There are multiple sources of funding available for startups. However, the source of funding should typically match the stage of operations of the startup. Please note that raising funds from external sources is a time-consuming process and can easily take over 3 - 6 months to convert.
This the stage where the entrepreneur has an idea and is working on bringing it to life. At this stage, the amount of funds needed is usually small. Additionally, at the initial stage in the startup lifecycle, there are very limited and mostly informal channels available for raising funds.
Bootstrapping a startup means growing the business with little or no venture capital or outside investment. It means relying on your savings and revenue to operate and expand. This is the first recourse for most entrepreneurs as there is no pressure to pay back the funds or dilute control of your startup.
Friends & Family
This is also a commonly utilized channel of funding by entrepreneurs still in the early stages. The major benefit of this source of investment is that there is an inherent level of trust between the entrepreneurs and the investors
Business Plan/Pitching Events
This is the prize money/grants/financial benefits that are provided by institutes or organizations that conduct business plan competitions and challenges. Even though the quantum of money is not generally large, it is usually enough at the idea stage. What makes the difference at these events is having a good business plan.
At this stage, a startup has a prototype ready and needs to validate the potential demand of the startup’s product/service. This is called conducting a ‘Proof of Concept (POC)’, after which comes the big market launch.
A startup will need to conduct field trials, test the product on a few potential customers, onboard mentors, and build a formal team for which it can explore the following funding sources:
Incubators are organizations set up with the specific goal of assisting entrepreneurs with building and launching their startups. Not only do incubators offer a lot of value-added services (office space, utilities, admin & legal assistance, etc.).
Government Loan Schemes
The government has initiated a few loan schemes to provide collateral-free debt to aspiring entrepreneurs and help them gain access to low-cost capital such as the KSUM seed fund, KSIDC Softloan and Startup India Seed Fund Scheme.
Crowdfunding refers to raising money from a large number of people who each contribute a relatively small amount. This is typically done via online crowdfunding platforms.
At the Early Traction stage startup’s products or services have been launched in the market. Key performance indicators such as customer base, revenue, app downloads, etc. become important at this stage.
Series A Stage
Funds are raised at this stage to further grow the user base, product offerings, expand to new geographies, etc. Common funding sources utilized by startups in this stage are:
Venture Capital Funds
Venture capital (VC) funds are professionally managed investment funds that invest exclusively in high-growth startups. Each VC fund has its investment thesis – preferred sectors, stage of the startup, and funding amount – which should align with your startup. VCs take startup equity in return for their investments and actively engage in the mentorship of their investee startups.
Banks/Non-Banking Financial Companies (NBFCs)
Formal debt can be raised from banks and NBFCs at this stage as the startup can show market traction and revenue to validate its ability to finance interest payment obligations. This is especially applicable for working capital. Some entrepreneurs might prefer debt over equity as debt funding does not dilute equity stake.
Venture Debt Funds
Venture Debt funds are private investment funds that invest money in startups primarily in the form of debt. Debt funds typically invest along with an angel or VC round.
At this stage, the startup is experiencing a fast rate of market growth and increasing revenues.
Series B, C, D & E
Common funding sources utilized by startups in this stage are
Venture Capital Funds
VC funds with larger ticket sizes in their investment thesis provide funding for late-stage startups. It is recommended to approach these funds only after the startup has generated significant market traction. A pool of VCs may come together and fund a startup as well.
Private Equity/Investment Firms
Private equity/Investment firms generally do not fund startups however, lately some private equity and investment firms have been providing funds for fast-growing late-stage startups who have maintained a consistent growth record.
Mergers & Acquisitions
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 (IPO)
IPO refers to the event where a startup lists on the stock market for the first time. Since the public listing process is elaborate and replete with statutory formalities, it is generally undertaken by startups with an impressive track record of profits and who are growing at a steady pace.
Investors may sell their equity or shares to other venture capital or private equity firms.
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.
What do investors look for in startups?
Objective and Problem Solving
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.
Management & Team
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.
Scalability & Sustainability
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.
Customers & Suppliers
Clear identification of your buyers and suppliers. Consider customer relationships, stickiness to your product, vendor terms as well as existing vendors.
A true picture of competition and other players in the market working on similar things should be highlighted. There can never be an apple-to-apple comparison but highlighting the service or product offerings of similar players in the industry is important.
Sales & Marketing
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.