You've started your own startup? Congratulations! The hardest part is to take a decision to begin. Most people fail at this step itself and so, you definitely deserve appreciation.
So what next? Are you looking to raise capital? Here is a guide.
Why do you need to raise Capital?
This is the most important question to ask yourself because when you raise capital, you are inviting external investors to own a part of your company. Which means that you're losing a part of your control. Are you ok with that? Your investors will have their own opinions, thought processes, and ideas for the business. Are you open to hearing them? What if your thought process doesn't align with theirs. How will you handle conflicts?
These are people-related questions that you should ask yourself before you raise funds. Apart from that, there are business-related questions that you should ask. For instance, why can't your business be profitable? Why does it need a capital infusion? What other options do you have apart from raising capital from investors? If it's just a small amount of money, can you put in some money from your savings? Do you have friends and family members who would be willing to invest? Can you take a loan? Basically, what other alternative options do you have to raise funds without giving away ownership of your business.
Here are some guidelines while you think:
- Are you someone who doesn't like to listen to others too much? Your investors will surely want you to listen to them.
- Are you someone who doesn't have a proper business plan in place? Your investors would want to see it. No one wants to spray and pray.
- Is your vision centered around building a Rs. 30 crores revenue and Rs. 5 crores profit business? It might be a large amount of money for you, but for investors, it's not an attractive proposition.
- Does your business require a relatively smaller amount of capital like a few tens of lakhs of rupees? You may consider putting some savings of yours and raising the rest of it from friends and family.
Basically, understand that by raising capital, you will lose a part of the ownership of the company which you should be fine with. Also, understand that investor money is not free money given to you to build your dreams. It's an obligation that you've taken on yourself and at some point in time, you'd have to return the money to your investors.
Assuming that you've thought through all of this and finally decided that you indeed want to raise money for your early-stage startup, here are 2 options.
Raising money from Angel Investors
Angel investors are high-net-worth individuals who have funds to invest in startups. Angel investors invest in startups for multiple reasons:
- Wanting to give back to the ecosystem. For instance, Founders like me who have created wealth via an acquisition, have spare money to invest. A lot of people from the ecosystem helped me in building Cogno. So now, I want to pay it forward by helping other founders.
- Understanding new trends in the market. A lot of Founders use Angel Investment as a tool to learn more about the new startups, and technologies active in the market.
- Making returns on their investment. Needless to say, all investors eventually are looking to grow their capital.
The biggest benefit of raising money from Angel investors is that they will be easy to convince and will invest mainly in you rather than in your business. A typical Angel investor will invest around Rs. 5 - 10 lakhs per startup and so, it is not worth it for them to spend a lot of time evaluating you. Therefore, the process of raising money from Angel investors would be much faster.
However, there is a major downside to this. Let's say you want to raise Rs. 5 crores of capital. One Angel Investor will typically put in Rs. 5 - 10 lakhs. So, you need some 50 - 100 such Angel Investors to be able to raise the total capital that you require. This becomes tricky because finding so many people and then managing them on your cap table is not easy. There are operational hassles, legal agreements, etc., to be managed.
So there are two main problems with raising money from Angel Investors:
- You need to spend time finding so many people.
- You need to manage so many people on your cap table
To solve this, there are a few Angel investor syndicates that you can find on platforms like AngelList. There also are some other Angel investor groups like IP Ventures, Dexter Angels, etc., which have pre-onboarded Angel Investors. They will help you organize a pitch to all of these investors at once and save you time. They will also take care of documentation, paperwork and the best part is that a single entity will come on your cap table and so, it becomes much easier to manage.
Apart from Angel Investors, there is an option of
Raising money from Venture Capitalists
Venture Capitalists or VCs are structured institutional investors. They are in the business of making money by investing in companies with high growth potential. There are many well-known VCs in India. Some notable names are Accel, Sequoia, Blume, Matrix, Nexus, Elevation, etc. Many of them invest at stages as early as pre-product, and pre-revenue depending on their comfort with the founder's capabilities.
Apart from the usual business plan and other stuff, VCs want 2 main things:
- They'd want to get about 20 - 25% of the company, irrespective of the amount of capital you want to raise. Smaller percentages are not worth it for them in terms of their time and efforts. So, if you want to raise capital from VCs, be mentally prepared for giving away at least a fifth of your company.
- They'd want a 5 - 7 year plan of how you'd take your business to $100M in revenues and $1B in valuation. VCs don't like the story of small profitable businesses. They make money via capital appreciation and not via profits. So, they want a $100M revenue story or they won't be interested.
For every 10 investments that a VC firm makes, 5 - 7 will go bust, 2 will just return the capital or give small returns, and 1 will give 10x - 50x returns. This 1 startup that gives 10x - 50x returns will cover up for the losses they incur in the 5 - 7 startups that will go bust. So, VCs are always on the lookout for this one startup that can give mega returns. If they don't see that in you, they won't invest.
For many early-stage founders who have a high-level idea of what they want to do, it might get quite difficult to raise money from the VCs because crafting a $100M revenue story on day one is quite difficult. That's why, most founders raise their seed round from Angel Investors, get some traction, and then go to VC firms for Series A and later rounds.
Having said that, the good thing about VCs is that most of them are quite hands-on. If an Associate or VP-level person from a VC fund likes you as a founder, they would be happy to invest time with you in building your $100M business plan. It requires a lot of big thinking and storytelling, which the Associate/VP can help you with, and then jointly take your case to the Partners to consider your case.
Let's take the example of BharatPe. Let's say you figure out the idea of QR code-based payments in your college and now you want to create a business out of this. You are a techie and you figured out the tech behind QR code-based payments. But here is a small problem, forget about a $100M revenue business plan, you don't even have an idea how you will monetize the QR code. A VC can help you here. They can sit with you and craft a business plan on how you will start doing transaction-based lending because you get the payment data via the QR code.
Lending is a massive industry and so, if you are able to scale the QR code business to a lot of merchants, you can easily build a loan book of $1B. With 12% interest and 2% NPA, that's a $100M revenue business. As a techie, you may not have any idea of all of this. But a good VC can sit with you, guide you on this and work on a business plan so that you can present this to their partners. Remember, as much as founders want VCs, VCs also want to bet their money on great founders.
Apart from this, VCs also have a support system in place. Most VC firms will help you with CA, a Lawyer, and in many cases, even an HR who will help you build a leadership team once you've raised capital. So that's a big benefit because they'd have seen hiring mistakes across multiple of their portfolio startups and so, they can help you increase the odds of avoiding the same mistake again.
So, to summarize:
- For small amounts of capital, it's best to go to Angel investors. Much more convenient.
- For relatively larger amounts of capital, it's worth investing time talking to VCs.
What's your take on this? Do share in the comments below.
I have shared a lot of my learnings about Business and Entrepreneurship on my YouTube Channel. Please check it here: https://youtube.com/@aman.goeliitb
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