All businesses need one thing in common- money or capital. It is a requirement right from inception, well through growth and expansion, capital continues to be the elixir of all enterprises. Money bequeaths more money, yet raising it has always been difficult, and costly too. The viability of a business not only depends on how the money is expended but also on how it is funded; therefore, capital structuring and source of funds play an indispensible role.
All businesses evolve through different phases like seed stage, early stage, growth and expansion stage in sequence, and the locus and focus of the borrowed funds differ from phase to phase. Finance needs also depend on the tenor of the loans, like short term, medium term and long term funds.
Because the basic objective of any business is to minimize cost and maximize profits, the ways and means of raising capital have to be thoroughly understood.
Raising capital during the seed stage:
Although high risks offer high returns, high risks do not attract huge investments, particularly during the initial stage i.e., the seed stage. It is during this stage that a potential business idea branches into a good business plan, sound management team and viable product prototype. Banks generally shy away during this phase due to lack of collaterals, and many entrepreneurs kick start their business with their personal investments from savings, mortgaged assets or loans from friends and relatives. A business does not sustain itself not only with money but also with the right advice and contacts, and this is where Angel Investors chip in.
Angel investors provide capital during the seed stage and also in the early stage when start-ups start their commercial operations in full scale. Angels are high net worth individuals, who invest in the risky business start ups and provide technical and market support based on their experience and contacts. They infuse funds into the business either by subscribing to equity capital or convertible debentures because the investment is of a long term nature, and they have at least minimum control over your decisions and operations due to this. Angle Investors also expect a high rate of return somewhere above 10% within of span of 3 to 5 years due to extremely high risk. Most of the angels exit from start- ups by offloading their stakes when start-ups take up funding from venture capital firms for further growth and expansion.
Raising capital during growth and expansion:
Once the start-up begins to generate considerable revenue from the early stage after breaking even, it needs more capital for growth and expansion. This phase has two stages, namely early stage financing and expansion/ later stage financing-- both require investors with deeper pockets, and venture capitalists fit in the role perfectly.
Venture capital funds:
Getting venture capital is not very easy; an entrepreneur has to demonstrate not only his past success but also a well developed business model, innovative technology and immense potential for growth and expansion. When compared to angel investors, VCs have deep pockets and stringent lending norms for start –ups and demand greater control over operations and decisions.
They infuse capital for activities like commercial scale manufacturing and sales during the early stage of a start-up, and fund for plant expansion, aggressive marketing and product line expansion during the expansion stage. Generally in India, VC investments are in the form of equity, conditional loans, conventional loans and debentures, and the amount of capital infusion can go up to 10 crores. Their exit routes include Initial Public Offering (IPO), the divestment of shares and buyback arrangement with promoters.
In India, SVCL (SIDBI VENTURE CAPITAL LIMITED) provides funding in all stages to unlisted companies mainly in small scale and small units graduating to medium scale enterprises.
Initial Public Offering (IPO):
After a company has significantly grown by generating profits through the funds provided by venture capital firms, it can expand further by taking the IPO path. Under this option, the company issues its shares to the public and raises money by listing the company shares in a stock exchange. By going public, the company not only has access to a wide pool of investors but also a cheap source of finance. Another advantage is that it can gradually gain the management control from venture capitalists by diluting their holdings through widening the equity base.
Loans from banks and financial institutions:
Although banks provide funds to finance short term and long term needs, the start-ups are not eligible unless they have collateral security and three year track record of consistent profits. Additionally, banks do not fund start-ups during their seed stage and early stage; they are retrospective in their approach. Apart from the other public sector and private banks, SIBDI also provides loans to new and existing small and medium enterprises through its various schemes. Since working capital determines the operational efficiency of a firm, companies need adequate short term finance to tide over their day to day expenses. All banks provide working capital finance through cash credit, trade credit, factoring and discounting.
Although angel and venture capital funds have a long way to go in India, the Indian financial market has many options to offer for both new and growing enterprises. The right strategy for any entrepreneur is to choose the right option at the right stage.