While most entrepreneurs think of VC funding as the most obvious way of funding their startups, there are actually many different ways in which you can fund your startup.
Getting Risk Capital I.E. Angel Investors Or Venture Capitalist – VCs
Angel investors or VCs are investors who give you capital in exchange of equity in the company.
Angels and VCs buy equity in a company for a price and expect to make a profit by selling it at a higher price. Just like it happens in the stock market, but in this case because your company is not listed, VCs make money by privately selling the stock they hold in your company to someone else. E.g. an angel investor may ‘exit’ by selling his/her stock to a VC and later the VC could exit by selling the stock they hold to either a Private Equity firm or to a strategic investor, or in rare cases by diluting their holding during or post an IPO.
The money that angel investors give is collateral free. I.e. you do not have to mortgage your house or something to get money from angel investors of VCs. In case the company fails, investors lose their capital and entrepreneurs do not have to return the capital. This is the one and only reason why angel investors and VCs will evaluate plans thoroughly before making a decision to invest in a company. In effect, they are taking the following risks about your venture:
- That you and your co-founders are a great team that is capable of scaling up the business
- That your concept will work
- That the market is large and therefore there is potential to build a large company
Because of this, funds raised from angel investors, VCs and later from Private Equity funds is called ‘Risk Capital’.
While angel investors and VCs provide capital without collaterals, and thus allow you to start up without having your own capital or collaterals for a loan, it is probably the most expensive form of capital. That’s because you are giving away equity in exchange for the capital you raise.
Let us understand this with an example. I am of course, simplifying and exaggerating for easier understanding, but the principle is correct.
Let us assume company A raises INR 10 lacs [i.e. USD 20,000] from an angel investor and gives the angel investor 10% equity in the company. Assume further that this company is able to successfully scale up and is receiving aINR 5 crore [USD 1 mn] funding from a VC for a valuation of INR 20 cr. [USD 2 mn]. Assume that the angel investor exists at this round by selling his stake to the VC. In this scenario, the VC would get about INR 1.5 cr for his/her share holding in the company. The illustration below gives a sequential view of the capital structure of the company after every event i.e. when the angel invests, when the VC invests and finally when the angel exits by selling his/her stake to the VC.
Bootstrapping is the art of going as far as you can without external funding. I.e. pooling together your own resources, usually at a pre-concept stage or at a prototype building stage.
Often, people bootstrap their startup while still keeping their job at some. Whether you should bootstrap or go for external funding is a factor of how much money you need, and for what. I.e. if you are building a solar micro-grid, it is unlikely to be funded through bootstrapping, as it is likely to be a capital-intensive business. However, on the other hand, an e-commerce venture can most likely be bootstrapped… often by using SAAS platforms, etc.
When to bootstrap
- When your concept is yet to be proven … and can be proven with limited capital
- When you too are unsure if you would like this to be your lifetime career and want to give it a shot
- When you have the resources to go past the concept proof stage
When not to bootstrap
- When the capital required for the proof-of-concept stage is more than what you can garner from your current resources
Even when you don’t need the capital, it is sometimes good to pitch to investors as it gives you a good feedback on your concept. If many investors say no, it may be worthwhile evaluating the concept and pan thoroughly before diving into the game.
You may want to consider the points below before you take the decision to bootstrap:
- Evaluate whether your idea has a good business case – speak to some experts, pay attention to those who are not excited about your idea. After all, even if it is not costing you a lot of money, your time invested has a lost opportunity cost.
- Prioritize: to bootstrap efficiently, you need to make your limited resources go far. Take a call on what is critical and what can be put off till you receive adequate capital.
- Keep the expenses side as low as possible. That means having a very, very lean team. That means hiring multi-taskers rather than specialists.
- Consider SAAS and outsourcing: Even if that is not your most preferred option, you should take a call on what is important. Is getting ‘something’ out in the market more important or getting ‘The most perfect product’ most important? SAAS platforms may not give you the customization possibilities, but often they can shave off a significant percentage of your funding needs. You can always develop your own platforms after you have proven the concept and the model.
In other words, taking a loan.
Institutional loans often require a collateral, which many entrepreneurs may not have. Even if you have the collateral, do a real hard evaluation if the business model and concept is fully ready for you to take an individual risk on. Often, getting other external investors gets you more parties to take strategic decisions with, and provides an invaluable group to bounce ideas with.
Friends & Family Round
For startups, which need limited capital to start up, a friends & family round may be an option worth considering.
Points to remember in a friends & family round
- Treat the friends & family round as a formal fund raising round too – pitch to the interested investors as you would to a group of angel investors or VCs
- Complete the paper work and other formalities too – issue equity shares
- Manage the relationship as a professional investor relationship – send quarterly reports, have a board, etc.
Get Strategic Investors
- Larger companies for whom your concept is an adjacent or related opportunity may find it interesting to investing as a strategic investor.
- Adjacent opportunity – e.g. Educational content platforms could be an adjacent opportunity for a large company in the education space
- Related opportunity – e.g. healthcare services for the poor is a related product for a microfinance company
- A strategic investor, apart from providing capital, also helps validate the concept for external investors thus making it easier for raising the next round of funding or for getting co-investors in the current round.
To sum it up – there is no ‘one size fits all’ situation here. Pick the one that is best suited your startups’ needs.