(I thought I will keep quite and stay away from startup/entrepreneur world after shutting down my ventures. As it turned out, I became more active and vocal. Evidently, more and more youngsters want to try a “startup” these days. Some of them are approaching me to find answers on how to go about starting the new journey. I am trying my best to share whatever I managed to learn in the past 3 years.)
Disclaimer : I have no qualification in this subject let alone being an expert. Following is a very high level view from someone who started as a novice 3 yrs back and forced to understand some of this. Target audience for this post are those who come from pure technology back ground with an idea of trying a startup but do not know how to go about funding the adventure. Please consult experts before settling down to a strategy.
1. Self Funding
No brainer… this is nothing but you spending the money you have. Either your parents gave you a lot of money or you have made enough in your own career that you can “afford to lose”. Depending on how much you have, you may go up to validating the idea enough to quit your job and take the idea fully. But it is unlikely that you will be able to build a complete business with your own money unless it is a traditional zero-risk business (if there is any like that).
An example would be, if your dad owns a retail grocery shop and you want to start an online wing of the shop. Probably the existing business (read your dad) may fund this idea.
Debt is nothing but taking loan from someone or some institution to run your business. It could be an individual, bank or some other. Typically they give you loan for the interest they can make.
The Unsecured Loan is something you don’t have to attach any of your property to get the loan. But such unsecured loans are very few and will come with a lot of terms and conditions. Your friends and family may give you such unsecured loans but you may want to think twice to take such loans.
The Secured Loan is something that you will show some security to get the loan. It could be any fixed asset (land, flat, gold etc.) that you own.
People who lend you unsecured loan may pay some attention to your idea and its viability. When it comes to Secured Loan, lenders pay least attention (if any) to your idea and business viability. You don’t need to convince them about your idea but they should be convinced about the value of the fixed asset you are attaching.
Debt is a great option if you think your idea is zero-risky. For example, if you are planning to take a franchise of Pizza Hut in an upcoming multiplex+mall in a class A city, how wrong you can go?
Be aware that there are regulations about debt vs equity ratio you should maintain in India. For example, you cannot fund your company with 100% debt.
3. Friends & Family (& Fools)
This is the option you go to your friends and family asking for investment. You will give part of your company (equity) to them in return of their investment. The biggest debate in this round is how to set a price to the equity? If someone gives you Rs 10,00,000/- (Ten Lakhs), should you be giving 1% of the company or 10% ? All that you have is an idea that is yet to be validated and the business may not even be in sight. There are creative ways to arrive at this number like convertible note, but they are too advanced for the scope of this post I want to limit to.
Theoretically, you have to convince Friends and Family about your idea and business for them to invest in your idea. But in reality, most of them invest because of their trust on you and your team than the idea.
If your idea is an innovative one, you are advised to involve friends & family even if you can put in a lot of your own money and/or debt. Besides reducing your personal risk, involving those friends and family who may be seen as experts/experienced in the area of the idea will build credibility to you and your idea. Imagine you going to an investor or a potential customer saying CEO of a product company has invested 25 Lakhs in your business! That 25 Lakhs endorsement from an industry leader is worth much more than what 25 Lakhs can pay you for your operations. It is absolutely a smart thing to give a much bigger equity to such people for the same amount of investment they make compared to a novice making the investment.
Angels are individuals who regularly (supposedly) on lookout for investment opportunities in new ideas and businesses. Typically they are experienced professionals who may have made enough money. Each individual angel will have his/her reasons why they want to invest. The reasons range from “staying connected to evolutions”, “giving back to echo system that supported them when they began”, “to make more money” and many more.
A quick search on internet reveals that there are many “angel groups” at national and city level in India and elsewhere. An angel group is just that, a group of angels. The advantage of these groups is that they are more organized and you may not have to pitch for each one of them in the group separately.
The downside from my personal experience is that it is difficult to convince a group about a new idea. One black-hat in the room can spread the negativity even before the idea starts flying. Rarely we find ideas that any group of more than 5 will instantly like and get convinced. Unfortunately, the one who is completely sold and excited typically do not talk as much as the one who quickly found “a reason” why it may not work. Almost all the ideas initially will have more than one reason why things may not work. My personal advise is, avoid group settings early on and until the idea is validated somewhat and a prototype is built. While this group mentality is true even for F&F and other options, Angel groups is probably the first time you encounter a group setting.
The best thing that can happen to you at Angel round is if you can convince one industry leader in your space about your idea. If that person writes a check to you, he/she will also take you to others. We call him/her a “lead investor”. Others will be less violent at you to dismiss your idea looking at who endorsed it earlier.
5. Seed Funds
Seed fund are mini VCs. These are institutional investors just like VCs. Once your prototype is done and small revenue started trickling, you are ready for a seed fund. There are a plenty of seed funds and quick search will reveal a few. I do not want to give any links and promote any.
These funds will pool money from their sources and invest in multiple startups. They have diligent process to evaluate ideas, teams and business before they decide what they want to invest in. They are also good at giving a value to your company.
Seed funds typically invest much smaller amounts compared to VCs. Typically Rs 0.5 to 1.5 Crores is what you may expect from them. Some of them may have an appetite to go beyond 3 Crores too.
Seed funds expect to exit early (say 18 months) unlike VCs who can wait for many years.
In summary, Seed funds come in early, invest small amounts and would like to exit sooner compared to VCs.
6. Venture Capitalists (VCs)
Venture Capitalists come with much deeper pockets compared to Seed funds. They can invest large amounts like Rs 10 Crore or even 100 Crores and more. They take a larger chunk of your company. They can wait for longer duration say beyond 5 yrs to break even. Sometimes they come back and invest more second time around if your company does really well.
First time when VC come around and makes the big investment, people call it Series-A. The subsequent investment is called Series-B.
Typically the company gets an authoritative value when a VC puts in the money. Say if a VC puts in Rs 10 Crores and takes 25% equity, your company is valued at Rs. 40 Crores. All you founders and other equity holders can now compute how rich you are given your own equities in the company. Your equities do mean something from then on!
(I welcome any corrections or additional information in comments to make it more helpful for the beginners)