Angel investors, VCs, Bootstrappng 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.

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:

• That you and your co-founders are a great team that is capable of scaling up the business
•  That your concept will work
• That the market is large and therefore there is potential to build a large company

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.

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 your concept is yet to be proven … and can be proven with limited capital
• When you too are unsure if you would like this to be your lifetime career and want to give it a shot
• When you have the resources to go past the concept proof stage

When not to bootstrap
When the capital required for the proof-of-concept stage is more than what you can garner from your current resources

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:

• Evaluate whether your idea has a good business case – speak to some experts, pay attention to those who are not excited about your idea. After all, even if it is not costing you a lot of money, your time invested has a lost opportunity cost.

• Prioritize: to bootstrap efficiently, you need to make your limited resources go far. Take a call on what is critical and what can be put off till you receive adequate capital.

• Keep the expenses side as low as possible. That means having a very, ver lean team. That means hiring multi-taskers rather than specialists.

• Consider SAAS and outsourcing: Even if that is not your most preferred option, you should take a call on what is important. Is getting ‘something’ out in the market more important or getting ‘The most perfect product’ most important? SAAS platforms may not give you the customization possibilities, but often they can shave off a significant percentage of your funding needs. You can always develop your own platforms after you have proven the concept and the model.

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

• Treat the friends & family round as a formal fund raising round too – pitch to the interested investors as you would to a group of angel investors or VCs

• Complete the paper work and other formalities too – issue equity shares

• Manage the relationship as a professional investor relationship – send quarterly reports, have a board, etc.

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. 

How much money should you raise for starting up?

Obviously, this depends on the nature of the business, what is required to be done, your and your team’s capabilities, the competition, etc.

What is essential therefore is to have a realistic estimation of the costs and investments required to reach the milestones.

There is no one 'right or appropriate number' on the investment required as that number would be different not just for different businesses but also would be different for different execution strategies for the same business plan.

In fact, there are startups in the online space which have done excellent progress with some angel investments, while there are others which are scaling up nicely with crores in funding, largely for marketing investments.

Broadly speaking, concepts that have been proven and just need great execution + marketing to build a scale business will need to raise larger capital. Concepts that have yet to be proven in the market place could do with lower levels of funding in the initial stages. This is because you don't need senior employees and huge marketing at pilot or proof-of-concept stages.

Most often entrepreneurs go wrong in estimating funding needs. They are unrealistically conservative on costs, and impractically optimistic about revenues. Underfunding your venture i.e. raising lesser money that is practically required can have serious consequences as you could run out of cash sooner than expected, thus leaving you without capital to continue the venture… or having to rush to raise another round in a distress situation.

One question investors are most likely to ask you is how much money you need in the round that you have approached them for. While most entrepreneurs give a one-figure reply, my preference is for entrepreneurs to provide a perspective of what can be achieved with different levels of funding. E.g. with INR 50 lacs [USD 100,000] you could develop the solution on a SAAS platform, hire a base team, prove the model in one market and prepare the company for scale. However, if you had INR 200 lacs as a commitment, even if the first tranche was the original INR 50 lacs, you could accelerate the hiring and scale up as soon as the key performance indicators were on the right trajectory. On the other hand, if you got just R. 25 lacs [I.e. USD 50,000] you would just develop the product, outsource the online marketing to an aggregator agency, and prove that the concept works.

You need to bear in mind that if you business is successful, you are most likely to need MORE CAPITAL. Most entrepreneurs assume that very quickly their business will be cash positive and that they are not likely to require more capital beyond the first round.

Working on a realistic business plan is therefore critical in determining how much money you are likely to need for your venture. Write to us at info@angelinvestorsconsortium.com for a template of a business plan.

Should startups seek funding from VCs or Angel Investors?

While there is no right or wrong answer to this question, there are a few points you may want to consider:

• Most VCs would not invest less than USD 1 mn. So, if you need lesser than USD 1mn capital, angel investors may be more appropriate.

• Decision-making is much longer for a VC as they have to follow their own processes and internal approvals. It can often take between 30 – 90 days after the VC has broadly agreed to invest. On the other hand, since angels are making investments in their individual capacity, decision making is faster.

• Most VCs are likely to ask for some control over decision-making, and most would certainly ask for board positions. Angels on the other hand may not seek board positions.

• VCs may not be able to participate closely with the operations, while angels who invest because of their interest in the domain may find great joy in assisting you with your daily challenges. Depending how deep your team’s expertise on critical aspects of your business are, you may want to consider whether you want someone who can help you on the operational front or you need someone who is hands off.

• VCs and Angel investors are ‘expected’ to give you different kinds of advice. Angel investors, because of the stage they participate in are expected to help you with the fundamental of the business at the starting point and guide you through the ‘setting up’ stage. They are also expected to help you with advice on what kind of investors to connect with, how to pitch and, often, help with the introductions too. On the other hand, VCs, because they usually participate after the concept is proven, are expected to give entrepreneurs advice on scaling up and of preparing the company for scale, fine-tuning the business model if required. They could also help with introductions, PR and in hiring senior employees.

• Most importantly, VCs usually invest after the concept and team have been proven. I.e. after market validation of the idea and after the team has demonstrated that it can deliver. Angel investors invest at a paper/power-point stage and give just enough money to prove the concept.

So, when seeking investments, evaluate what your needs are and what your situation is and then decide if you want to approach VCs or angel investors.