The signs are everywhere. Students, women, yuppies, the unemployed, those facing a mid-life crisis, and a whole lot of other categories have succumbed to the e-bug. Frankly, the environment has never been more conducive. Of course, the risks associated with start-ups remain (see Hurdles you will face), with more than 50% of all start-ups failing within the first five years.
It’s just that landing funds to fuel your venture is easier than ever before. Venture Intelligence, a research firm focused on venture capital and private equity deals in India, says there are 43 angel networks, 111 venture capital investors and 37 incubators in the country
We have certainly come a long way from the days when bootstrapping-falling back on savings, fixed assets, and money from friends and family-was the only option. Nonetheless, this is still the most preferred starting point for a majority of new businesses.
The trouble with bootstrapping is that it usually means scrimping on capital, which, in turn, curtails the start-up’s flexibility and ability to grow. There is also a very real risk of fledgling entrepreneurs overleveraging themselves. Says Nishant Verman, associate, Canaan Partners: “It is not uncommon to see entrepreneurs taking a huge credit card debt for their start-ups. They should take calculated risks and not become reckless.”
A less risky way to raise seed capital is to pool resources with a group of people who have shared interests and work together to escalate a business idea to at least a prototype. This is how the Bangalore-based CustomerXPs, a software product company, stockpiled its seed capital of Rs 2 crore.
“I came across Aditya Lal, Balaji Suryanarayana and Sandhya V, all people with whom I had worked earlier, and decided to set up my venture with them. All of us invested equal amounts of money in the start-up and have equal stakes,” says Rivi Varghese, CEO, CustomerXPs.
However, if you are sure of the scalability of your venture and are not obsessive about retaining independent control, private funding could be the best option. This type of funding comes in various forms, each typically catering to different stages of a start-up, such as the seed stage, early stage and growth stage. Here are some of the options.
These are high net worth individuals, who invest in a start-up in return for a minority share in the business. They are usually serial entrepreneurs or heads of major multinational firms. They can also be a group of individuals who pool in funds to invest. The key networks include Mumbai Angels, Indian Angel Network, Hyderabad Angels, Pune Tech Angels, Business Angel Network of Kerala and East Angels.
Angels typically come into the picture at a start-up’s seed stage, when the business idea is just a concept. The wannabe entrepreneur has no team, no product and no customers. The business plan itself is very iffy. So what draws an angel’s attention? Business ideas that have the potential to generate solid returns, as well as the person behind it, but they are basically in it for altruistic reasons. Says Saurabh Srivastava, co-founder, Indian Angel Network: “Angels like mentoring an entrepreneur and nurturing a start-up in its initial stage.”
Since all start-ups are risky propositions at this stage, angels typically don’t put in a huge sum. “We invest in start-ups that are unlikely to draw the interest of venture capitalists since the size of investment is rather small, from Rs 50 lakh to Rs 5 crore, depending on the angel approached and the business idea. Only in special circumstances will the deal size stretch to Rs 10 crore,” adds Srivastava. In return, they take a 20-30% stake in your firm.
Angels are patient investors; they typically remain invested for 7-8 years. They review the progress regularly and are even willing to go back to the drawing board, if required. “Angel investing provides an immediate induction of more minds, which helps in efficiently strategising for the challenges that can be faced by start-ups,” says Siddhartha Nigam, partner, M&A, at Grant Thornton, a managed accounting and consulting firm.
No wonder Sasha Mirchandani, co-founder of Mumbai Angels, claims that angel-backed companies tend to do better than the ones that directly approach venture capital investors. You can also expect quick access to funds. It can take anywhere between a day and three months to close a deal.
The concept of angel funding is still at a nascent stage in India, so they are difficult to find. You need to boast the right contacts/professional network to bag such funding, besides having the right credentials. Says Srivastava: “Factors like the entrepreneur’s reputation, integrity, clarity of mind and his response to feedback are important for me. He should also be a good listener.”Mirchandani, on the other hand, is more concerned with the capital efficiency of a business idea. “We write small cheques, so the start-ups approaching us need to be extremely careful with the capital,” he explains. This is why so many IT start-ups, typically both capital-efficient and easily scalable, find favour with angel investors.
However, as Verman stresses, easy funding is still difficult to come by. “India is no Silicon Valley, where a super angel like Mike Maples will invest in a product when it’s no more than a blueprint sketched on a notepad, as in the case of Twitter,” he warns.
“Currently, angels are interested in funding education, mobile value-added services and apps, innovations in healthcare and rural entrepreneurship,” says N Muthuraman, director, RiverBridge Investment Advisors, a boutique financial advisory firm.
For the uninitiated, venture capital firms invest their shareholders’ money in start-ups in return for a minority share in the company.
They typically invest at an early stage of a start-up; unlike angels, precious few are willing to back an idea at the concept stage. That’s logical, because a start-up needs more funds at the early stage when the working capital requirement is high. This is when the fatter cheques of venture capitalists come into play. Venture capital firms have been known to help start-ups organise the next round of funding as well.
Says Arvind Modi, associate vice-president (investments), Gujarat Venture Finance Ltd, which provides venture capital to tech start-ups: “We like ventures where the product or service is established and the start-up requires funding for commercialisation or scaling up of operations. Venture capital players may not invest in research and development activities.”
However, there are exceptions. Many firms, such as Accel India Venture Fund, Sequoia Capital, Seedfund, Ncubate Capital, Nexus India Capital and Draper Fisher Jurvetson (DFJ), are increasingly willing to provide seed stage funding, but let us consider the thumb rules.
Also, these investors usually don’t believe in one-man shows; it is risky if everything depends on one person. “Unless an entrepreneur is very experienced, he won’t be able to deal with the challenges posed by a start-up single-handedly,” adds Verman.
You will also need to have an exit strategy. The basic purpose of any venture capital investor is to sell his stake for a profit after 4-5 years. So, cover options for the next round of investment, typically from a private equity player, the possibility of an IPO or a potential buyer, along with an approximate exit valuation, in your presentation.
This is practically the only option that gives entrepreneurs access to deep pockets at a time when they are trying to build the company. Private equity’s fatter cheques are typically reserved for mature companies. You also get expert help and access to the firm’s entire network.
“Venture capital funds in India are risk-averse; they require proof of concept and decent revenue visibility before investing,” says Muthuraman. In addition, each player will have sectoral preferences. They don’t just offer you funds for your business, but also bring along their expertise.If they do not have prior experience in investing or running a business in your sector, they won’t be able to understand your business and, hence, will not invest in it. “So if you are a healthcare company, there is no point approaching an early-stage tech-focused firm like ours,” says Verman.
Also, a typical player expects an internal rate of return of 25% on the investment in 4-5 years. “To meet the expectation, the company’s compounded annual growth should be over 25%,” says Modi. A business with low scalability may not be able to provide them with the desired returns on their investment and, hence, will be rejected outright. The safest bets are the ones where there is a business and professional connect.
“It is a highly dilutive way of raising capital. It suits companies that have very high scalability and don’t need too much recurring capital,” advises Muthuraman. Also, be prepared to wait for 3-6 months to close a deal.
The most sought-after sectors by this segment are biotech, mobile value-added services, education, healthcare, e-commerce, IT-ITeS, infrastructure and green technology.
This is a medium-term loan that is exclusively provided to companies backed by venture capital firms.
How venture debt works.
The USP here is that no collateral is required to be eligible. Instead, venture debt providers evaluate applicants on the basis of a start-up’s fundamental enterprise value, assessing how it will grow and, thereby, pegging its future cash flow and ability to repay the loan. You can expect funding of Rs 2.5-20 crore, depending on the growth stage of company and the nature of requirement.
Says Ajay Hattangdi, managing director, SVB India Finance: “An experienced founding team, a credible business plan and a solid venture capital investor base are some factors that we would consider in our assessment.” He adds that the interest rates are fixed for the tenure of the loan and are competitive compared with rates that SME clients can usually obtain from banks.
Venture debt financing is structured specifically to support seed and early-stage start-ups. Hence, it understands that a venture is prone to volatility early in life and, consequently, provides more flexibility to entrepreneurs. According to Muthuraman, this is a useful tool for an entrepreneur wanting to minimise his equity dilution early on as it can bridge the gap between the funds provided by the venture capitalist and his actual requirement.
These funds come with the least amount of restrictions and can be utilised for any business initiative, from basic operations and working capital to supporting capital expenditures and making acquisitions.
Apart from the interest on the loan, venture debt providers typically require an equity kicker, or shares of your company, to compensate for the higher risk taken. “The kicker enables us to get a share in the upside if the company does well. It also enables us to keep our loan interest rate down to a minimum,” says Hattangdi.
This is a standard option for entrepreneurs but not for seed-stage start-ups. Says Sushil Munhot, chairman and managing director, Small Industries Development Bank of India (SIDBI): “One should look at bank funding only after the product has gone through seed or venture cycle and one wants to commercialise it further.”
Usually banks and finance companies fund up to 80-90% of the loan-to-value ratio (borrowed amount divided by the asset value you are purchasing or refinancing), depending on the credit history of the borrower and the collateral put up, be it property, machinery or marketable securities. Bank loans can be availed of for short or long term, but the latter is usually given to established start-ups.
However, Muthuraman says banks now give importance to cash flow rather than the primary security or additional collateral. Recognising the fact that the collateral requirement deters many a start-up, particularly in the early stages, the government and SIDBI have set up a Credit Guarantee Fund Trust for Micro and Small Enterprises. The scheme lends up to Rs 1 crore to small enterprises for working capital and capital expenditure without collateral.
Incidentally, finance companies also offer collateral-free working capital loans to small enterprises with at least three years of operations. “Such loans are disbursed on the basis of historical cash flows and ability to repay,” says Kavi Arora, CEO, Religare Finvest. These are available at interest rates of 16-20%, while loans against property cost 12-18%.
It is usually the cheapest source of funding and helps in controlling costs. Besides, if a start-up maintains a healthy credit track record while servicing the loan, access to all other sources becomes easier.
Such loans typically go to existing small businesses which have shown over three years of profitability and credit history.
Ultimately, the key to landing smart funding is to never lose hope. If you are convinced that you have identified a genuine market need and that you can actually implement your innovation, just put together a convincing business plan and start scouting for suitors. This is one area where the more the cooks, the better the broth. Sooner or later, someone is sure to say ‘I will’.
Essential lessons when you embark on the entrepreneurial journey.
Prepare your family
“My wife wasn’t too comfortable with my entrepreneurial zeal, so we agreed to give it a year. If I failed to zero in on something within this period, I would return to a job.” – Rivi Varghese, Customer XPs.
Plan your finances
“You might not earn anything in the first 2-3 years, so you need to plan your family’s finances accordingly. A capital cushion is essential to ensure that your family lives comfortably.” – Ashutosh Garg, Guardian Lifecare
Forget the job perks
“As a manager in a company, you are accustomed to other people doing things for you. In a start-up, you have to take care of everything yourself- from operational expenses to food bills.” – Jiggy George, Dream Theatre
Learn to cope with failure
“I met 15 VCs before one agreed to fund me. One investor rejected my proposal within five minutes of a presentation. Instead, he spent an hour trying to convince me to go back to my job.” – Kunal Bahl, Snapdeal
Have a plan ‘B’ ready
“After the first few months, we realised that service was not our core competence. Besides, the margins were quite low. This was the time we concluded that it was better to focus on products.” – Rahul Anand, Happily Unmarried
Don’t take too much debt
“If you are thinking of starting up, this is the best time. But don’t take a home loan since it kills entrepreneurship. You can never get out of it.” – Binny Bansal, Flipkart
Gain enough experience
“I used to teach at a diving centre in Lakshadweep. After teaching more than 600 students for eight years, I decided to float my own diving company.” – Anees Adenwala, Orca Dive Club
Interact with like-minded
“My partner Abhishek was running an e-commerce portal, which was acquired by a bigger website. He expressed interest in working with me and we launched our site.” – Chetan Bafna, Fetise.com
Believe in yourself
“Belief in one’s idea can take you a long way. Our concept was ahead of its time, but I didn’t give up on my vision. At every step, there were people who ridiculed the idea. I had the last laugh.” – VSS Mani, Just Dial
Have a plan that is unique
“The business plan should be unique and clutter-free. An entrepreneur must look into his area of core competence and use it to devise a strong plan.” – Kavindra Mishra, Zovi.com