Startup Funding

Funding refers to the money required to start and run a business. It is a financial investment in a company for product development, manufacturing, expansion, sales and marketing, office spaces, and inventory. Many startups choose to not raise funding from third parties and are funded by their founders only (to prevent debts and equity dilution). However, most startups do raise funding, especially as they grow larger and scale their operations. This page shall be your virtual guide to Startup funding. 

Why Funding is Required by Startups

A startup might require funding for one, a few, or all of the following purposes. It is important that an entrepreneur is clear about why they are raising funds. Founders should have a detailed financial and business plan before they approach investors.

Prototype Creation
Product Development
Team Hiring
Working Capital
Legal & Consulting Services
Raw Material & Equipments
Licenses & Certifications
Marketing & Sales
Office Space & Admin Expenses

Types of Startup Funding

Stages of Startups and Source of Funding

There are multiple sources of funding available for startups. However, the source of funding should typically match the stage of operations of the startup. Please note that raising funds from external sources is a time-consuming process and can easily take over 6 months to convert.

Ideation

This the stage where the entrepreneur has an idea and is working on bringing it to life. At this stage, the amount of funds needed is usually small. Additionally, at the initial stage in the startup lifecycle, there are very limited and mostly informal channels available for raising funds.

Pre-Seed Stage

Bootstrapping/Self-financing:

Bootstrapping a startup means growing the business with little or no venture capital or outside investment. It means relying on your savings and revenue to operate and expand. This is the first recourse for most entrepreneurs as there is no pressure to pay back the funds or dilute control of your startup.

Friends & Family

This is also a commonly utilized channel of funding by entrepreneurs still in the early stages. The major benefit of this source of investment is that there is an inherent level of trust between the entrepreneurs and the investors

Business Plan/Pitching Events

This is the prize money/grants/financial benefits that are provided by institutes or organizations that conduct business plan competitions and challenges. Even though the quantum of money is not generally large, it is usually enough at the idea stage. What makes the difference at these events is having a good business plan.

Validation

At this stage, a startup has a prototype ready and needs to validate the potential demand of the startup’s product/service. This is called conducting a ‘Proof of Concept (POC)’, after which comes the big market launch.

Seed Stage

A startup will need to conduct field trials, test the product on a few potential customers, onboard mentors, and build a formal team for which it can explore the following funding sources:

Incubators:

Incubators are organizations set up with the specific goal of assisting entrepreneurs with building and launching their startups. Not only do incubators offer a lot of value-added services (office space, utilities, admin & legal assistance, etc.), they often also make grants/debt/equity investments. You can refer to the list of incubators here.

Government Loan Schemes

The government has initiated a few loan schemes to provide collateral-free debt to aspiring entrepreneurs and help them gain access to low-cost capital such as the Startup India Seed Fund Scheme and SIDBI Fund of Funds. A list of government schemes can be found here.

Angel Investors

Angel investors are individuals who invest their money into high-potential startups in return for equity. Reach out to angel networks such as Indian Angel Network, Mumbai Angels, Lead Angels, Chennai Angels, etc., or relevant industrialists for this. You can connect with investors by the Network Page.

Crowdfunding

Crowdfunding refers to raising money from a large number of people who each contribute a relatively small amount. This is typically done via online crowdfunding platforms.

Early Traction

At the Early Traction stage startup’s products or services have been launched in the market. Key performance indicators such as customer base, revenue, app downloads, etc. become important at this stage.

Series A Stage

Funds are raised at this stage to further grow the user base, product offerings, expand to new geographies, etc. Common funding sources utilized by startups in this stage are:

Venture Capital Funds

Venture capital (VC) funds are professionally managed investment funds that invest exclusively in high-growth startups. Each VC fund has its investment thesis – preferred sectors, stage of the startup, and funding amount – which should align with your startup. VCs take startup equity in return for their investments and actively engage in the mentorship of their investee startups.

Banks/Non-Banking Financial Companies (NBFCs)

Formal debt can be raised from banks and NBFCs at this stage as the startup can show market traction and revenue to validate its ability to finance interest payment obligations. This is especially applicable for working capital. Some entrepreneurs might prefer debt over equity as debt funding does not dilute equity stake.

Venture Debt Funds

Venture Debt funds are private investment funds that invest money in startups primarily in the form of debt. Debt funds typically invest along with an angel or VC round.

Scaling

At this stage, the startup is experiencing a fast rate of market growth and increasing revenues.

Series B, C, D & E

Common funding sources utilized by startups in this stage are:

Venture Capital Funds

VC funds with larger ticket sizes in their investment thesis provide funding for late-stage startups. It is recommended to approach these funds only after the startup has generated significant market traction. A pool of VCs may come together and fund a startup as well.

Private Equity/Investment Firms

Private equity/Investment firms generally do not fund startups however, lately some private equity and investment firms have been providing funds for fast-growing late-stage startups who have maintained a consistent growth record.

Exit Options

Mergers & Acquisitions

The investor may decide to sell the portfolio company to another company in the market. In essence, it entails one company combining with another, either by acquiring it (or part of it) or by being acquired (in whole or in part).

Initial Public Offering (IPO)

IPO refers to the event where a startup lists on the stock market for the first time. Since the public listing process is elaborate and replete with statutory formalities, it is generally undertaken by startups with an impressive track record of profits and who are growing at a steady pace.

Selling Shares

Investors may sell their equity or shares to other venture capital or private equity firms.

Buybacks

Founders of the startup may also buy back their shares from the fund/investors if they have liquid assets to make the purchase and wish to regain control of their company.

Distressed Sale

Under financially stressed times for a startup company, the investors may decide to sell the business to another company or financial institution.

Steps to Startup Fund Raising

The entrepreneur must be willing to put in the effort and have the patience that a successful fund-raising round requires. The fund-raising process can be broken down into the following steps

The startup needs to assess why the funding is required, and the right amount to be raised. The startup should develop a milestone-based plan with clear timelines regarding what the startup wishes to do in the next 2, 4, and 10 years. A financial forecast is a carefully constructed projection of company development over a given time period, taking into consideration projected sales data, as well as market and economic indicators. The cost of Production, Prototype Development, Research, Manufacturing, etc should be planned well. Basis this, the startup can decide what the next round of investment will be for.

While it is important to identify the requirement of funding, it is also equally important to understand if the startup is ready to raise funds. Any investor will take you seriously if they are convinced about your revenue projections and their returns. Investors are generally looking for the following in potential investee startups:

  • Revenue growth and market position
  • Favorable return on investment
  • Time to break-even and profitability
  • Uniqueness of the startup and competitive advantage
  • The entrepreneurs’ vision and future plans
  • Reliable, passionate, and talented team

A pitchdeck is a detailed presentation about the startup outlining all the important aspects of the startup. Creating an investor pitch is all about telling a good story. Your pitch isn’t a series of individual slides but should flow like a story connecting each element to the other. Here is what you need to include in your pitchdeck

Every Venture Capitalist Firm has an Investment Thesis which is a strategy that the venture capitalist fund follows. The Investment Thesis identifies the stage, geography, focus of investments, and differentiation of the firm. You can gauge the Investment Thesis of the company by thoroughly going through the company website, brochures, and fund description. To target the right set of investors, it is necessary to research Investment Thesis, their past investments in the market, and speak with entrepreneurs who have successfully raised equity funding.  This exercise will help you:

  • Identify active investors
  • Their sector preferences
  • Geographic location
  • Average ticket size of funding 
  • Level of engagement and mentorship provided to investee startups

Pitching events offer a good opportunity to interact with potential investors in person. Pitchdecks can be shared with Angel Networks and VCs on their contact email IDs.

 

Angel networks and VCs conduct thorough due diligence of the startup before finalizing any equity deal. They look at the startup’s past financial decisions and the team’s credentials as well as background. This is done to ensure that the startup’s claims regarding the growth and market numbers can be verified as well as to ensure that the investor can identify any objectionable activities beforehand. If the due diligence is a success, the funding is finalized and completed on mutually agreeable terms.

A term sheet is a “Non-binding” list of propositions by a venture capital firm at the early stages of a deal. It summarizes the major points of engagement in the deal between the investing firm/investor and the startup. A term sheet for a venture capital transaction in India typically consists of four structural provisions: valuation, investment structure, management structure, and finally changes to share capital.

  • Valuation

Startup valuation is the total worth of the company as estimated by a professional valuer. There are various methods of valuing a startup company, such as the Cost to Duplicate approach, Market Multiple approach, Discounted cash flow (DCF) analysis, and Valuation-by-Stage approach. Investors choose the relevant approach based on the stage of investment and market maturity of the startup.

  • Investment Structure

It defines the mode of the venture capital investment in the startup, whether it is through equity, debt, or a combination of both.

  • Management Structure

The term sheet lays down the management structure of the company which includes a list for the board of directors, and prescribed appointment and removal procedures.

  • Changes to share capital

All investors in startups have their investment timelines, and accordingly they seek flexibility while analyzing exit options through subsequent rounds of funding. The term sheet addresses the stakeholders’ rights and obligations for subsequent changes in the company’s share capital.

What do investors look for in startups? 

Why do investors invest in startups? 

Investors essentially buy a piece of the company with their investment. They are putting down capital, in exchange for equity: a portion of ownership in the startup and rights to its potential future profits. Investors form a partnership with the startups they choose to invest in – if the company turns a profit, investors make returns proportionate to their amount of equity in the startup; if the startup fails, the investors lose the money they’ve invested.

Investors realize their return on investment from startups through various means of exit. Ideally, the VC firm and the entrepreneur should discuss the various exit options at the beginning of investment negotiations. A well-performing, high-growth startup that also has excellent management and organizational processes is more likely of being exit-ready earlier than other startups. Venture Capital and Private Equity funds must exit all their investments before the end of the fund’s life.

Startup India Funding Support

SIDBI Fund of Funds Scheme

The Government of India formed a fund of INR 10,000 CR to increase capital availability as well as to catalyze private investments and thereby accelerate the growth of the Indian startup ecosystem. The Fund was set up as a Fund of Funds for Startups (FFS), approved by the Cabinet and established by the Department for Promotion of Industry and Internal Trade (DPIIT) in June 2016. FFS does not invest in startups directly but provides capital to SEBI-registered Alternate Investment Funds (AIFs), known as daughter funds, who in turn invest money in high-potential Indian startups. SIDBI has been given the mandate of managing the FFS through the selection of daughter funds and overseeing the disbursal of committed capital. The fund of funds makes downstream investments in venture capital and alternative investment funds that in turn invest in startups. The fund has been formed in a way that creates a catalyzing effect. Funding is provided to startups across different life cycles. 


As of 31st May 2021, SIDBI has committed INR 5409.45 Cr to 71 AIFs further INR 1541.79 Cr has been distributed to 51 AIFs. A total of INR 5811.29 Cr has been injected to boost 443 startups.



Startup India Seed Fund Scheme

Department for Promotion of Industry and Internal Trade (DPIIT) has created Startup India Seed Fund Scheme (SISFS) with an outlay of Rs. 945 CR, which aims to provide financial assistance to startups for proof of concept, prototype development, product trials, market-entry, and commercialization. This would enable these startups to graduate to a level where they will be able to raise investments from angel investors or venture capitalists or seek loans from commercial banks or financial institutions. The scheme will support an estimated 3,600 entrepreneurs through 300 incubators in the next 4 years. The Seed Fund will be disbursed to eligible startups through eligible incubators across India.