How to Finance A Startup Business?
Apparently, startups are the new trend in the market. After all, a startup of your own seems to be better than any other 9 to 5 job, isn’t it? But running a startup isn’t a cakewalk too. From the conceptualisation to legalising the startup and managing everything as your own boss, things often get tricky and tiring. Nevertheless, with this blog on How to Finance A Startup Business, at least your financial problems would be eased!
What is a startup?
In case you are lost and wondering about what is a startup? A startup is a young company founded by two or more entrepreneurs to develop a unique product or service and serve its target market. Its intention is to offer products or services that bridge the market gap and fulfil the needs of customers.
To know more about startups, visit our blog about startups here.
What are the problems for startups today?
Recognition and Finances are the major problems that new startups face.
Startups have a tough time in capital markets because they are not well known to the general public before they start their operations. They often struggle with funding as they can’t find suitable Investors, therefore resorting to traditional methods such as borrowing from friends and family, money lenders, banks, self-financed through savings, etc. Although these techniques may be effective in the start, they can’t sustain the organization in the long run.
How to Finance A Startup Business?
This blog “How to Finance A Startup Business?” talks about two major funding sources that startups can utilize.
Angel financing is a business investment model where high net worth individuals can help startups by providing finance in exchange for equity in the company. Such high net worth individuals are often referred to as “business angels”.
As angel financing involves equity exchange, it also includes a high risk – high return trade-off. This means that the investors are taking high risk in expectation of a high return. In order to adhere to such expectations, startups can further invest the finance received in high- income yielding projects, or in other instruments such as debt or equity of other companies. This also helps the startup get a steady income. The startup should analyze the prospects of its projects, form budgets and make wise decisions to finance its projects.
Some advantages of angel financing are:
- Angel financing is less risky when compared to debt financing, as startups are not obliged to pay back the capital to investors unless they decide to wind up.
- Angel investors do not expect immediate returns as they tend to invest in an organisation in the long run.
- Since a startup is not well versed with industrial contacts, angel investors can help establish them and share their knowledge and mentor the entrepreneurs.
- As startups work with such knowledgeable and experienced investors, research proves that such organizations have substantial growth, a greater rate of return and a stable foot in the market.
- Organisations also get credibility for associating themselves with such investors, apart from establishing contacts with potential customers, bankers and other professionals.
However, startups tend to give 10%-50% of their equity shares to investors in exchange for funding. This can lead to a loss of control. After investing money, they may opt for a hands-on approach towards the businesses. This means that they may want an exit strategy, such as selling the business to a larger company or listing the shares in the market and making the company public. Such terms and conditions should be carefully looked upon, before taking the decision of getting financed by angel investors.
Venture capital is a form of private equity, which is provided to startups by Investors who believe that these have long term growth potential. It may not necessarily be in monetary form. This means that capital can be provided to startups in the form of technology or managerial expertise as well. Some of the leading venture capitalist firms in India are Helion Venture Partners, Accel Partners, and Sequoia Capital India.
Three types of venture capital funds
This stage involves seed financing, startup financing, and first-stage financing.
- Seed financing refers to a small sum given to the entrepreneur for being eligible for a startup loan.
- First stage financing is the financial aid given to companies that have spent their initial capital and need money to begin business activities on a full scale.
This can further be classified as second stage financing or mezzanine financing and bridge financing
- The second stage of financing involves lending money to companies that are at the beginning stage of expansion.
- Bridge finance is provided as a short term finance option to companies that are getting listed in the stock exchange for initial public offer and require funds to carry out business activities during the time gap.
Acquisition or Buyout financing
This financial aid is used by companies when they acquire a part of an entire entity. Leveraged buyout financing helps the management to buy a particular product line or the entire company.
The advantages of Venture capital are as follows:
- It helps companies fund initial operational activities.
- Large sums of equity finance can be accessed by startups
- The business is not under an obligation to repay capital unless it is winding up
- The experts also provide technical, managerial, and valuable inputs to the entrepreneurs
However, as in angel financing, investors become part owners of the company and can intervene in the decision -making process. They may also opt for an exit route by the way of the initial public offer, promoter buyback, sale of the company, or merger with other companies. These steps may be taken only if the firms are not yielding profits as expected. So entrepreneurs should analyze every project taken up and ascertain future revenues that are favourable to the investors.
Irrespective of the source of finance, a startup should be keen on the following:
- The startup idea must be useful to a large customer base. Even if the target market is small, it should cater to all the needs of the customers.
- It can be difficult to win the investors’ trust initially, but the entrepreneurs should be confident about their ideas and put them forward in a tactful manner.
- Customer satisfaction should be the prime objective of the startup. Winning customers’ trust by providing prompt after-sales service can improve the position of a start-up because a word of mouth will always attract more customers.
If investors find a promising startup with a dedicated team of managers, they wouldn’t hesitate from investing in it. Thus, team spirit and motivation are the key factors to attract heavy investments.
We hope that this blog on How to Finance A Startup Business is of help to you. For more such blogs, stay tuned to Blogger Bunny.