This article has been written by  Kartik H. Shah, pursuing a Diploma in contract drafting with LS. from Lawsikho.com. 

 

During the lifespan of any business, the promoter will have to find ways to fund it, to create liquidity in order to expand, and in many cases, just sustain the business. Therefore, the planning of business funding is of paramount importance to the success of the business. There are several legal ways to raise money for a business, but the avenue to pursue depends upon the stage the business is at. This article gives an overview of the many sources of funding for a business. 

Self-funding

Also known as bootstrapping, investing personal savings into the business is the way many business owners decide to begin. Usually, first-time businessmen are unable to get funding without showing proof of some success and momentum in the business.

Another way you can fund your business easily is by asking friends and family to invest. This would be easier than some of the other options below as this would require fewer formalities and lesser costs. A lot of times, interest rate is something that only family and friends would be flexible with.

Your personal investment in your dream business is one of the many things future investors will take into consideration before they buy in, so self-funding should be considered the first step to funding a business.

Business Loan Schemes from the Government 

Government Business Loan Schemes have low interest rates and flexible repayment plans, because they are designed for a specific purpose, i.e. promoting micro, small and medium enterprises’ business within the country. Having recognized the importance of small and medium enterprises (SMEs) in India, the Government has decided to boost existing business loan schemes and even start new ones.

These schemes are basically categorised into three categories according to their uses. First, a Working Capital Loan is used to provide businesses with working capital, which is the type of capital that helps businesses run their day to day activities and pay for business expenses like operations, salaries and utility bills.

Second, Corporate Term Loans, which are used for the purpose of expanding a business. The money lent in Corporate Term Loans are of large amounts and are expected to be repaid over longer durations of time, with a negotiable interest rate.

Third, Term Loans, which are expected to be repaid within a specific period of time, may enable the business to buy property, raw materials, or for hiring new staff. 

A few of the top business loan schemes from the Government of India are listed below:

Micro-units Development and Refinance Agency (MUDRA): It is an organisation set up by the Government of India to provide microfinance to SMEs, for providing low-cost credit to small companies and start-ups, who are often refused loans from banks. MUDRA loans are provided in the following 3 categories: 

i. Shishu Loans, which are up to INR 50,000/-

ii. Kishor Loans, which are up to INR 5,00,000/-

iii. Tarun Loans, which are up to INR 10,00,000/-

1. Credit Guarantee Fund Scheme for Micro and Small Enterprises (CGMSE) was started in the year 2000, which provides a collateral-free credit system for new and existing businesses which fall under its eligibility criteria.
   The scheme provides working capital loans without any collateral of up to INR 10,00,000/-. The loans under this scheme are financed by several public and private sector banks covered under the scheme.
2. National Small Industries Corporation Subsidy (NSIC subsidy) offers two beneficial options for small businesses:

i. Raw material assistance, which covers both indigenous and imported raw materials.

ii. Marketing assistance, which covers funds to enhance the SME’s competitiveness and increase its products’ market value.

The NSIC subsidy is for small and medium businesses who want to improve the quality and/or quantity of manufacturing. 

Bank Loans

Although banks are usually the first place business owners go when they think about funding, banks can often be very reluctant to lend to businesses unless they can prove traction and potential success of the business in the market. The procedure of getting a loan approved by the bank would generally involve sharing the business plan, project report, valuation and other details based on which its officers make a decision. Banks may even require some sort of guarantee or security before they sanction a business loan.

Interest rates for business loans in India range from 11.15% to 22% per annum, and some banks even charge an additional processing fee of around 1% to 2.5%. In the long run, this may prove to be a rather expensive way of funding your business, but we must also keep in mind that most large businesses have rather large debts.

Competition Prizes

Several businesses and start-ups alike raise funds by winning prize money in business pitch competitions and presentations. A drastic hike in the number of competitions has tremendously helped to increase the opportunities for businesses to raise funds. Such competitions either involve building a product or presenting a business plan. In order to improve his chances in a certain such competition, a business owner must make his business stand out. He may pitch a business plan, or present an idea, but he must ensure that it is comprehensive enough to convince people that his business is well-worth investing in. An advantage to raising funds by winning a contest could often be that along with funds, the promoter gets a platform to present his business to potential investors, so he can kill two birds with one stone.

Some of the most popular business competitions and contests are:

– Next Big Idea, which is organised by Intel, DST, NSRCL & IIMB. This contest is aimed at students and entrepreneurs whose businesses are focusing on biotechnology, education, electronics & communication, energy, environment & clean technology, health and biomedical devices and other related fields. For more information on this contest, click here.

– Proto, is a business idea competition aimed at entrepreneurs with all innovative ideas from any industry.

– Champion of Champions: A technology business competition, it welcomes incubates and companies with non-venture capital financing.

Start-up Incubators

Someone running a start-up knows the importance of infrastructure, seed funding, mentoring and training. Incubators help start-ups solve the problems commonly associated with running a start-up business at an early stage. The start-up funding ecosystem is a lot more developed now due to the presence of incubators such as SINE, Seedfarm, Startup Village, etc., who provide start-ups with training, infrastructure, mentoring, networking opportunities (with potential investors and customers), assistance with financial management and marketing assistance.

Oftentimes, it so happens that the entrepreneur wants to perfect his product and build better versions of it without testing it in the open market. Incubators provide entrepreneurs with guidance on the business side of running a start-up, like making sales and in turn, providing revenue to the company. Sometimes incubators are also known to provide access to angel investor networks and venture capital.

Angel Investors

Angel Investors are individuals who have surplus liquidity, which they would like to invest into upcoming businesses. Many of them work in networks in order to collectively assess businesses before investing. They can also offer business advice and mentorship along with injecting capital into the business.

Well known businesses like Unacademy, Cred, Urban Clap and Inshorts have been funded and supported by angel investors.

Usually, angel investors invest lesser amounts than venture capitalists. Some of the largest angel investor networks are Mumbai Angels, Indian Angel Network and Keiretsu Forum, which has chapters across all major cities in India and across the world. It also has a mentoring program for business owners on strategy, finance, marketing, regulatory matters and valuation.

Venture Capital Fund (VCF)

A venture capital fund is a fund managed by professionals. They invest in a portfolio of companies which have huge potential. Usually VCFs invest in a business by buying equity and exit when there is an acquisition or an IPO. They act as mentors, providing the expertise of business and evaluate its sustainability and scalability.

Small businesses who want to expand, and have passed the start-up phase, already generating revenue are the targets for most VCFs. Venture capital funds would be more interested in a fast-growing company like Zomato or PayTM so they could gain exponential returns to invest and grow quickly.

Although venture capital as a funding option does have its advantages, it also has a few disadvantages. Venture capital funds are generally unwilling to remain part of the company for more than three to five years. They look to recover their investment plus returns within this window of time. VCFs may not be too interested in a business if it has a product that is going to take longer to develop and get to market.

They generally look at stable, larger companies who already have a momentum going. A promoter must be flexible with venture capital funds and may have to give up more control of the business as well, so for a promoter who feels he is comfortable enough without mentorship or is not willing to make a compromise in the control he has over his business, venture capital may not be the best option.

Family Offices

Family offices are private wealth management teams of Ultra High Net-worth (UHNW) Investors and, as the name suggests, their families. In recent times, there has been increasing evidence of family offices investing directly in start-ups and other businesses, rather than just investing in a Venture Capital fund. Family offices usually prefer to invest in the fields of education, information technology, financial technology and health technology, among others.

Bezos Expeditions is the family office of Amazon founder Jeff Bezos. It makes investments in seed, early and late stage businesses across a wide range of networks.

An Indian example would be the family office of Uday Kotak, the Managing Director of Kotak Mahindra Bank and the eighth richest man in the country, who announced in 2018 that he was setting up a family office to invest his $10.3 billion fortune.

Crowdfunding

One of the newer, more popular ways of funding a business, crowdfunding is like taking a loan, investment, pre-order or contribution from more than one individual simultaneously.

How does it work?

After putting up detailed descriptions of his business onto the crowdfunding platform, the entrepreneur or promoter will provide information on the amount of funding needed and for what reasons, the objective of the business and the plans for making a profit. The consumers then read it and contribute if the idea appeals to them. Anyone can contribute to a business they believe in on a crowdfunding platform by pledging to make a purchase once the product is launched or by donating a certain sum of money.

One of the great advantages of crowdfunding is that most of the time, marketing is taken care of along with finance, and that interest in the product is maintained in the market until the product is launched. It is a great way to find out if the product has an actual and sustainable demand in the market before larger chunks of money are pumped into its development. Although it might attract venture capitalists’ attention further down the road if the campaign gains success, crowdfunding puts the funding into the hands of common people, rather than hand over any amount of control to venture capitalists.

The crowdfunding space can get competitive to say the least, so a promoter must make sure his business idea is rock solid and can attract the attention of the common man with business details and some presentations.

A few popular international crowdfunding websites are Kickstarter, GoFundMe and RocketHub. In India, the popular crowdfunding platforms are Indiegogo, Ketto and Catapooolt.

Private Equity Funds

Private equity fund is basically a general term defining a pool of money from several investors to gather several millions, and sometimes billions of dollars, which are used to purchase equity in companies.

While technically venture capital is private equity too, it can be differentiated in the following way:

Venture capital usually invests in unproven, younger companies, whereas private equity funds are more attracted toward experienced and market-proven businesses. Private equity may be the way to go if the original investors are looking for an opportunity to get some returns on their investment, or if the business requires some infusion of liquidity. Private equity funds will provide the business with new ideas and new people who might approach it from a different angle.

On the other hand, younger companies don’t always fit in very well with private equity investment strategies. A business owner may also feel that private equity funds are a bit ruthless when it comes to workforce, role of founding promoters and sentimentality, as they would have a purely profit-oriented approach. Their primary goal would be to enable the company to be valued a lot higher than before so that they can turn a profit.

A brand new type of private equity has been seen in recent times, where investors contribute a smaller sum towards a would-be entrepreneur who then looks for the best business to acquire and run. Once he has finalised on this, the investors write the big cheques that are required to acquire the business. This type of private equity is known as a search fund and could work as a boon for a business which not only needs some cash inflow but also a new executive at the top to take the business in a successful direction.

Buyout

A buyout can be defined as the acquisition of the controlling interest in a company. It often takes place when the purchaser believes that the company or business is undervalued and has the potential to be bigger success.

Usually, the purchaser takes on the debt of the company or borrows money in order to purchase it. He then uses the assets and cashflow of the subject company to repay the loan. This is known as a leveraged buyout.

Some well-known examples of successful leveraged buyouts in India are:

• Tetley, a UK based company was bought out by Tata Tea for a sum of $271 million.
• American Axle, an American motor company was bought out by Tata Motors for $2 billion.
• Hansen Transmissions, from the Netherlands was bought out by Suzlon Energy for $465 million.

It should be noted that a leveraged buyout of Indian companies must comply with legal and regulatory framework in India. Due to the strict restriction of RBI on lending and the stringent laws imposed by Government of India as well as Ministry of Finance regulations, an LBO is not considered a feasible option for companies. It is important to study market conditions, industry and company-specific characteristics before implementing a leveraged buyout.

IPO (Initial Public Offering)

When a company goes public with an IPO, it receives money from investors and in return gives them a share of the company. Issuing public shares allows a private company to raise money from the public. The Dutch are given credit for conducting the first modern IPO, when they offered shares of the Dutch East India Company to the general public. Ever since, IPOs have been used as a means for a company to raise capital from the public in return for a share of the company, thus receiving the inflow of cash.

When a company reaches the phase in its growth where it is believed to be strong enough to handle the meticulousness of SEBI regulations along with responsibilities to public shareholders, it starts announcing its interest to go public. If the company meets the eligibility criteria of SEBI, they begin the IPO procedure.

In conclusion, it should be noted that funding a business is one of the primary responsibilities of the promoter. If the business is well funded, it will most probably grow faster. It will satisfy creditors, make customers happy and keep employees motivated. On the other hand, an under-satisfactorily funded company will constantly face difficulty in finances and in turn, operations. Therefore, it is imperative for a promoter to consider which type of funding he should go for based on the stage his business is in.