Funding options to raise capital for Businesses and Startups.

Okay, so after all of these modules that you’ve read through, have you ever stopped to wonder about how exactly a company gets its initial capital or funding? Think about it. A company that’s starting out doesn’t have a cushion of capital to rely on. In fact, it is hard for a brand new company to raise funds for its operations, since it still has an unproven business model. In some cases, the promoters step in and help with small business funding by infusing the initial capital for starting the business. But, then again, what if the promoters are not financially strong enough to support a business? That’s exactly what we’ll be answering in this chapter. 

To better understand small business funding and the many funding options for a business in general, let’s first take a brief look at the lifecycle of a business. 

The life cycle of a business 

The life cycle of a business is essentially a series of changes or progressions of the business over a period of time. Irrespective of the type of business and the industry, almost all companies go through the following five distinct stages during their life cycle. 

The launch stage

Also known as the startup stage, the launch stage is when a company or a business is incorporated. In this stage, the promoters of a company infuse it with the initial bare-minimum capital required to get off the ground. Since the sales are low and the revenue streams are not very strong in this phase, the launch stage is often considered by many to be the riskiest stage of all. 

The growth stage

Once a business crosses the risky launch stage, it is said to have entered the growth stage. Here, the sales of the business begin to pick up and it starts to establish its own identity, reputation, and credibility. Since the number of sales have gone up, the revenue streams also become steady, with a shrinking time lag between sales and the collection of payments. Thanks to this newfound growth, the business starts seeing profits. The goal now evolves to boosting revenue through increased level of marketing and scaling up production and efficiency.  

The shake-out stage

Once a business has seen tremendous levels of growth, it enters the shake-out stage. Here, the sales of the business begins to peak, but the rate of growth in sales and revenue begin to slow down. This can happen due to either one or both of these two reasons:

• Saturation of the market 
• Entry of new competitors

In the shake-out stage, the costs and expenses associated with a business tends to shoot up significantly, eating into the revenues and profits. To increase the profit share, businesses generally tend to cut expenses and costs here.

The maturity stage

A business is said to have matured when sales, revenue, and profit begin to slowly get thinner. Most businesses tend to branch out at this stage and invest in radical technologies, diversify their business, and seek to branch out to new and emerging markets. This move can help extend the  life cycle of the company, and it can even bring about some much-needed growth.    

The decline stage 

In this stage, the sales and revenue of a business start to dry up. There’s very little that a business can do to reinvent itself from this stage. And, anything that can be done to refresh its business would require immense capital contribution, which is almost always not possible at this phase. Generally, businesses that are in the decline stage either try to merge or amalgamate with other successful entities, or exit the scene completely by shutting their operations.    

Okay, so now that we’ve seen how the lifecycle of a business looks, where do funding options  fit in? Let's try to get some answers to this burning question.        

How do businesses raise money?

Contrary to what you may think, there are various ways in which a business can raise money. Some businesses even go the crowdfunding way to gain access to capital. But this funding option is still in the nascent stage and is more of a hit or miss. Let’s look at the more traditional forms of small business funding and raising of capital.  

Through loans 

You probably already thought of this, didn’t you? Funding a business through loans is still one of the most popular ways to gain access to capital. Most small businesses and startups prefer to approach banks and other financial institutions to raise funding by way of business loans. 

Gaining access to funds via loans would require a business to share its business idea, its plan, and an extensive project report showing the projected cash flows with the financial institution from which the loan is being obtained. The loan is granted if the bank or the financial institution deems the business to be viable after conducting a thorough assessment and examination of the plan.

Almost all the banks in India offer business loans with a variety of options and terms and conditions to choose from. Some even offer collateral-free loans. And sometimes, banks may not entertain a business’ request for a loan if the credit rating is unfavourable or if the business doesn’t meet their set of requirements. In such a case, microfinance providers and NBFCs (Non-Banking Financial Corporations) may come in handy, since their requirements for granting business loans are usually not as stringent as a bank’s. 

Businesses that are in the launch stage may often find it difficult to get loans from financial institutions due to their relatively new presence. However, businesses that are in the growth stage are often the more favoured entities for business loans. 

Through angel investors

Angel investors are essentially individuals with a high net worth or annual income. They’re highly accredited and typically operate alone, looking for exciting investment ideas and startups to invest their money in. Sometimes, a group of angel investors may band together and create a sort of a fund to make investments in businesses. 

Generally, businesses that require low to moderate levels of funding approach angel investors to acquire capital. To capture the attention of an angel investor, a business would have to share its plan and have an exciting and enthusiastic pitch. In return for investing money in a business, angel investors typically receive a portion of the company’s equity.

Also, most angel investors do not actively participate in the day-to-day affairs of a business. They prefer to not have a say in the way the business spends their cash. However, some angel investors, who may have invested a significant portion of the capital, might request for a directorship in the company. 

Angel investors typically stick to funding businesses that are in the launch stage and rarely invest in growing companies. Therefore, angel investors are the best option for small business funding. 

Through venture capitalists

Also known as VCs, venture capitalists are essentially firms and corporations that pool money from various partners and invest those funds in businesses. Although venture capitalists might sound quite similar to angel investors, they are not. VCs are capable of investing huge sums of money in businesses and easily outrank angel investors. 

In exchange for their investment, VCs also receive a portion of the business’ equity. Since venture capitalists invest large portions of capital, they generally expect a greater degree of managerial control, often with a seat in the board of directors. Unlike angel investors, VCs typically stay invested for quite a long period of time. 

Venture capitalists prefer investing in slightly mature companies with a positive cash flow and revenue stream. This makes them the ideal sources to seek funding for businesses in the growth stage, since the main target of VCs is to invest in companies with a large scope of growth.    

Through debt instruments

Businesses that are quite established and deep in their life cycle typically opt for funding through the issue of bond and debt instruments like debentures. In order for a company to issue and successfully raise capital through such instruments, they need to have developed a successful business model with strong revenues and a large asset base. 

Also, funding through the issue of debt instruments is the perfect option for businesses that prefer to possess complete control over the operations and management of cash flows. Generally, businesses that are in the shake-out stage and the mature stage are the ones who opt for this method of funding. However, companies that are in the growth stage may still opt to raise funds through debt instruments, but it is more likely to be hit or miss since the public may not view the business as favourable.    

Through private equity

Similar to VCs, private equity firms pool the funds from multiple investors and create a private equity fund. This is usually much larger than your typical venture capitalist. These private equity firms then invest these funds in businesses in exchange for a stake in the equity. 

Private equity firms are generally very knowledgeable and possess immense technical and professional qualifications. They almost always insist on having a place in the board of directors of the company and have a significant say in the way a company manages its cash.

Private equity firms do not generally invest in companies that are in their early stages. Instead they look to invest in companies that are in the shake-out stage or the mature stage. PE investments are great for companies that require huge amounts of capital, but do not wish to issue or list their shares to the public.   

Through the issuance of shares to the public

A well-established company can also raise capital directly from the public by issuing its equity shares up for sale. When this method of funding takes place for the first time in the life of a company, it is popularly known as an ‘Initial Public Offering (IPO).’ 

When a company lists its shares up for subscription via an IPO, any person with a demat account can apply for and buy its shares by paying a certain price. The funding that the company receives from the IPO can be used to further its business, expand into new territories, purchase new assets, or even settle existing debts.    

In order for this method of funding to be successful, a business needs to generally be established. This is simply because it would ensure maximum visibility to the public. However, there have been instances where companies in the growth stage have successfully raised capital through IPO.  

Wrapping up

So, that’s about it for this lesson. It was quite comprehensive, wasn’t it? The primary intention of this chapter was to set the stage for the upcoming ones. Over the next few chapters of this module, we’ll delve even deeper into the concept of Initial Public Offering (IPO) and take a look at the various processes involved in an IPO. 

A quick recap

• Irrespective of the type of business and the industry, almost all companies go through the following five distinct stages during their life cycle. 
• Also known as the startup stage, the launch stage is when a company or a business is incorporated. In this stage, the promoters of a company infuse it with the initial bare-minimum capital required to get off the ground.
• Once a business crosses the risky launch stage, it is said to have entered the growth stage. Here, the sales of the business begin to pick up and it starts to establish its own identity, reputation, and credibility.
• Once a business has seen tremendous levels of growth, it enters the shake-out stage. Here, the sales of the business begins to peak, but the rate of growth in sales and revenue begin to slow down.
• A business is said to have matured when sales, revenue, and profit begin to slowly get thinner. Most businesses tend to branch out at this stage and invest in radical technologies or diversify their business.
• In the decline stage, the sales and revenue of a business start to dry up. There’s very little that a business can do to reinvent itself from this stage.
• Funding a business through loans is one of the most popular ways to gain access to capital. Most small businesses and startups prefer to approach banks and other financial institutions to raise funding by way of business loans.
• Another option is seeking funding from angel investors. Angel investors are essentially individuals with a high net worth or annual income. They’re highly accredited and typically operate alone, looking for exciting investment ideas and startups to invest their money in.
• Venture capitalists, who are essentially firms and corporations that pool money from various partners and invest those funds in businesses, also help companies raise money. VCs are capable of investing huge sums of money in businesses and easily outrank angel investors. 
• Businesses that are quite established and deep in their life cycle can also typically opt for funding through the issue of bond and debt instruments like debentures.
• Then, there are private equity firms that pool the funds from multiple investors and create a private equity fund. This is usually much larger than your typical venture capitalist.
• Lastly, a well-established company can also raise capital directly from the public by issuing its equity shares up for sale. When this method of funding takes place for the first time in the life of a company, it is popularly known as an ‘Initial Public Offering (IPO).’