As each start-up travels through its unique and exciting journey from an idea to first funding, it faces the same question asked of start-ups across the globe: Where will the funding come from now?
The answers differ widely depending on whether you are looking for seed, inflection or growth capital. One could zero down on the answer by asking these three questions at each life stage of the company: Who should I go to for the funding at this point? Why will this investor fund me? What will they look for in return?
Seed capital: This is when you have an idea that you are convinced has potential, which with the right effort can grow to a Rs.100 crore business in five years.
•Who? The first ports of call are the extremely reliable sources: self-funding, friends and family. Another growing avenue are incubators and accelerators, who might also bring in an anchor investor.
•Why? The investor is backing the promoter team and their conviction that this idea will work. Friends and family will invest because they want you to succeed, an accelerator or anchor investor will invest because they believe you will succeed. The accelerator and the anchor investor will also get involved through industry or product expertise and access to potential customers.
•What? Friends and family are the most generous of investors; they are not looking for discussions on valuation and equity stake. The accelerator or anchor investor is looking for higher returns than the next level investor for the risk taken at the ideation stage. As a rule of thumb, sweat equity for the promoter team would be around 25-40% percent, with rest equity divided between the promoter and the investors.
Inflection capital: The company has its first paying customer in and is now looking to acquire the first 10-100-1,000-10,000 customers depending on the type of
•Who? You would look at either angel networks and smaller venture-capital funds ($100,000 to $1 million) or larger VC funds ($2-3 million).
•Why? Investors still betting on the team (never ceases to be important). In addition, they evaluate the business potential through testimonials of the paying customers. They get involved in the business to help the company to get its first few clients in through their network
•What? Angel networks and early stage VC firms are looking to fund the inflection point so that they are a part of the deal when the larger round of funding comes from the next investor. Typically, the investors would look at equity stake of between 10-30% of the company at this stage
Growth capital: So you have proven your business model, have the first 100 or 10,000 customers in, and are now ready to invest for growth.
•Who? Both strategic investors and larger VC funds. The amount you are looking to raise is upwards of $3-4 million.
•Why? Still the team. Also, the investor is convinced that the business has traction and the ability to scale with the right systems and funding in place. VC funds will work with the team to hire the right people and also put their network to use as needed
•What? Investors are looking for a definite period of exit either through a strategic sale or to a larger fund at healthy valuations. Typical equity stakes at this stage would be around 10-20%
The one key thought I want to leave you with is this: Delay raising external funding as much as possible. Instead build a business that investors compete to be a part of.
Nandini Mansinghka is an angel investor.