Understanding the Basics of Start-Up Funding

Introduction

A startup is a company that is in the initial stages of business. A startup company (startup or start-up) is an entrepreneurial venture which is typically an emerging, fast- growing business that aims to solve an unmet need by developing a viable business model around an innovative product, service, process, or a platform. A startup is usually a company designed to effectively develop and validate a scalable business model.

Definition of a Start-Up

"Start Up as defined vide Notification No. G.S.R. 127 (E), dated 19th February 2019 by DPIIT as: An entity shall be considered as a Startup:

• up to a period of ten years from the date of Incorporation/Registration, if it is incorporated as a Private Limited Company or registered as a Partnership Firm or a Limited Liability Partnership in India.
• Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded Rs 100 crore.
• Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
• Provided that an entity formed by splitting up or reconstruction of an existing business shall not be considered a 'Startup'.

Funding Requirements

A Startup may require Funds for various activities like:

1. Product Development
2. Acquiring Machinery and Inventory
3. Paying Salaries to the Employee
4. Renting of Space
5. Administrative Expenses etc.

Sources of Funding for Startup

Seed Capital

Startup business needs the nurturing of finance to explore and grow. The funding done at the nascent stage is called seed funding and the capital is known as a seed capital. Technically, seed capital is the initial capital used at the time of starting the business. This capital can come from the founders ( Bootstrapping),families or friends. It is required for the market research, product development, and other initial stage operations.

Crowdfunding

Crowdfunding is the use of small amount of capital from large number of individuals to finance a new business initiative. Social Media or Crowdfunding Website.

Loan from Banks & NBFCs

Loans from banks and NBFCs help finance the purchase of inventory and equipment, besides securing operating capital and funds for expansion. Regular payment of EMI irrespective of revenue Substantial collateral requirement.

Incubators

These set-ups precede the seed funding stage and help the entrepreneur develop a business idea or make a prototype by providing resources and services in exchange for an equity stake ranging from 2-10%. Incubators offer office space, administrative support, legal compliances, management training, mentoring and access to industry experts as well as to funding through angel investors or VCs.

Startup Valuation

Startup valuation is the process of quantifying the worth of a company, aka its valuation. During the seed funding round, an investor pours in funds in a startup in exchange for a part of the equity in the company. This is why valuation is important for entrepreneurs as it helps in determining the equity which they must give to a seed investor in exchange of funds.

Valuation matters to every startup because it helps in deciding the amount of equity an entrepreneur must give to an investor in exchange for requisite funds. This implies that if a company has a higher valuation, it must give a lesser amount of equity or shares to an investor in exchange for seed investment. Deciding a Correct Valuation is important and care must be taken about Down Round in subsequent Investment rounds.

Basic Valuation Approach for a Startup

Say Amount to be raised from a Funding round is Rs.50,00,000 If Founders Ask Rs.50,00,000 for 5 % Equity dilution then the Value of the startup shall be Rs.10,00,00,000 If Investors Offer is Rs.50,00,000 for 10% Equity then the Value of the Startup shall be Rs.5,00,00,000.

Different Valuation Approach for a Startup (Selected Methods)

• Comparable Transaction Method
• Revenue Multiple Method
• Discounted Cash Flow method
• Book Value Method

Venture Capital

Venture capital (VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth (in terms of number of employees, annual revenue, scale of operations, etc.

Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake.

Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful.

Simply put, Venture Capital is a Capital provided to especially new startups and entrepreneurship enterprises to standup and deliver.

Venture capital ("VC") / Private Equity ("PE") is often the first large investment a startup can expect to receive.

Financing Stages

There are typically six stages of venture round financing offered in venture capital, that roughly correspond to these stages of a company's development.

1. Seed funding: The earliest round of financing needed to prove a new idea.
2. Start-up: Early-stage firms that need funding for expenses associated with marketing and product development.
3. Growth (Series A round): Early sales and manufacturing funds. This is typically where VCs come in. Series A can be thought of as the first institutional round. Subsequent investment rounds are called Series B, Series C and so on. This is where most companies will have the most growth.
4. Second round: Working capital for early-stage companies that are selling product, but not yet turning a profit. This can also be called Series B round and so on.
5. Expansion: Also called mezzanine financing, this is expansion money for a newly profitable company.
6. Exit of venture capitalist: VCs can exit through secondary sale or an IPO or an acquisition. Early-stage VCs may exit in later rounds when new investors (VCs or private-equity investors) buy the shares of existing investors. Sometimes a company very close to an IPO may allow some VCs to exit and instead new investors may come in hoping to profit from the IPO.

Bridge financing is when a startup seeks funding in between full VC rounds. The objective is to raise a smaller amount of money to "bridge" the gap when current funds are expected to run out prior to planned future funding, intended to meet short-term working capital needs.

Angel Investor

An angel investor (also known as a private investor, seed investor or angel funder) is a high-net-worth individual who provides financial backing for small startups or entrepreneurs, typically in exchange for ownership equity in the company. Angel investing is often the primary source of funding for many startups who find it more appealing than other, more predatory, forms of funding.

The support that angel investors provide startups fosters innovation which translates into economic growth. These types of investments are risky and usually do not represent more than 10% of the angel investor's portfolio.

Pitch Presentation

Pitch Presentation is a short and brief presentation to the investors explaining about the prospects of the Company and why they should invest into the Startup business.

1. Pitch Presentation should not be more than 20 Minutes.
2. Points to be covered during a Pitch Presentation:

• Introduction
• Team
• Problem
• Solution
• Marketing/Sales
• Projections or Milestones
• Competition
• Business Model
• Financing

Conclusion

• Venture Capitalist and Angel Investor fill in the Capital requirement gap of new emerging technologies and innovation many Startups have progressed due to their innovative entry and exit strategies.
• Venture Capitalist and Angel Investor Shall play a important role in the development of the Economy given the high level of enthusiasm for the Startup among the People of the Country.