Common securities – How do companies fund their operations?

Deciding on how to finance their operations is a typical conundrum for startup businesses. The type of security an organization offers in exchange for the money it receives directly affects its cash flow, ownership structure, and legal duties. Therefore, businesses must carefully and strategically pick from different fundraising ideas and each form of security.

Bootstrapping is the inception of everything. As a startup grows, it needs money for manufacturing, marketing, and operations. Founders look for a seed investment from angel investors, then move on to venture capitalists, and finally launch an initial public offering (IPO), depending on the stage of the firm.

Government grants, debt financing, and equity financing are the three major sources of fundraising for startups. However, hybrid financing has also been gaining much popularity lately, and startups are increasingly raising capital using warrants and convertible debts. Each of these fundraising options has its own advantages and disadvantages. 

In this blog, we will talk about some common fundraising ideas for private limited companies, their advantages and downsides:

Ways of Funding Startup Operations

Bootstrapping

Bootstrapping has always been a source of investment for companies in India. Raising money from friends and family is amongst the most common ways of funding your operations, especially if the business is at the prototype or pre-seed stage. Compared to angel investors, family and friends are more patient and offer firms more time, money, and resources to expand their enterprises.

Angel Investors

Individual investors or a group of wealthy people with extensive experience who are focused on financing startups in exchange for their equity. These investors have surplus money that they use their own net worth for funding startups. Most of them have gone through the process of launching a firm and are seasoned business owners. 

They are aware of the potential risks and the pain points. Before investing, they investigate the business, do their homework, and attend the pitch prepared by the founders. Once they are convinced, they agree to provide the money in exchange for convertible debt or equity in the firm.

Venture Capital Funds

Another prominent way of fundraising for startups is through venture capital funds. Venture capital funds are pooled from private investors who provide funding in exchange for equity stakes in startups and SMEs. Since venture capitalists are a type of institution, they give huge sums of money to small and medium-sized businesses so they may grow and expand while keeping an eye on their performance to ensure their investment leads to sustainable growth.

Startups give stock or equity-linked securities to venture capital firms in exchange for investment. When the business goes public or is bought, they leave.

Family Businesses

Family offices are a new source of investment for companies in India. Family enterprises that pass on their fortune to the following generation have a history in India.

When choosing a family business, choosing the correct family office to contact is vital. More than 140 family offices in India have made significant investments in the Indian startup scene. According to research by Praxis Global Alliance and 256 Network, they have been actively participating in 50+ agreements every year since 2015. According to the research, Indian Family Offices would contribute 30% of the $100 billion that Indian companies are predicted to raise by 2025.

Debt Financing 

When companies borrow funds or issue debentures, it is generally referred to as debt financing. Since creditworthiness is the primary factor when raising debt, only firms with a good financial record can raise funds using debt.

When a firm is growing and requires working money, bank loans or stock are not a good funding alternative. Most startups prefer debt because it allows them to raise funds without dilution, and the investors, get a fixed return on their investments, as debts for them are more secure than equity. The holders of the debentures are the company’s creditors, and the firm is expected to pay them the principal amount along with the predefined rate. Debenture holders are also given priority in repayment when the firm goes into liquidation. Some other examples of debt are non-convertible debentures and redeemable preference shares.

Accelerators and Incubators

Incubators and accelerators are essentially preparatory schools for businesses, whereas all of the aforementioned startup funding alternatives are for currently operating firms. These programmes, which last between four and eight months, give entrepreneurs access to cash as well as a network of mentors, investors, and firms.

Typically located in large cities, accelerators and incubators accept an ownership investment in exchange for the programme. These programmes are either managed by independent organisations or are a component of big businesses or technological giants.

Government Grants and Funds 

When the Indian government introduced the “Startup India” initiative in 2016, startup funding in India expanded beyond angel investors and venture capitalists. Startups enrolled in the programme are eligible for benefits such as an 80% reimbursement on patent expenses and a three-year income tax exemption.

The Small Industries Development Bank of India (SIDBI) made raising capital easy for startups. The government organises different fundraising events where startups can raise money as loans. DPIIT also recently created a Startup India Seed Fund Scheme (SISFS) that has an outlay of INR 945 Crore and allows raising capital for business for Proof of Concept, prototype development, product trials, market-entry, and commercialisation.

Crowdfunding

Crowdfunding which was initially used as a fundraising idea for non-profits is now increasingly used by startups for raising capital. It has become an additional, less well-liked method of fundraising in which a group of retail investors seek alternative investment opportunities on a fundraising site/platform. They congregate, peruse the business plan, and invest in their chosen company. It involves each investor contributing a certain amount to a business concept to receive a better interest rate.

When raising capital for business through crowdfunding, one must be cautious as crowdfunding is prone to scandals and con artists. Unregistered digital fundraising sites/platforms are discouraged by SEBI.

Hybrid Securities

When startups raise funds using securities that have the features of both debt and equity, such securities are commonly referred to as hybrid securities. In the current times, most investors prefer preference shares over equity, as preference shares are placed ahead for repayment at the time of liquidation. Other examples of hybrid securities are convertible notes and warrants, which give investors the right to convert their investments into equity at the occurrence of a triggering event.

Conclusion

When fundraising for startups, consider keeping a balance between debt and equity, as raising more equity will lead to ownership dilution, while raising more debt will make the business riskier for investors. Talking about the most common sources of fundraising, equity is undoubtedly the most common source for listed companies, followed closely by venture capital and debts, mostly used by unlisted private companies and startups. When raising funds for startups, companies must carefully consider how raising different securities will affect their cap table before proceeding with the fundraising process.