Thursday, March 3, 2011

Sources of Funds for Start-Ups

The first type of funding option that a start-up should look for is Bootstrapping. A start-up can be bootstrapped either by investing own funds or by introducing a consulting model, which can feed the development of a product. Though this is a very typical model used by software product development companies, it can be used by entrepreneurs from any other industry who have substantial experience to offer consultancy in their respective fields.

Family and Friends
Next best option is to borrow funds from friends and family. If you are lucky you may have uncles [or in-laws] loaded with wealth either from business itself or because of ancestral property. This option makes sense as it can get you interest free loan and [most likely] not dilute your share in the company! If at all you may be able to negotiate with minimal interest share.

Angel Investors
As the name suggests, angel investors are angels because they come at a time when the risk is highest. You may have sounded out your idea to sensible people and you may have even validated your idea at a significant scale. You may even have a ‘Proof of Concept’ to showcase, but you may still not be generating revenues. Angel investors are such investors who invest usually at this stage of a start-up's journey.

Seed Funding
Seed firms provide seed funding at the very early stage, just like the angel investors or the angel groups - probably at the idea stage. The difference here though is that usually angel investors are single entities. Seed firms are companies. Usually seed firms also provide “incubation” also which includes mentoring and providing office space to the start-ups. They play a significant role in getting the processes and functions in place for a start-up.

Crowd Funding
Crowd funding is a very tried and tested concept of raising funds for usually for a cause like forming a relief fund, selling a piece of art or, as recently film maker Onir did, for funding the production of a movie. [Read my article on Crowd Funding – A New and Tactical Method of Funding for Start-ups, to know more on crowd funding]. Whenever there has been an offbeat creation, crowd funding has come as an option. The reason has to be strong and compelling for sourcing a crowd fund. Now extend the same philosophy to the start-up drive that has presently taken some concrete shape in India.

VCs or Venture Capitalist firms are the companies who usually come in at a later stage when there is a proof of concept, revenue, profits and there is a vast potential for scalability of the model. There is better information about the total available market and the target customer(s), and hence a better predictability of the return on investments. When VCs invest it is usually a stage where seed investors would like to exit. VCs typically invest large sums of money which may start from 1 crore and above. When the VCs invest usually the founders have to dilute a big part of their stake.

The whole funding process comes at different stages and comes with its own pros and cons. It is a progressive process with one type of investor exiting and the other type coming on board. Many times there is a thin line between sources of funds like Friends & Family /Angel Investors/Seed Funds. There is no hard and fast rule to approach any type of investor, but references do matter when you try and approach VCs and the Angel Groups. Typically it is advisable to approach VCs only after there are some profits to show and that you would like to take your start-up to the next level – to the expansion stage.

Figure 1
Progression of Funding /Investment through the Stages of a Start-Up.