Stages of Startups and Source of Funding

INTRODUCTION

There are multiple sources of funding available for startups. However, the source of funding should typically match the stage of operations of the startup. Please note that raising funds from external sources is a time-consuming process and can easily take over 6 months to convert.

1. IDEATION

This is the stage where the entrepreneur has an idea and is working on bringing it to life. At this stage, the amount of funds needed is usually small. Additionally, at the initial stage in the startup lifecycle, there are very limited and mostly informal channels available for raising funds.

Pre-Seed Stage

(a) Bootstrapping/Self-financing:

Bootstrapping a startup means growing the business with little or no venture capital or outside investment. It means 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.

(b) 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

(c) Business Plan/Pitching Events

This is the prize money/grants/financial benefits that are provided by institutes or organizations that conduct business plan competitions and challenges. Even 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.

The ideation phase is about laying the foundation for future growth. Carefully selecting the appropriate funding sources, entrepreneurs can set their startups on a path to success while maintaining the flexibility to pivot and adapt as their business evolves.

2. VALIDATION

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.

Seed Stage

A startup will need to conduct field trials, test the product on a few potential customers, onboard mentors, and build a formal team for which it can explore the following funding sources:

(a) Incubators:

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 (office space, utilities, admin & legal assistance, etc.), they often also make grants/debt/equity investmentsYou can refer to the list of incubators here.

(b) 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. A list of government schemes can be found here.

(c) Angel Investors

Angel investors are individuals who invest their money into high-potential startups in return for equity. Reach out to angel networks such as Indian Angel Network, Mumbai Angels, Lead Angels, Chennai Angels, etc., or relevant industrialists for this. You can connect with investors by the Network Page.

(d) Crowdfunding

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.

3. EARLY TRACTION

At the Early Traction stage startup’s products or services have been launched in the market. Key performance indicators such as customer base, revenue, app downloads, etc. become important at this stage.

Series A Stage

Funds are raised at this stage to further grow the user base, product offerings, expand to new geographies, etc. Common funding sources utilized by startups in this stage are:

(a) 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.

(b) 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.

(c) 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.

4. SCALING

At this stage, the startup is experiencing a fast rate of market growth and increasing revenues.

Series B, C, D & E

Common funding sources utilized by startups in this stage are:

(a) Venture Capital Funds

VC funds with larger ticket sizes in their investment thesis provide funding for late-stage startups. 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.

(b) 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

(a) Mergers & Acquisitions

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).

(b) 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.

(c) Secondary Market Sales

Investors may choose to sell their shares in the secondary market, where private equity or venture capital firms often buy out existing stakes. This can be an attractive option for investors looking to exit without a full acquisition or public offering.

(d) Management Buyouts (MBOs)

In a management buyout, the startup’s management team or founders buy the majority of the company’s shares, gaining control from the current investors. This can be a favorable option when the management team has a clear vision for the company’s future and wishes to steer it without external influence.

(e) Share Buybacks

A share buyback allows the company to purchase its own shares from shareholders. This can increase the value of remaining shares, provide an exit for investors, and offer tax advantages.

key factors to consider when seeking funding for a startup

When seeking funding for a startup, there are several key factors to consider to maximize the chances of success:

  1. Clear Business Plan: Develop a comprehensive business plan that outlines the startup’s mission, target market, unique value proposition, revenue model, and growth strategy. A well-defined business plan demonstrates a clear vision and potential for success, which is crucial for attracting investors.
  2. Market Research and Validation: Conduct thorough market research to understand the industry landscape, target audience, and competition. Validate the startup’s product or service offering to ensure that there is a genuine need in the market.
  3. Financial Projections: Prepare detailed financial projections that include revenue forecasts, expenses, and a clear path to profitability. Investors need to see the startup’s potential for generating returns on their investment.
  4. Strong Team: Build a talented and experienced team with the skills necessary to execute the business plan effectively. A strong team adds credibility and mitigates the perceived risk for potential investors.
  5. Unique Value Proposition: Clearly articulate the startup’s unique value proposition and how it differentiates from competitors. Investors seek startups that offer innovative solutions to existing problems.
  6. Scalability: Demonstrate the scalability of the business model. Investors are interested in startups with the potential for significant growth and expansion.
  7. Milestones Achieved: Highlight any significant milestones achieved, such as successful product development, initial sales, partnerships, or traction in the market. This demonstrates progress and reduces perceived risk.
  8. Legal and Regulatory Compliance: Ensure that the startup complies with all legal and regulatory requirements. This includes intellectual property protection, permits, and adherence to industry standards.
  9. Risk Mitigation: Identify and address potential risks associated with the business. A comprehensive risk management strategy shows that the startup is prepared to navigate challenges effectively.
  10. Alignment with Investor’s Objectives: Research potential investors to understand their investment preferences, industry focus, and stage of investment. Tailor the pitch to align with the interests of targeted investors.

These factors collectively contribute to a compelling investment opportunity, increasing the likelihood of securing funding at different stages of a startup’s growth.

  • Bootstrapping refers to self-funding a startup through personal savings or business-generated revenue. Entrepreneurs consider it because it allows them to maintain full control and ownership without the pressure of external investors.

  • Friends and family can provide early-stage funding with flexible terms and an inherent level of trust. This method is accessible and can help entrepreneurs bridge the gap until more formal funding is secured.

  • These events are competitions where entrepreneurs present their business plans to win grants, prize money, or financial benefits. They offer networking opportunities, feedback, and potential funding to support the idea stage of a startup.

  • Incubators support startups by providing more than just capital. They offer mentorship, strategic networking, and essential business services, often becoming long-term partners in the startup’s growth.

  • Government loan schemes like the Startup India Seed Fund provide collateral-free loans to startups, enabling them to access capital without the need for traditional banking collateral.

  • Angel investors are affluent individuals who invest in startups in exchange for equity. They bring capital, industry experience, mentorship, and valuable networks to help startups grow.

  • Crowdfunding involves raising small amounts of money from a large number of people, typically through online platforms. It’s a way to gather community support, validate the market, and fund early-stage development.

  • Startups enter the Early Traction Stage after launching their product in the market. They focus on scaling their user base, refining their offerings, and establishing market presence.

  • During the Scaling Phase, startups can seek larger rounds of funding from venture capital funds and private equity firms. These funds provide capital for significant expansion and operational scaling.

Stages of Startups and Source of Funding