TheRodinhoods

Angel investors, VCs and other funding options for startups

While most entrepreneurs think of VC funding as the most obvious way of funding their startups, there are actually many different ways in which you can fund your startup.

 

Getting risk capital i.e. angel investors or Venture Capitalist – VCs

Angel investors or VCs are investors who give you capital in exchange of equity in the company.

Angels and VCs buy equity in a company for a price and expect to make a profit by selling it at a higher price. Just like it happens in the stock market, but in this case because your company is not listed, VCs make money by privately selling the stock they hold in your company to someone else.  E.g. an angel investor may ‘exit’ by selling his/her stock to a VC and later the VC could exit by selling the stock they hold to either a Private Equity firm or to a strategic investor, or in rare cases by diluting their holding during or post an IPO.

The money that angel investors give is collateral free. I.e. you do not have to mortgage your house or something to get money from angel investors of VCs. In case the company fails, investors lose their capital and entrepreneurs do not have to return the capital. This is the one and only reason why angel investors and VCs will evaluate plans thoroughly before making a decision to invest in a company. In effect, they are taking the following risks about your venture:

Because of this, funds raised from angel investors, VCs and later from Private Equity funds is called ‘Risk Capital’.

While angel investors and VCs provide capital without collaterals, and thus allow you to start up without having your own capital or collaterals for a loan, it is probably the most expensive form of capital. That’s because you are giving away equity in exchange for the capital you raise.

Let us understand this with an example. I am of course, simplifying and exaggerating for easier understanding, but the principle is correct.

Let us assume company A raises INR 10 lacs [i.e. USD 20,000] from an angel investor and gives the angel investor 10% equity in the company. Assume further that this company is able to successfully scale up and is receiving a INR 5 crore [USD 1 mn] funding from a VC for a valuation of INR 20 cr.  [USD 2 mn].  Assume that the angel investor exists at this round by selling his stake to the VC. In this scenario, the VC would get about INR 1.5 cr for his/her share holding in the company. The illustration below gives a sequential view of the capital structure of the company after every event i.e. when the angel invests, when the VC invests and finally when the angel exits by selling his/her stake to the VC.

 

Share holding at starting Phase

Entity

 Investment

 No. of shares

Price per share

% holding

Founder

 1,00,000

 50,000

2

50%

Co-founder

 1,00,000

 50,000

2

50%

Total

 2,00,000

 1,00,000

 

100%

 

Share holding after angel investor invests INR 10 lacs and takes 10% equity

Entity

 Investment

 No. of shares

Price per share

% holding

Founder

 1,00,000

 50,000

2

45%

Co-founder

 1,00,000

 50,000

2

45%

Angel investor

 10,00,000

 11,111

90

10%

Total

 2,00,000

 1,11,111

 

100%

 

Further, a VC invests INR 5 cr and takes 25% of the equity

Entity

 Investment

 No. of shares

Price per share

% holding

Founder

 1,00,000

 50,000

2

34%

Co-founder

 1,00,000

 50,000

2

34%

Angel investor

 10,00,000

 11,111

90

8%

VC

 5,00,00,000

 37,037

1350

25%

Total

 2,00,000

 1,48,148

 

100%

 

If the angel investor sells his/her shares to the VC, then the VC would have paid the angel investor a sum of Rs.150,00,000 i.e. Rs.1.5 cr to buy the angel investors shares in the company. The capital structure of the company would be as below.

Entity

 Investment

 No. of shares

Price per share

% holding

Founder

 1,00,000

 50,000

2

34%

Co-founder

 1,00,000

 50,000

2

34%

Angel investor

 10,00,000

 

 

 

VC

 6,50,00,000

 48,148

1350

33%

Total

 2,00,000

 1,48,148

 

100%

 

  

Bootstrapping

Bootstrapping is the art of going as far as you can without external funding. I.e. pooling together your own resources, usually at a pre-concept stage or at a prototype building stage.

Often, people bootstrap their startup while still keeping their job at some. Whether you should bootstrap or go for external funding is a factor of how much money you need, and for what. I.e. if you are building a solar micro-grid, it is unlikely to be funded through bootstrapping as it is likely to be a capital-intensive business. However, on the other hand, an e-commerce venture can most likely be bootstrapped… often by using SAAS platforms, etc.

When to bootstrap

  

When not to bootstrap

 

Even when you don’t need the capital, it is sometimes good to pitch to investors as it gives you a good feedback on your concept. If many investors say no, it may be worthwhile evaluating the concept and pan thoroughly before diving into the game.

You may want to consider the points below before you take the decision to bootstrap:

 

 

Debt

In other words, taking a loan.

Institutional loans often require a collateral, which many entrepreneurs may not have. Even if you have the collateral, do a real hard evaluation if the business model and concept is fully ready for you to take an individual risk on. Often, getting other external investors gets you more parties to take strategic decisions with, and provides an invaluable group to bounce ideas with.

 

Friends & Family round

For startups which need limited capital to start up, a friends & family round may be an option worth considering.

Points to remember in a friends & family round

  

Get strategic investors

Larger companies for whom your concept is an adjacent or related opportunity may find it interesting to investing as a strategic investor.

Adjacent opportunity – e.g. Educational content platforms could be an adjacent opportunity for a large company in the education space

Related opportunity – e.g. healthcare services for the poor is a related product for a microfinance company

A strategic investor, apart from providing capital, also helps validate the concept for external investors thus making it easier for raising the next round of funding or for getting co-investors in the current round.

 

And, of course without a doubt, bootstrapping your venture with revenues from customers is the best possible funding route for your venture.