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Startup Funding in India: An In-Depth Guide

Article by Eshani Jain.

Finance in a definition is the monetary support for a business.

Funding Your StartUp in India

It is the most integral part of any business since you require it to start, run, and operate your business. Finance is what allows you to convert your dreams into reality. In the process of giving a surface to these dreams, the biggest challenge faced by a startup is to gather finance.

In this article, I will go through various ways in which a startup can raise finance for itself.

Equity Finance

Equity finance is the way of raising capital by selling the ownership of the company in the form of shares.

In course of the initial stages of a company's growth, when it does not have sufficient revenues, cash flow, or assets to act as collateral, equity financing can attract capital from early-stage investors who are ready to take risks along with the entrepreneur.

Related Read: The Definitive Guide on How to Choose a Revenue Model for Your Business

Equity financing is generally regulated by the state or national government to protect the interests of the investors.

In India equity financing is regulated by The Securities & Exchange Board of India (SEBI), Department of Economic Affairs, Ministry of Corporate Affairs, and Reserve Bank of India (RBI).
  1. Angel Investors
Angel Investors for Equity Financing
These are individuals who provide capital for a business start-up in exchange for ownership equity or convertible debt in the company. Angel investors support firms in their initialization stage when it's difficult for them to obtain funds from traditional sources of finance such as banks, financial institutions, etc.

They usually invest online through equity crowdfunding or by organizing themselves into angel groups or angel networks to share investment capital.

According to the AIF Regulations "Investment by an angel fund in any venture capital undertaking shall not be less than twenty-five lakh rupees and shall not exceed five crore rupees." Also, it states that "angel funds shall accept, up to a maximum period of three years, an investment of not less than twenty-five lakh rupees from an angel investor."

There are various Angel Investors and Angel Investment Networks in India that are actively working to fund startups a few of them are:
  • Indian Angel Network
  • Chennai Angels
  • Mumbai Angles
  1. Venture Capital
It is a form of private equity investment made in start-up companies at their early stage. Venture capital firms or funds invest in startups which they expect to have high growth potential and they invest in them in return for equity or ownership stake in these companies.

Since startups face a high rate of uncertainty, Venture Capital investments face a high risk of failure. The startups they invest in are usually in the field of software, information technology, biotechnology, and other high technology industries.

Venture capitalists generally invest in a company for a duration of three to seven years and act complementary to the entrepreneurs in making important decisions related to the startup. It is an investment that is not subject to repayment.

It is usually most suitable for businesses having a huge upfront capital requirement with no cheap alternative.

Venture Capital Financing has been classified into 3 types based on its application at various stages which are:
  1. Early Stage Financing
  2. Expansion Financing
  3. Acquisition Financing
The various steps that compromise the process of Venture Capital Financing are:
  1. Establish Fund
It involves planning for investment objectives and exploring ways to generate capital for investment.
  1. Deal Flow
Activities are carried out to create opportunities or to find the best ones available.
  1. Decisions for Investment
This stage involves screening and evaluating the deal. It also involves negotiating the structure of the deal.
  1. Monitoring and Value Addition
They develop various strategies regarding their working pattern in the company and take up certain rights and duties.
  1. Exit Plan
It is the last stage in venture capital financing. In this, they develop the plan for exiting the company based on the nature of investment, extent, and type of financial stake, etc.The main motive of the plan is to make minimum losses and maximum profits.

Pros and Cons of Equity Financing

PROS:
  • The biggest advantage is that the investor assumes all the risk and If by chance the business does not succeed, you don't have to pay back the money. Thus, making it way less risky than debt financing.
  • Since there are no loans to be paid back, all the cash and profit available can be reinvested in the business.
  • Equity financed businesses don't have to pay interest to their shareholders, they only have to share a part of their profits.
  • There is no obligation to repay the money acquired through equity financing.
  • It does not take funds out of the business and so has no impact on the cash flow of the startup.
CONS:
  • The business is required to share the control and ownership of the company with the investors.
  • The company has to share profits in the business in the form of dividends with the investors.
  • Availing equity finance is a complex process and it requires the business to share its monthly and all annual reports with the investors and shareholders.
  • It can lead to a conflict due to deferring interests of the investors.
  • Approaching investors is time-consuming and expensive.

Debt Financing

Debentures and loans are great way to debt finance your startup

It is a form of financing under which a company borrows money from an external source for a specific period and has to repay the principal amount along with a sum of interest depending upon the agreement when the period comes to an end.

Such borrowing doesn't result in loss of ownership of the company like that in equity financing. Various methods of Debt Financing are as follows:
  • Loans from Banks and Financial Institutions
It is one of the most popular forms of debt financing. Businesses borrow money from the banks or financial institutions for a specific period on expiry of which they have to return the borrowed amount along with the sum of interest charged. The business has to provide a collateral to the bank as a security against the loan in case of default.

A person with low income can also use a mutual fund as collateral for the loan. However, loans do not result in any sort of loss of equity stake in the company or dilution of controlling and managing power. Loans generally have many tax benefits as well. There are various types of loans based on the requirements of the business such as:
  • Unsecured Business Loans
  • Secured Business Loans
  • Small Business Loans
  • Equipment Loans
Loans can also be short-term, intermediate, and long-term based on the need of the business.

A short term loan is a loan with a tenure of one to twelve months, a medium-term/ intermediate loan has a tenure of one to five years and a long term loan has a tenure of more than five years and is generally a secured loan.
  • Credit Guarantee Fund Trust for Micro and Small Enterprises
CGTMSE, a government launched initiative by the Ministry of Medium, Small and Micro Enterprises (MSME) in association with the Small Industries Development Bank of India (SIDBI). Its motive is to provide hassle-free and collateral-free loans to the rising entrepreneurs and helping them to realize their dreams.

All designated commercial banks and Regional Rural Banks (RRBs), including NSIC, NEFDi, and SIDBI are eligible lending institutions under the CGTMSE scheme and both new and existing micro and small enterprises including service enterprises are eligible for a maximum credit capacity of Rs. 200 lakhs.
  • Micro Units Development and Refinance Agency Ltd. (MUDRA)
It is an NBFC supported the development of the micro-enterprise sector of the country. It provides refinance support to Banks/NBFCs/MIFs for lending finance to micro units having a loan requirement up to 10 lakhs of rupees. The various schemes of loans are categorized into 3 types:

First, 'Shishu' covering loans up to 50,00. Second, 'Kishore' covering loans above 50,00 up to 5 lakh and third 'Tarun' covering loans above 5 lakhs up to 10 lakhs.

It provides refinance under the Scheme of Pradhan Mantri MUDRA Yojana.

The objective of the MUDRA loan is to promote entrepreneurship among the youth of the country. It extends loans for numerous purposes such as:
  1. Loans for Vendors, Traders, and other Service Sector activities
  2. Working Capital loans
  3. Equipment Finance
  4. Transport vehicle loans (commercial only)
  5. Loans for agriculture allied non-farm income-generating activities, etc.
  6. Textile Products Sector / Activity
  7. Food Products Sector
External Commercial Borrowing (ECB) is an instrument that facilitates access to foreign capital by Indian enterprise and PSUs. It is a loan made by non-resident lenders to Indian businesses in the form of foreign currency.

It comprises of commercial bank loans, buyers' and suppliers' credit, floating-rate notes, etc.

ECB's also includes credit from formal export credit agencies and commercial borrowings from the private sector window of multinational financial institutions such as International Finance Corporation (Washington), ADB, AFIC, etc.

However, funds raised from ECBs cannot be used for investment in the stock market or speculation in real estate. The ECB guidelines and policies are regulated and monitored by the Department of Economic Affairs, Ministry of Recently, it was announced by the Central Bank of India that start-ups can now raise to USD 3 million each in a fiscal year through external commercial borrowings route.

However, startups cannot borrow money through ECB by Overseas branches or subsidiaries of Indian banks according to the RBI. The maximum cost at which startups can raise money depends upon the agreement between the lender and the borrower.

Pros and Cons of Debt Financing

PROS
  • The entrepreneur/organization retains full ownership and control.
  • It provides a tax advantage as the interest paid on debt is tax-deductible, it reduces the net obligation.
  • It allows you to retain profits since your only obligation is to repay the money to the lender.
  • It makes futuristic planning easier since you are aware of the amount of debt and interest to be paid.
CONS
  • It has various qualification requirements which are deemed to be a must like a good credit rating and a multitude of documents.
  • You are personally responsible for the repayment of the entire debt amount along with the interest.
  • Accessibility: Since banks are very conservative it is difficult for a startup to easily get a loan.
  • Collateral is the most important requirement to be fulfilled to be granted a loan.
  • A business needs to be sure that it will be able to generate continuous cash flow cause it will have to repay the interest and principal amount on the exact due date.
  • High-interest rates
  • Debt hinders the growth of a business as most of the revenue is utilized in repaying the debt.
  • If a company has a high debt it becomes difficult to attract equity investors because high debt is associated with high risk.

Other Financing Mediums

The finance industry is pivotal to the economic world has developed immensely over the past few years and so has given birth to various new modes of financing other than the traditional methods of debt and equity financing. These unconventional and contemporary methods of finance have spread upon their roots and created a high reputation and a huge market for themselves.

Few of these unconventional methods of funding are as follows:

Crowd Funding

Crowdfunding your startup is a great way to fund it.

It is a form of crowdsourcing and alternative finance.

In crowdfunding an entrepreneur showcases his idea on an online venue like Wishberry, BitGiving, Fuel A Dream etc, before a large group of people and convinces them about the utility and success of the idea by sharing with them his vision, impact of the business on the community, rewards, and returns for the business, etc.

This allows an entrepreneur to fund his venture by raising small amounts of money from various sources. Crowdfunding is used to fund a wide range of entrepreneurial projects such as creative and artistic projects, medical expenses, community-oriented social projects, etc.

It is not only a great place to market your product and attract the required media attention but also to get instant access to market feedback.

It allows an entrepreneur to benefit from information flow and accrue low-cost capital from around the globe by selling their product and equity. 4 general types of Crowdfunding are as follow:
  • Rewards-based Crowdfunding: It is a form of funding campaign under which the investors are given different rewards in the form of services or products which the company produces depending upon their amount of investment. Generally, there are 3 levels of rewards based on the levels of contribution.
  • Equity-based Crowdfunding: In this form of crowdfunding an investor expects to receive a part of ownership in the company in return for his amount of investment.
  • Debt-based Crowdfunding: In this type of funding campaign people lend money to the entrepreneur on the commitment that he will repay it along with interest after a certain period.
  • Donation-based Crowdfunding: In donation-based crowdfunding, the entrepreneur doesn't have to give anything in return to the investors for their funds since they invest to support the idea or cause of the company.

Incubator

Startup incubators are generally non-profit entities that are run by both public and private entities. They are many a time associated with universities and business colleges. A business incubator helps startups through their early stages of development by providing workspace, seed funding, support staff, mentoring, business advice, contacts, and capital.

They also help with regulatory compliance, technological commercialization, and intellectual property management. Incubators also assist in accounting and financial management and business etiquette. In return for providing various services incubators either own a stake in the company or charge a monthly fee that covers the major services provided by them.

Incubators are very selective in admitting companies to their programs and their acceptance criteria vary through each program.

The 3 stages of Business Incubation Development are as follows:
  • Pre-Incubation Stage: includes the activities carried out to shape the business idea, model, and plan into a reality.
  • Incubation Stage: includes all activities carried out to support the startup to reach the expansion stage.
  • Post Incubation Stage/SME: includes activities that are carried out at the point when the startup is ready to walk on its own feet.

Accelerator

Accelerators for startups also known as seed startups are fixed-term, cohort-based, and mentorship-driven programs. Accelerator program offers seed money to startups in exchange for equity shares in the company.

Startups not only benefit in the form of seed money under this program but they also get to learn about the legal side of the business, the practice of pitching, and a multitude of valuable information about how a company works through various seminars and workshops organized.

They invest in the business only at their early stage and for a duration not more than 3-6 months.

Accelerators have primarily evolved from incubators yet they both have many differences and are affected by different environmental factors.  Accelerators have gained immense popularization lately because of their positive impact on regional entrepreneurial ecosystems.

They are considered unique because of their 4 distinct characteristics which are: they are fixed-term, cohort-based, mentorship-driven, culminate in graduation, or "demo day."

These 4 characteristics collectively are not possessed by any other early-stage financing program may it be angel investors, incubators, or venture capitalists.

Bootstrapping

Bootstrapping requires entrepreneurs to be crafty

It is a method of financing in which the entrepreneur finances himself, putting to use his personal savings, sweat equity, lean operations, quick inventory turnover.

It is beneficial since it allows the entrepreneur to maintain full control over his business and operations and provides him a sense of freedom of experimentation as he is not answerable to any other investor.

It also allows the entrepreneur to focus all his energy and efforts on the business idea and the product instead of pitching for venture capitalists and other sources of capital. However, it places a huge financial risk on the entrepreneur and may limit the growth of the company due to restricted finance.

Restricted finance can undermine the quality of the product and prevent promotion. A few of many successful examples of Bootstrapping are Spanx, Tough Mudder, Electronic Data Systems, etc.


Questions to Ask Yourself before Deciding Your Ideal Startup Financing Medium-

  1. How much equity of my company am I comfortable giving up?
  2. Am I comfortable giving up a part of the ownership of my company in return for advice and services?
  3. Do I want to raise funds from a platform that is open to the public (in the context of crowdfunding)?
  4. Does my business fit the investment program profiles?
  5. Will my business be able to generate the necessary cash flow if I opt for debt financing?
  6. Do I have a good credit rating?
  7. Do I have enough savings that will give an opening push to my business?
  8. Am I prepared to share the controlling power of my company?
  9. Do I only need funds or guidance as well?
  10. How much capital do I need to achieve my goal?
  11. Are there any tax benefits?
  12. What business category does my startup fall in?
  13. What do I want to risk for raising funds?
  14. What will be my method of repayment?
  15. What are the market interest rates?
Author Bio: Eshani Jain, the author of this article is a student of Bachelor of Commerce (Hons) at Kamala Nehru College, DU. She is currently interning at WinSavvy.

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