Summary :
In our earlier release, we discussed few modes of funding in the initial phases of businesses. We continue that here and take this forward with few modes available once the Business picks up its initial business.
Content :
a.
Crowdfunding
As the word suggests, this is the capital raised from a large number of Individuals in a small amount from each. There are two sub-types to this however. One is Equity-based crowdfunding and other is Reward-based. Lets understand this with examples;
Equity-based funding – Raising capital from a large number of Individuals with an amount as minimum as INR 5000 each, raising a capital of approx. INR 50 lakhs. This will need 1000 individuals to invest, for you to be able to raise the required amount. The % share in equity that gets diluted from the Founder’s perspective will generally be the same which would otherwise would have been diluted in case of Angel Investment.
Reward-based funding – Raising capital against issue of a non-financial reward. This can be in the form of any product/ service that is offered to the individuals which lures them to invest. There are various online platforms that undertake this activity for large numbers of Businesses or startups. This one is attractive, since there is not requirement of repayment of the capital back or distributing the returns on investment.
b.
Venture Capitalists (VCs)
These are pool of funds created by their Sponsors/ Managers, for investments. VCs generally create their own niche by deciding the sector / geography they want to invest in. The pool of funds is created out of the Individual Investors or Family offices that are interested in investing capital in the defined sector / geography which the VCs target in.
This the most attractive mode of funding and used substantially by businesses to raise large amount of capital. Founders too like this because VCs generally come with some amount of skill in the sector they are investing in. VCs also their domain knowledge as well as network which are exploitable by the Founders in the conduct of their business.
VCs are sought after by the Founders generally when the Business is up in the market and ready for scale. VCs are able to provide enough muscle to the Businesses for them to be able to market their products extensively and fulfil the orders from their customers.
The terms of investment are nearly uniform across the industry and may include inter-alia the following:
- To offer expertise and extensive network;
- Atleast a seat from VC’s side on the Board of Directors of the Company;
- They have a defined exit plan, which may include sale to strategic investors or public issue;
- Businesses need to follow a robust corporate governance.
These terms often restrict the otherwise flexible operations of the Company and make them more process oriented, which consequently consumes a lot of time and efforts.
c.
Loan from Banks
These are the long known and traditional methods of funding. These generally come up when Businesses have largely exhausted the other modes of funding listed earlier. These include working capital finance, Term Loan (for Capital Investment) and like. These are however, resorted to as last resort for one or all of the following reasons:
- Payment of finance cost;
- Periodic payment of Principal loan amount and finance cost;
- Requirement of security in the nature of collateral or shares;
- Guarantees in the nature of Personal / Corporate, etc.
The primary benefit of this type of loan is that the funding doesn’t need Equity ownership to be diluted and the interest rate charged on the loan is as per the market / industry standards. We have, however seen Banks not funding at all in the following cases;
- Minimum 3 years have elapsed from the commencement of business operations;
- Company is in cash profits;
- Company/ Founder has some asset for it to be able to secured the finance.
In certain cases, Banks may also provide a Charter for the Businesses to follow while they have outstanding loans payable to the banks. The level of control however exercised by the banks on the Business operations is generally very low.
d.
Private Equity Investment
This mode of investment is generally preferred by Companies, the business operations of which are matured enough and need visibility in the Investor market, just prior to the Public issue. Private Equity investors do enhance the market visibility of the Businesses and make them well prepared for the potential public issue. Private Equity also prepare Businesses from the perspective of Corporate governance, Investor relations, etc. which are critical areas which a publicly listed company is required to deal with on an ongoing basis.
The investments are made by the Funds who have pooled in investments from various sources and invest them with the Business to earn profit on its public issue. You would have heard about Tiger Global, Sequoia, etc. as few of the well known Private Equity Fund houses that invest in the Businesses, prior to IPO.
e.
Public Issue / IPO
This mode is generally referred to as the last mode of funding in a Company lifecycle. The process is entirely regulated and a number of approvals are required for the purpose of IPO. Under this, Founders offer few shares for sale to the public, on a recognised platform and in a regulated manner. Company raises capital from public, at a price that is arrived at by an independent Merchant Banker.
Companies use this mode of funding generally to repay the debts or invest more into capital assets for extensive expansion. The catch here is the story which is created by the Company which makes the public subscribe to such issue / offer for sale, proposed by the Company / Founders.
We have recently seen a variety of public issue by companies (including Startups) and many of them have been successful. The key challenge post public issue, is however, to maintain the Investor relations and the Corporate Governance, while you dealing with the Public money.
We believe we have been able to explain a brief overview of the various modes of funding. Approaching either of the above methods of funding needs careful examination of the situation a business is into, the stage at which the business is and the overall objective of the Founders with the future of their business operations. If you need any assistance in evaluation of any kind of funding, we are ready to help you and just a few clicks away.
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