large number of people in exchange for an equity stake in the company. Companies can usually expect to raise anywhere between $50,000-$150,000. However, this type of crowdfunding is currently illegal in India.
Crowdfunding is a good way of raising finance for companies with time to inaugurate a campaign. Donation-based crowdfunding is especially good considering it does not need to be paid back. It can also help raise large amounts of money in short periods of time. One example of a startup that has proven crowdfunding successfully is Oculus Rift, one of the largest VR system companies of today. Primarily using donation-based crowdfunding on Kickstarter, the Swedish startup was able to raise $2.4 million spread across around 9,500 backers in 2012. The company later grew to be acquired by Facebook for $2 billion.
However just because it worked for Oculus Rift doesn’t mean it’s the best option for you. It is very plausible your campaign will not succeed, especially if your idea has been done before. Campaigns need to be well thought out, personally spread their message effectively and target the right audience, which can all take a lot of time and money to determine. And even then, the success rate of achieving your target on crowdfunding websites is only 38.9%. So if presentations aren’t your strength, you may want to consider other options before spending lots of time creating a campaign.
An angel investor is a person willing to invest large sums of capital into a start-up in exchange for equity in the company. Although the amount of money invested depends on the investor and the requirements of the company, angel investors can invest around $25,000 – $100,000. Angel investors also offer guidance and mentorship apart from just monetary funds so they can greatly help increase your chances of success.
However, angel investors often expect a high return on investment and even take partial control of the business, leading to dilution of ownership. Finding an angel investor also requires a lot of time and networking so if you don’t have those types of connections, it may be better to skip this type of investment.
But just because angel investment seems like the right option for your startup, doesn’t necessarily mean the angel investor is. Firstly, you should ask yourself if their investment is worth the equity stake they are requesting for, if they are inflexible, chances are they’re not the correct option. Since these investors often want to be involved in the decision-making process, they should also ideally have some knowledge of the field your company is based in. Understanding how involved an investor wants to be in the company is also essential to prevent future conflicts. If the angel investor you’ve chosen doesn’t suit these options, this investor may not be good for your company.
If you think angel investment is the right choice for you, you can try connecting with investors on websites such as; AngelList, Seed Invest and Golden Seeds LLC or searching up lists of angel investors near your area.
Venture capitalists (VCs) provide funds to companies showing high growth potential in exchange for an equity stake in the company. They also provide additional support in the form of mentoring and human resource management. Often, VCs can also use networking to connect you to the top business leaders in your field, guaranteeing a chance at success. Companies can usually expect to raise a lot of funds in this channel of investment, established startups can even earn investments up to $20 million, and it doesn’t need to be paid back! As of now, some profound venture capital websites are Sequoia Capital, Lightspeed venture partners, Google ventures and Alta partners.
However, due to the high risk that comes with being a venture capitalist, they often require a high rate of return. Just like angel investing, giving VCs equity stakes can lead to dilution of ownership. Additionally, raising venture capital can take anywhere from 3 months – 9 months and some early-stage startups just might not have the time for that. Venture capital is also more suitable for startups that are tech-based and geographical location plays a big role in venture capital. Startups located in hotspots such as silicon valley are far more likely to raise funds this way as compared to startups in smaller cities.
Venture capitalists also prioritize quick growth in order to get the highest return on their investment. However, this may not necessarily be good for a startup. A business may not have the right resources and experience to be able to scale that quickly, possibly leading to its demise. Furthermore, due to the startup losing the equity in every round of funding, it’s possible to end up with less cash at high profits. Unless you are sure your startup is ready to grow quickly and are comfortable with losing equity stakes, venture capital might not be the option for you.
Bootstrapping, Friends and Family
Bootstrapping is a way of investing primarily through using the owner’s personal funds or raising capital from friends and family. With the flexibility to gain funds with flexible payment terms, interest rates (or possibly no payment at all), why don’t more startups use this form of funding?
Firstly, you probably won’t be able to raise as much money as compared to the other methods considering you’re asking for people’s hard-earned money without any reward. Furthermore, business failure will directly affect your friends and family, putting additional pressure on the owner. Your startup also has less credibility if it’s fully funded by bootstrapping as it suggests an incapability to raise funds.
However, bootstrapping is always a good way to raise immediate, small amounts of capital. Especially right after the ideation phase where you may not have a physical product to show investors, bootstrapping can help fund research and development.
Revenue Based Financing
Revenue-based financing is when firms raise capital from investors in exchange for a percentage of future revenue. These payments continue until a certain multiple of the original investment has been paid. This type of financing allows companies to retain full control and ownership. The owner also doesn’t have to worry about paying back a certain amount of money as the investor will get a certain amount of money regardless of the value of the revenue, reducing the pressure on the owner. Another huge advantage of Revenue-based financing is that it doesn’t require multiple rounds of pitching or campaign like most options, you can expect to earn capital in as little as 4 weeks!
An example of an Indian startup that successfully used revenue-based financing is The Label Life. The CEO Preeta Sukhtankar claimed that despite the 40% interest they were paying investing firm Klub in return, revenue financing still greatly helped her company in terms of working capital and inventory. He also commented on the flexibility of the 12-month repayment cycle.
However, it is often difficult to find investors if your startup is still in the ideation or ‘pre-revenue phase. Having to make definite payments also limits working capital and cash flow, limiting the growing capacity of a startup. Ideally, this model works best for companies who are looking for large investments to fund expansions or capital expenditure without diluting their ownership.
When a firm raises funds by selling its debt instruments to investors. The investors are repaid the debt within a pre-agreed interest rate and timeline. Usually, debt financing is issued between 6% to 15%. Debt financing doesn’t dilute the ownership and offers flexible repayment options. Unlike interest rates on bank loans which are subjected to monetary policies, debt financing agreements have fixed interest rates, allowing companies to plan their repayment options.
On the other hand, debt financing can be difficult to qualify for depending on the credit score of the business owners. In cases of bankruptcy, the owner’s assets will be seized as a repayment to the investor. Unlike equity financing options, debt financing needs to be repaid, causing an additional hassle to the startup.
Examples of India’s largest debt financing firms are Alteria Capital, Trifecta Capital and Softbank ventures Asia.
There’s no doubt that you know that bank loans are a popular way startups raise funds, but how do you know if it’s the right option for you?
Although bank loans can often be denied on credit terms, they can be used for almost any type of business, unlike crowdfunding, angel investment and venture capital; all of which are more suited for tech-based startups or startups in niche markets. It also allows startups to retail full ownership of their business.
However, it’s possible to not be eligible for loans depending on your revenue, credit history and financial records. Furthermore, typically bank loans raise around $20,000, which may not be enough for large-scale startups. Loans that require monthly installments will also restrict your cash flow, which may not be the best idea if you’re just starting out.
Divestiture is a sale of an asset owned by the company such as a subsidiary, intellectual property, factories, e.t.c.
The amount of capital you raise largely depends on the asset you decide to sell. It also means you no longer need to finance the maintenance or development of that asset and can also help foster partnerships with other companies.
An example of a company that successfully used a divestiture is Weyerhaeuser. In 2004, they divested $9 billion out of their $16 billion operations, using the capital raised to transform their company into timber and real estate.
However, it is common to be unsure of how to approach a divestiture. Lucky for you,
GrowthPal, through its very unique M&A platform can help you out! If you’re ready to sell a part of your company, we can help you find the right type of investor so you no longer have to worry about spending your time and resources on raising funds- We do it for you!
To sum up, the key things to ask yourself before deciding what the best source of finance is for your company is:
- How much capital does your business require? (For large amounts of capital, you should be looking at equity financings such as venture capital and angel investment)
- Will you be able to repay debt financing?
- What is your equity dilution (you should have at least 75% if you are an early-stage startup)
- Do you need additional resources such as knowledge and enterprise apart from just monetary funding?
We hope we have made it a little easier for you to pick the best source of finance for your startup. Reach out to us to find how we can help your business grow. Contact us today at [email protected]