The number of startups in India has exponentially increased, especially in the recent years. While a huge number of them have successfully established themselves in the market, others have not been lucky enough to do so due to various reasons. One of the major reasons startups often fail is their inability to raise funds in time to empower their business operations and enable unhindered growth.
Considering businesses require funds to manage their expenses, the lack of an ample amount of money would certainly spell doom for the startup. As such companies often choose to raise money externally through various forms of investment.
To help avoid potential financial hindrances, we have listed the various ways through which a startup can raise funds for their business in India.
When Do Startups Need to Look for Investors to Invest?
Different startups may choose to raise funds at different stages of their company. Each stage attracts different types of investors, who bring in different expertise to the table and have different expectations from their investments. Besides, each consequent round can be expected to raise more money.
A few options to raise funds are mentioned for your reference below.
Ideation
This initial stage is where an individual has an idea and is working towards making it true. As such, this stage does not raise a huge amount of funds. Besides, at such an early stage, very few and usually informal channels are available to raise funds.
Pre-Seed Stage
- Bootstrapping/Self-Financing
Bootstrapping refers to growing a business with little or no venture capital or outside investment. It basically means completely relying on your savings to manage the business and bring your ideas to life. This is usually the first method of financing for most startups, as you don’t have to be worried about paying back or diluting the startup at such an early stage.
- Business Plan/Pitching Events
This channel includes prize money, grants and/or financial benefits provided by various institutes or companies that conduct challenges and competitions. Although the funds raised is not really large.
Friends and family are also one of the primary channels to raise capital to bring your ideas to life. The key aspect in such a source of investment is that there is a certain amount of trust between the entrepreneur and the investors.
Validation Stage
At this point in a startup, there is probably a prototype ready, following which the potential demand of the startup’s product/service shall be validated. This is known as carrying out a ‘Proof of Concept (POC)’, which shall be followed by the major market launch.
Seed Stage
Startups would need to conduct field trials, test the products on potential, bring some members onboard, and build a formal team, which needs them to raise certain amounts of funds using the following channels:
Incubators refer to organizations that have been set up for the sole purpose of helping entrepreneurs build and launch their startups. While you may receive a lot of value-added services such as office space, utilities, admin and legal assistance, etc., such entities may also make equity investments or offer debt or grants.
Raising money from a large number of people, where each of them contributes a small amount of money, is known as crowd funding. This is usually carried out online on crowd funding platforms.
Angel investors are people who wish to invest their money in startups that have a high potential according to them in exchange for equity in the company. Reaching out to various angel investors like Mumbai Angels, Indian Angel Network, Lead Angels, and Chennai Angels can help you raise the funds required for the startup.
Government began certain loan schemes to offer collateral-free debt to aspiring entrepreneurs and help them gain low-cost capital through schemes like Startup India Seed Fund Scheme and SIDBI Fund of Funds.
Early Traction Stage
At the Early Traction stage, the startup’s products/services have been launched in the market. Owners need to keep an eye on key performance indicators such as the customer base, revenue, app downloads, etc. for various uses in the future.
‘Series A’ Stage
Money raised at this point of time helps the startup grow its user base, product offerings, step into new geographical regions, etc. Some common funding sources used to raise money at this stage are mentioned below:
- Banks/Non-Banking Financial Companies (NBFCs)
You can raise formal debts at this stage from banks and NBFCs, as the startup can show significant market traction and revenue to validate its ability to apply for such loans. This is especially applicable for working capital. It should be noted that some owners may prefer debt over equity, as the former does not require you to dilute the startup’s equity for payment.
Venture Capital (VC) funds are professionally managed investment funds that only invest in high-growth startups. Each VC has a specific investment thesis, which involves their preferred sectors, stage of the startups and funding amount. In exchange for the investment, VCs take the startup’s equity in return and are actively involved in mentoring the investee startups.
Private investment funds that invest in startups primarily in the form of debt are known as Venture Debt funds. Such funds are usually invested alongside an angel or VC round of investments.
Scaling Stage
The startup observes a rapid rate of market growth and an increase in the revenue at this stage.
Series B, C, D & E Stage
Some common funding sources startups may use at this stage are:
- Private Equity/Investment Firms
While private equity/investment firms do not invest in startups in general, as of late, some of them have been offering funds to fast-growing late-stage startups, who have maintained a steady growth.
VC funds with larger ticket size in their investment thesis offer funding for late-stage startups. It is strongly advised to only approach such entities after the startup has gained certain market traction. Besides, a pool of VC may collaborate and fund a startup together as well.
Exit Options
The investor may choose to sell the portfolio company to another company in the market. Basically, it involves one company combining with another, either through acquisition (completely or partially) or by being acquired (completely or partially).
Investors may choose to sell their equity holdings or shares to other venture capital or private equity firms.
When a startup lists its stocks in the market for the first time, the event is known as IPO. As the public listing process is quite tedious, generally, only startups with an impressive track record of profits and that have a good and steady growth rate choose to go down this path.
At times, founders of the startup may choose to buyback their shares from the investors if they wish to regain control of their company and have enough liquid assets to make it happen.
Legal Steps Involved in Raising Funds for Startups in India
Entrepreneurs must be patient and willing to, with utmost care, carry out the various steps involved in raising funds for their business. Considering there are various legal aspects to raising funds, you must familiarize yourself with the various steps involved:
- Evaluating Startup’s Need for Funds
The startup must evaluate why do they need funds and the right amount that needs to be raised. It needs to develop a milestone-based plan with specific timelines that states what the startup aims to do in the next two, four and ten years. It needs to calculate and make a financial prediction for the development of the company, while taking projected sales data and market and economic indicators into consideration as well.
- Judging Investment Readiness
Along with ensuring if your startup needs funds, it is imperative to assess if your startup is ready to raise funds. If convinced about your revenue and the potential returns you may offer them, any investor shall be willing to invest in your company. A few things investors look for in potential investee startups are:
- Revenue growth & market position
- Promising returns on investments
- Time to break-even & profitability
- Entrepreneur’s vision and strategy
- Uniqueness of the startup
- Competitive advantage of the startup
- Trustworthy, passionate and proficient team of professionals
- Preparation of Pitch Deck
A pitch deck is basically an all-inclusive presentation that outlines all the key aspects of the startup. Creating an effective investor pitch is all about sharing a good story, where it is not just a series of individual slides but a presentation of your startup’s story. At the initial stages, the review committee and the potential investors are always curious to understand the idea behind the startup. Besides, they also review if it has a strong case and meets with all the expectations an investor has from an investee (mentioned in the above pointer).
Note: While pitching events are excellent opportunities to meet potential investors, pitch decks can be shared with Angel Networks and VCs on their email IDs as well.
All VC firms have an ‘investment thesis’, which is a strategy that the VC fund follows. The investment thesis identifies the stage, geography, focus of investments, and differentiation of the firm. You can get an idea about a VC’s investment thesis by going through their website, investment history, brochures, and fund descriptions. It is imperative to understand the investment thesis to ensure you target the right investors. An exercise that may help with this process is:
- Identify active investors.
- Market/sector preferences.
- Geographic location.
- Average ticket size of their fundings.
- Level of engagement & mentorship provided to investee startups.
- Due Diligence by Interested Investors
Both angle investors and VCs conduct an extensive due diligence of the startup before settling down on any equity deals, where they review several aspects of the company from financial decisions and team’ credentials to the startup’s background. This is done to verify the claims of growth made by the startup and spot any objectionable activities before finalizing the deal. If the due diligence is a success, the funding is approved and completed on the terms agreed mutually by both parties.
A term sheet refers to a ‘non-binding’ list of suggestions by a VC firm at the early stages of the deal. It covers the crucial points of engagement in the deal between the two entities. A term sheet for VC transaction in India usually consists of four structural provisions– Valuation, Investment Structure, Management Structure, and Changes to Share Capital.
Valuation: Startup valuation refers to a business’s total value as per the calculation of a professional valuer. There are numerous methods of valuating a startup - Cost to Duplicate approach, Market Multiple approaches, Discounted cash flow (DCF) analysis, and Valuation-by-Stage approach. Investors finalize the best approach based on the stage of the startup when the investment is being made as well as the market maturity of the startup.
Investment Structure: It describes the channel of VC investment in startups, i.e., whether it is through equity, debt or a blend of both.
Management Structure: The management structure of the business – that includes a list for the Board and prescribed appointment and removal procedures – is included in the term sheet.
Changes to share capital: All investors have their investment timelines and, as per which, they seek flexibility when reviewing the exit options after successive rounds of fundings. All the rights and responsibilities of the stakeholders for subsequent changes in the business’ share capital is mentioned in the term sheet.
Startup Seed Fund Schemes
It is vital for entrepreneurs to have an easy availability of capital at the early stages of their business’ growth. While funding from angel investors and VC firms is only available after providing the POC, the aim of the Startup Seed Fund Scheme (SISFS) is to provide financial aid to startups for POC, product trials, prototype development, market entry, and commercialization.
By doing this, the scheme allows startups to reach a level where they shall be eligible to raise funds from angel investors or get a loan from commercial banks, VC firms, or other financial institutions. The below-mentioned criteria must be fulfilled by startups for them to enjoy the benefits of the SISFS:
- It should be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) and incorporated for a maximum of 2 years at the time of application.
- Startups that are developing innovative solutions in markets like social impact, water management, education, agriculture, railways, oil and gas, biotechnology, healthcare, energy, mobility, defense, space, textiles, etc. shall receive preferential treatment.
- The startup must be using technology in its primary product or service or business model or distribution model or methodology to solve the issue it aims to resolve.
- The startup must have a business idea to develop a product or a service with a market fit, potential to scale and sustainable commercialization.
- As per the Companies Act, 2013 and SEBI (ICDR) Regulations, 2018, Indian promoters must hold at least 51% shares in the startup when applying to the incubator for the scheme.
- It must not have received more than INR 10 lakhs as monetary support under any other Central/State government scheme.
Note: This does not include prize money from competitions and grand challenges, access to labs, subsidized working space, access to prototyping facility or founder monthly allowances.
- The applied startup can receive seed support in the form of debt/convertible debentures, as per the scheme’s or grant’s guidelines.
Startup India Investor Connect
A dedicated platform – Startup India Investor Connect – that connects startups to investors, promotes entrepreneurship and increases engagement across diverse sectors, functions, stages, geographies, and backgrounds as per the need of the ecosystem was launched in the sixth meeting of the National Startup Advisory Council (NSAC) on 11th March 2023.
Key Features of the Portal
- Investment opportunities as the platform will bring together startups and investors, enabling startups to gain visibility in front of investors, pitch their ideas and create investment opportunities for them.
- AI based matchmaking to connect startups and investors based on their respective requirements.
- Enable connection between investors and startups in emerging cities.
- Virtual marketplace creation for investors to find innovative startups suitable for their needs.
Conclusion
Startups need to handle various vital processes like gaining traction, ideation, expansion, etc. However, they also need to, at times, raise funds to ensure they carry out such activities without any hindrances. With the wide range of options available where startups can get investments from, it is quite feasible for startups to reach out to investors depending upon the stage of their startup and the amount that needs to be raised.
Although it is significantly easy to reach out to investors, it is imperative to keep all legal aspects related to such investments in mind and all regulations must be strictly followed to avoid any potential issues in future.
Thank you for getting in touch! 
