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Read this and rest assured you can be on your own against venture capitalists and angel investors
Nowadays, when we talk about funding, we tend to synonimise it with venture capital or third party investment. The case, however, is not so. Venture capital/Angel funding is only a part of the entire story. I see start-ups blindly running after VCs with their business pitch just after starting their ventures. 98.98 per cent times either they return empty handed or compromise by diluting an unwelcome percentage of their stake. As a result all they get is bitter experiences and deflated confidence. While in reality the start-up might not even require third party funding at this stage? So, where does the problem lay?
Plato once said, 'A good decision is based on knowledge and not on numbers'. True! If you do not have knowledge about your business, numbers or projections will not help. Through this article, we intend to provide the basic knowledge to start-ups about the various sources of funding available for financing their business along with their associated pros and cons.
Let us first analyse your start-up. Every venture typically goes through the following stages in its life cycle:
Prototype
A better word for this might be 'idea'. Basically this is the stage in which you start visualising your product/service.
Starting-up
This is the stage wherein your idea gets validated and you move on with setting up your entity. You register your private limited company/Limited liability partnership (LLP). The main focus here is to build your product/service. It generally consists of the first one-two years of an entity.
Warm-up stage
At this stage actually revenue starts flowing into the entity. This is when you struggle to get the right kind of team and market your products.
Expansion/Diversification
This is the stage wherein you have your set team, a ready market and steady revenue inflow to support your expenses. Now you start eying new product lines and new market capturing tactics.
Saturation
This is when your start-up is no longer a start-up. A large dedicated customer base, a well defined business model and set hierarchy. Your start-up has indeed come a long way!
Now, why am I giving you all these details and not even started on the funding sources? Simply put, if you do not know the disease, which medicine will you take? The type of funding required in Stage 1 will definitely not be same as that of Stage 5. Then why run after the same source for all stages? Makes sense, doesn't it?
Now, let us analyse the different sources of funding in detail:
1. Seed capital
As the name suggests, this is the initial amount invested is Stages 1 and 2. This amount can be introduced from founder's own savings or by way of loans from friends and family (legal consultation required).
Pros:
Cons:
Solution
Numerous seed funds are being started every day. A possible solution may be to connect with them. They not only assist with initial capital but also provide necessary insights and mentorship.
2. Incubators/Accelerators/Entrepreneurship cells
These are entities run by Government organisations, seasoned entrepreneurs or leading educational institutes of the country. They usually invest in your idea, provide you a working space and help you connect with prospective investors. This sort of funding in very suitable for Stages 1 and 2.
Pros:
Cons:
Solution
This is indeed a very good source of finance. However, a background check of the accelerators is advisable.
3. Bank financing
This is a very good source of funding for stages 3, 4 and 5. Bank loans are the most common source of financing. This is a flexible mode of securing funds without any pressure on equity.
Pros:
Cons:
Solution
Special care should be taken while availing term loans. It is advisable to apply for short-term working capital loans as and when required.
4. Venture capital
These are generally investment firms who have the potential of pumping large amounts of money in exchange of for equity in the company. VCs are professional investors.
Rounds of VC financing
There can be multiple rounds of VC funding. Each round is typically denoted by a letter of the alphabet (Series A, B, C).
Interesting thing about VC financing is that usually it is received in exchange of convertible preference shares or cumulative convertible preference shares (CCPS). Hereby, the investors are secured about their privileges and enjoy preferential rights till they gain equity ownership.
The different VC rounds reflect different valuations. Usually a Series B funding will see a higher valuation than that of Series A. There can also be a 'Down Round', wherein the valuation of the current round will be lower than the previous series. However, this is not a very common scenario.
Pros:
Cons:
Solution
VC funding is your big ticket to enter into the big corporate arena. However, you must be very careful while striking the deal with them.
5. Mezzanine financing & bridge loans
Once a company receives VC funding, the start-up feel is washed away. The next important stage that would be in the horizon is initial public offering (IPO). The need of the company grows and the funding sources for Stages 1, 2, 3 and 4 can no longer suffice the requirement. Usually the following options are now considered:
Till the time the company carries out either of this, the company may opt for mezzanine financing or 'bridge' financing. As the name suggests, these are short term financial assistance which are often used 6 to 12 months before an IPO.
These are some of the most common sources of funding for a start-up. As you can see now, every stage in the life cycle of a start-up is unique. So are the choices.
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