NASSCOM Product

Fund Raising 101 for Startups

Blog Post created by NASSCOM Product Moderator on Jun 23, 2017

It is estimated that founders can end up spending more than 50% of their time raising funds for their venture. While the amount of time spent on this activity may be debatable and vary based on multiple factors including the credibility / track-record of the founder, investment climate, industry sector, etc., what is undisputed is the fact that fund raising is a major focus area AND a huge drain on founders’ time. Unfortunately, it is also one activity that cannot be delegated to anyone lse.

 

In my case, at every stage of all my ventures’ growth and development, I’ve had to spend huge amounts of time focussing on fund raising.

 

So, given how critical this activity is, founders will be well advised to ask themselves the following questions,BEFORE they plunge headlong into raising funds,

 

 

  1. “Do I really need external funding”?  Very often, people can build businesses without

Institutional capital (venture capital, or, even early-stage angel funding). A business can be built, out of cash flows of the business, customer advances, entrepreneur’s own savings, loans from friends and family or other softer resources. There are a lot of businesses such as professional services firms that break even quickly, which can be boot strapped without external funding.

 

Founders, therefore, need to ask themselves what funds are really required till they reach profitability and whether there is an absolute imperative to seek outside funding or if the amount is something that they can mobilise internally

 

  1. “Is it Risk capital or just Working capital that I need”? Typically, working capital refers to capital you need to deploy for a period of time,which is likely to be returned to the business; E.g., for buying an inventory of goods that you will end up selling at a profit for which money will flow back into the business. For this, you need to invest an initial amount that can be recovered later. Working capital could also go towards salaries etc., that you need to pay initially but can be recovered from the services provided by your employees. On the other hand, risk capital is different and would go towards R&Dand product development costs, branding, marketing, etc. In this case, the results of undertaking these activities are unknown, and things may or may not work out; nevertheless, you need these elements in order to build out the business but the entire capital invested is “at risk.”

 

Potential funders for both the types of capital listed above are different. Working capital typically comes from banks, NBFCs(non-banking financial institutions) or sources that don’t expect safety of the principal to be compromised and seek some collaterals or guarantee in return for lending the funds. They are mostly willing to fund over the short-term and expect moderate returns.

 

Risk capital,however, is for “risk investors” who would expect a stake or piece of your company. They understand the high risk, expect multi-bagger returns or compensation for the risk. These include angel investors, VC (venture capital) firms, etc.

 

  1. ”When should I raise to raise Venture Capital or equity funding”?This can be particularly tricky. When you raise external funding too early in the game, you may end up with a low valuation, and you dilute your stake disproportionately. However, choosing to raise funds too late and you don’t have enough fuel (cash) to experiment and try out various things, take risks and play aggressively for a win.

 

In my opinion, if you are clear about needing VC funding then the earlier, the better. Dilution (of his / her stake) never affected any entrepreneur. Entrepreneurs are passionate people who want to see their dreams and passion change into reality. For this, they need all the help they can get given the low odds of success (Less than 5 % of startups actually last / succeed). No company ever shuts down because the founder diluted too much; rather, companies have to shutter because the last Rs10,000 to pay the bills is no longer there.

 

But, some experts think differently. They advocate that you should develop the business to a certain stage so that you are clear about how much money is required, for what purpose this will be used, and can show some market traction before raising funds - at which point the valuation will be better, and dilution of stake will be lower. As I said before, the timing issue is a tricky one to resolve.

 

 

 

  1. What will be the source of funds?” (Angels / HNIs, Angel networks, Seed stage funds, Venture Capitalists, PE firms)

 

This should be determined by a few factors such as:

  • The quantum of the fund raise: Each class of investor has their sweet spot on how much they typically invest and should be approached accordingly based on the size of funds one is seeking.
  • Stage of the business: The clarity of business model, proof of concept, market validation is important and will decide whom to approach. VCs usually need a more mature set-up compared to a seed stage fund, which in turn would like to come in when there is some proof as compared to an angel or HNI who bets on an idea. Some exceptions to the rule may apply. For instance, some VCs have a start-up accelerator funds or pools. PE firms usually provide what is known as “growth-capital”. They will come in after the proof of concept has been validated and soundly established, when there is clear profitability or a path to profitability exists. PE firms provide give funds for growth, and not for proving the business model.

 

  1. How much funding should I raise?

 

Raising higher than normal funding may encourage profligate spending and excesses as we have seen during the boom days. However, having access to money rarely killed a company, but the lack of it (money) will certainly do. But how much to raise is determined by the amount that is needed to execute your plan and getting to the next milestone. The next milestone could be:reaching profitability, reaching enough scale to be able to attract the next round of funding for a much larger amount, developing the product fully so that you can deploy it in ‘live’ customer environments, or developing the business to a level where you will start generating revenues to sustain your monthly burn, etc.

 

It is important to raise as much funding as you can based on a) your need b) market appetite and b) your capability to attract investors. It’s better to have more rather than less funding.

 

K Ganesh, Serial Entrepreneur and Partner – GrowthStory.in 

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