Startup Funding Stages: Different Stages Of Funding For Startups Explained
For a startup, funding can create the difference between getting it successfully off the ground or burning it down to ashes. And to raise money, new-age businesses go through several startup funding stages.
According to a recent study, over 94% of new businesses fail during the first year of their operation. Unsurprisingly, lack of funding turns out to be one of the most common reasons for such failure.
We all know money is the bloodline of any business. And to grow consistently in the exciting roller coaster journey from the idea to revenue generation, a business needs capital.
As the Indian startup ecosystem is growing, startup funding has become a buzzword. Also, with an increase in first-time founders, it’s a common sight at almost every stage of the business journey to find entrepreneurs asking themselves – How do I finance my startup?
Decoding Startup Funding Stages
If you find yourself on the same point, this article will help you understand how the process of funding works and the different stages of startup funding.
There are multiple sources of funding available for startups. However, the source and amount of funding typically match or actually depends on the stage of operations of the startup.
A startup can typically be in one of these 5 stages when it is looking for funds – Ideation, Validation, Early Traction, Scaling, and Exit. Below are the startup funding stages every startup goes through in its journey.
1. Ideation / Pre-Seed Stage
This is the startup funding stage where the entrepreneur has an idea and is working on bringing it to life. Also called the pre-seed stage, the amount of funds needed in this stage is usually small, and there are very limited and mostly informal channels available for raising funds.
At this stage, the most common funding sources are:
- Friends & Family
- Friends & Family
Bootstrapping a startup means growing the business with little or no venture capital or outside investment, meaning relying on your savings and revenue to operate and expand.
This is the first recourse for most entrepreneurs as there is no pressure to pay back the funds or dilute control of your startup.
Friends & Family
This is also a commonly utilized channel of funding by entrepreneurs still in the early stages. The major benefit of this source of investment is that there is an inherent level of trust between the entrepreneurs and the investors.
Business Plan/Pitching Events
This is the prize money/grants/financial benefits provided by institutes or organizations that conduct business plan competitions and challenges. Though the quantum of money is not generally large, it is usually enough at the idea stage.
What makes the difference at these events is having a good business plan. These events are also a good way to network within the startup ecosystem. Some of the popular startup contests in India are NASSCOM’s 10000 startups, Microsoft BizSparks, Conquest, NextBigIdea Contest, and Lets Ignite.
At this stage, a startup has a prototype ready and needs to validate the potential demand of the startup’s product/service. This is called conducting a ‘Proof of Concept (POC)‘, after which comes the big market launch.
Also called the seed stage, here startups conduct field trials, test the product on a few potential customers, onboard mentors, and build a formal team. Startups at this stage generally explore the following funding sources:
Incubators are organizations set up with the specific goal of assisting entrepreneurs with building and launching their startups. Not only do incubators offer a lot of value-added services like office space, utilities, admin & legal assistance, etc., they often also make grants/debt/equity investments.
In India, popular names are Amity Innovation Incubator, AngelPrime, CIIE, IAN Business Incubator, Villgro, Startup Village, and TLabs.
Government Loan Schemes
The government has initiated a few loan schemes to provide collateral-free debt to aspiring entrepreneurs and help them gain access to low-cost capital, such as the Startup India Seed Fund Scheme and SIDBI Fund of Funds.
Angel investors are individuals who invest their money into high-potential startups in return for equity. Indian Angel Network, Mumbai Angels, Lead Angels, Chennai Angels, etc., are a few renowned angel networks. Entrepreneurs may also reach out to relevant industrialists for this.
Crowdfunding refers to raising money from a large number of people who each contribute a relatively small amount. This is typically done via online crowdfunding platforms.
Some of the popular crowdfunding sites in India are Indiegogo, Wishberry, Ketto, Fundlined, and Catapooolt.
3. Early Traction
Of the several startup funding stages, this stage holds the utmost importance. This stage comes when the startup has launched its products or services in the market. Key performance indicators such as customer base, revenue, app downloads, etc., become important at this stage.
Also called the Series A Stage, here raised funds are used to further grow the user base, product offerings, and expand to new geographies, etc.
Common funding sources utilized by startups in this stage are:
Venture Capital Funds
Venture capital (VC) funds are professionally managed investment funds that invest exclusively in high-growth startups. Each VC fund has its investment thesis – preferred sectors, stage of the startup, and funding amount – which should align with your startup.
VCs take startup equity in return for their investments and actively engage in the mentorship of their investee startups.
Some of the well-known Venture Capitalists in India are – Nexus Venture Partners, Helion Ventures, Kalaari Capital, Accel Partners, Blume Ventures, Canaan, Sequoia Capital, and Bessemer Ventures.
Banks/Non-Banking Financial Companies (NBFCs)
Formal debt can be raised from banks and NBFCs at this stage as the startup can show market traction and revenue to validate its ability to finance interest payment obligations.
This is especially applicable for working capital. Some entrepreneurs might prefer debt over equity as debt funding does not dilute equity stake. Almost every bank in India offers SME finance through various programs.
For instance, leading Indian banks – Bank Of Baroda, HDFC, ICICI, and Axis banks have more than 7-8 different options to offer collateral-free business loans.
Venture Debt Funds
Venture Debt funds are private investment funds that invest money in startups primarily in the form of debt. Debt funds typically invest along with an angel or VC round.
At this stage, startups try to add revenue at a faster rate while also increasing efficiency. Here, funding rounds raised by the startups are Series B, C, D & E. Common funding sources utilized by startups in this stage are:
Venture Capital Funds
VC funds with larger ticket sizes in their investment, thus providing funding for startups operating in the later stages. It is recommended to approach these funds only after the startup has generated significant market traction. A pool of VCs may come together and fund a startup as well.
Private Equity/Investment Firms
Private Equity/Investment firms generally do not fund startups, however lately, some private equity and investment firms have been providing funds for fast-growing late-stage startups who have maintained a consistent growth record.
5. Exit Options
Exits provide capital to entrepreneurs and startup investors. In the case of investors, they can return the money to limited partners (Venture Capitalists) or the investors themselves (in the case of business angels). Following options, investors and entrepreneurs may choose as exit options.
Mergers & Acquisitions (M&A)
The investor may decide to sell the portfolio company to another company in the market. In essence, it entails one company combining with another, either by acquiring it (or part of it) or by being acquired (in whole or in part).
Initial Public Offering (IPO)
IPO refers to the event where a startup lists on the stock market for the first time. Since the public listing process is elaborate and replete with statutory formalities, it is generally undertaken by startups with an impressive track record of profits and who are growing at a steady pace.
Last year, 8 Indian startups went public, including, Paytm, Zomato, Policybazaar, NYKAA and CarTrade.
Investors may sell their equity or shares to other venture capital or private equity firms.
Founders of the startup may also buy back their shares from the fund/investors if they have liquid assets to make the purchase and wish to regain control of their company.
Some Quick Ways To Raise Money For Your Business
There are a few more ways to raise funds for your business. However, these might not work for everyone.
Product Pre-sale: Selling your products before they launch is an often-overlooked and highly effective way to raise the money needed for financing your business. Remember how Apple & Samsung start pre-orders of their products well ahead of the official launch? It is a great way to improve cash flow and prepare yourself for consumer demand.
Selling Assets: This might sound like a tough step to take, but it can help you meet your short-term fund requirements. Once you overcome the crisis situation, you can again buy back the assets.
Credit Cards: Business credit cards are among the most readily available ways to finance a startup and can be a quick way to get instant money. If you are a new business and don’t have sufficient money, you can use a credit card and keep paying the minimum payment. However, keep in mind that the interest rates and costs on the cards can build very quickly, and carrying that debt can be detrimental to a business owner’s credit.
If you need legal assistance for your startup, contact us.