With a vast range of options for funding available today, the selection of a suitable source is quite tricky for founders. With a detailed, compelling pitch, they can ride the tide
In India, start-ups are growing at an astounding rate with a record fund raising of $3.9 billion for the first six months of 2019. Last year, they clocked more than 100 per cent growth with funding doubling from $2 billion to $4.2 billion, from 2017 to 2018, according to NASSCOM. The country is on its way to becoming a startup hub with more than 1,200 new businesses coming into existence in 2018, including eight unicorns, thus taking the total number to 7,200 start-ups last year. When compared to the first six months, investments this year across 292 deals saw a 44.4 per cent jump from the $2.7 billion received by domestic start-ups in the first half of 2018, according to Venture Intelligence.
Private funding through private markets like equity, venture capital and angel investing, is the reason for this phenomenal growth of start-ups in India. In the past, private firms often went public when their need for capital exceeded what investors could provide. However, in the last decade, firms have found a good alternative in private markets. This because of two reasons. First, drawn by the potential of high returns, more investors have entered the space, thus creating an influx of available capital. This has in turn altered the trajectory of private companies because they are no longer forced to raise capital on public markets. Second, as more investors pour money into private markets, it has now become easier for new private companies to get funding needed for growth. As a result, there has been a sharp influx in the number of Venture capital (VC)-backed startups and PE-backed companies in recent years. In other words, as more money flows into this space and as more firms stay within, private markets will continue to grow in value and opportunity.
Even though the private funding market is booming, it is not easy for start-ups to raise funds. They require several things — capital, strategic assistance and introduction to potential customers, partners and employees among other things. Entrepreneurs will be better prepared to obtain funding if among other things, they understand the basic difference between distinctive type of private funding available. VC is the finance that investors provide to start-up companies and small businesses. These are believed to have long-term growth potential and can be provided at different stages of the companies evolution. VC generally comes from well-off investors, investment banks and any other financial institutions. However, it does not always take a monetary form; it can also be provided in the form of technical or managerial expertise. It is basically a subset of Private Equity (PE), which focusses on emerging firms seeking substantial funds for the first time. PE tends to fund larger and more established firms that seek an equity infusion or a chance for company founders to transfer some of their ownership stakes. Apart from the stage of investment, PE firms make investments in a few companies only and provide funds to matured firms that have a good record while VC firms make their investments in a large number of small companies, who may not necessarily have the desired track record.
Third, PE investment can be made in any industry as opposed to VC in which investment is made in high growth potential industries like energy conservation, biomedical, quality upgradation, information technology and so on. Fourth, the risk profile in VC is comparatively higher than PE. Lastly, the use of funds is different in both cases. In PE, funds are utilised in financial or operational restructuring of the vendee company. On the other hand, VC funds are utilised in streamlining business operations by way of developing and launching new products or services.
While the roots of PE can be traced back to the 19th century, the birth place of VC was in the US. It developed as an industry only after the Second World War. Georges Doriot, Harvard Business School professor, is generally considered to be the “Father of VC”, who raised $3.5 million fund to invest in firms that commercialised technologies developed during WWII. ARDC’s first investment was in a company that had ambitions to use X-ray technology for cancer treatment. The $200,000 that Doriot invested turned into $1.8 million when the firm went public in 1955. In a VC deal, large ownership chunks of a firm are created and sold to a few investors through independent partnerships that are established by VC firms. Sometimes these partnerships consist of a pool of several similar enterprises.
Another important way of raising funds, particularly for small business and companies in emerging industries, is through angel investors, which is typically a diverse group of individuals, who have amassed their wealth through a variety of sources. However, they tend to be entrepreneurs themselves or executives recently retired from the business empires built by them. Self-made investors providing VC typically share several key characteristics. The majority look to invest in companies that are well-managed, have a fully-developed business plan and are poised for substantial growth. These investors are also likely to offer to fund ventures that are involved in the same or similar industries or business sectors with which they are familiar. If they haven’t actually worked in that field, they might have had academic training in it. Another common occurrence among angel investors is co-investing where one angel investor funds a venture alongside a trusted friend or associate, often another angel investor.
Although angel investors and venture capitalists have a number of similarities like catering to innovative start-up businesses, there are also a number of differences between them. First, an angel investor works alone. Venture capitalists are part of a company. Angels are rich, often influential individuals, who choose to invest in high-potential companies in exchange for an equity stake. Given that they are investing their own money and there is always an inherent risk, it’s highly unlikely that an angel will invest in a business owner who isn’t willing to give away a part of their company. Venture capital firms, on the other hand, comprise a group of professional investors. Their capital comes from individuals, corporations, pension funds and foundations. These investors are known as limited partners. General partners, on the other hand, are those, who work closely with founders or entrepreneurs; they are responsible for managing the fund and ensuring that the company is developing in a healthy way.
Second, they invest different amounts. While angel investing is relatively limited in its financial capacity, this mode of investing can’t always finance the full capital requirements of a business. Venture capitalists, on the other hand, can raise large amounts of fund.
Third, they have different responsibilities and motivations. Angel investors are primarily there to offer financial support. While they might provide advice if asked for or introduce to important contacts, they are not obliged to do so. Their level of involvement depends on the wishes of the company and the angel’s own inclinations. A venture capitalist looks for a strong product or service that holds strong competitive advantage, a talented management team and a wide potential market. Once venture capitalists are convinced and have invested, it is then their role to help build successful companies, which is where they add real value. Among other areas, a venture capitalist will help establish a strategy and recruit senior management. He/she will be on hand to advise and act as a sounding board for CEOs. This is all with the aim of helping a company make more money and become more successful.
Fourth, angel investors only park funds in early-stage companies. They specialise in early-stage businesses, funding the late-stage technical development and early market entry. The funds an angel investor provides can make all the difference when it comes to getting a company up and running. Venture capitalists, on the other hand, invest in early-stage companies and more developed firms, depending on the focus of the venture capital firm. If a start-up shows compelling promise and a lot of growth potential, a venture capitalist will be keen to invest.
A venture capitalist will also be eager to invest in a business with a proven track record that can demonstrate it has what it takes to succeed. The venture capitalist then offers funding to allow for rapid development and growth. Lastly, they differ in due diligence. Venture capitalists focus more on due diligence. These are some of the differences between PE, venture capital and angel investors and the decision of which to approach is personal. To improve the odds of securing investment and appealing to an investor, a start-up company should take the time and consideration to create a detailed, compelling pitch. With sufficient luck, it can end up with the financial and entrepreneurial support to skyrocket its business.
(The writer is Assistant Professor at Amity University)
Writer: Hima kota