Bootstrapping, angel investing or venture capital investments? The one area that invariably puzzles potential entrepreneurs is related to the funding of a venture. In the book Entrepreneurship Simplified: From Idea To IPO, Ashok Soota, founding chairman of information technology firm Happiest Minds Technologies, and S.R. Gopalan, founder of advisory services firms Dawn Consulting and Bizworth India, offer tips for every aspiring entrepreneur, on subjects as varied as idea generation and raising funds. Edited excerpts from the chapter “Funding Your Venture”:
Bootstrapping: Merits and Demerits
The one big argument for bootstrapping (a situation in which an entrepreneur builds a company with personal capital, generally a small amount), even if external investors are available, is when deferring the induction of investors might ensure a significantly higher valuation. However, there are multiple approaches to increasing valuation. In essence, we are mostly in favour of seeking external investors from the start.
The reasons for this approach are multiple. Firstly, good investors not only validate your idea but also help you to modify and adapt it. They also add value in multiple ways, such as adapting your business model, sharing risk and so on.
If the founders do have funds to invest, we see it as preferable to put these in as part of the first round. The external investors will see it as a positive that the founders are putting their own neck on the line. Also, the founders’ money comes in on equal terms with the investors’ money with respect to valuation. In a sense you become your own venture capitalist (VC) with such an approach.
On the other hand, if the founders put in all their investible funds into bootstrapping, there is a big danger that they will run short of cash by the time they are negotiating with VCs. The prospect of dwindling cash and unpaid salaries creates anxieties and may lead to accepting the very first offer which comes the founders’ way.
Angels or VCs?
Prajakt Raut, entrepreneur and entrepreneurship evangelist, sees many advantages (and some disadvantages) in starting with angel investors over VCs. Ashok’s (Soota) view is somewhat different.
Angel investors will typically invest only up to $1 million in your venture and the way cash gets burned while creating a business, you will soon be knocking on the door of VCs anyway. In a majority of cases, the bulk of the organization’s pre-IPO life will be spent with them as your investors. Since every round involves some dilution, you may as well go straight to the VCs if you can get them interested in your venture. Prajakt’s view is that VCs and angel investors give different kinds of advice and that angel investors would be more likely to help you with the “fundamentals of the business at the starting point and guide you through the setting-up stage”. Our view is that a good VC will provide valuable assistance at this stage as well.
What Is the right amount of money to be raised?
We’d like to define a few principles to answer this:
■First, assess the total money you will need before the company reaches cash break even.
■Add to this a sum for acquisitions to be made if these are likely to be part of your strategy.
■The total number you’ll yield from the steps above determines the amount of money you are required to raise till the IPO or whatever exit you plan to make...
■At no time should the venture be left with less than six months’ cash to fund operations. Accordingly, the first round should be adequate for a minimum of two years. Our preference would be three years.