A common statistic that has come to a consensus with numerous consultancy agencies is that 90% of all startups fail in the first five years. Numerous reasons can be attributed to their failure, like lack of market research, wrong product fit, and poor marketing of said product, are the most commonly cited. Another overlooked factor is the exhaustion of capital. While financing is apparent and crosses the mind of every entrepreneur, traditional financers like banks are unwilling to invest vast sums in unknown companies with little to no credit history.
Although there are popular proven options like debt financing and equity financing, this requires your startup to have a solid foundation for the aforementioned parties to have faith in your idea/product to park their money in. There are other relatively non-mainstream means to finance the businesses, which will aid the entrepreneur in the initial phases, some of which were used by currently thriving startups in their starting days.
"Startups across all regions have a lot of homework to do in today’s dynamic business landscape in terms of attracting venture capital," Ahmed Nasser, Founder & CEO of Annex Investments.
Bootstrapping is a highly recommended approach for entrepreneurs. It drives the business to grow in an organic way without the dominant arm of the investor directing the trajectory of the company. According to research by the National Bureau of Economic Research (NBER), over 82% of startups are initially funded by the founder's personal resources, making bootstrapping one of the most popular methods to get a business off the ground.
This method of financing enables the business owner to cultivate disciplined financial habits with an eye on every rupee that is entering and leaving the company. The cost-conscious culture that is being developed is also an addendum. The emphasis on cashflow management from the outset is a key reason companies like the Kamath brothers' Zerodha and Sridhar Vembu’s ZOHO retained their founding values and became successful.
Despite its advantages, bootstrapping requires the company to reinvest all the revenue generated right back into the company, leaving the founders unable to taste the fruit of their success. It requires a lot of patience and time.
Revenue based financing(RBF) is a relatively safer option which keeps the company’s account books away from debt. While traditional repayments demand fixed monthly payments irrespective of the profits/loss the company is facing. RBF allows startups to negotiate a percentage of the income generated, which means lower repayments in lean months and higher ones during periods of explosive growth. This option is relatively safer for the lender and recipient as both of them do not have to face the element of uncertainty.
This flexible nature of RBF can be a lifeline for startups that experience fluctuating income, particularly in industries with seasonal demand. According to a report by the Alternative Finance Industry Survey, revenue-based financing has grown by over 40% year-on-year in recent years, signaling its growing appeal to startups. In 2022 alone, U.S. companies raised approximately $2 billion through RBF, primarily driven by the desire for non-dilutive capital that allows founders to maintain control over their businesses.
Klub, an Indian fintech company, has emerged as a leading platform offering RBF to early-stage and growth-stage companies. It provides capital to companies in exchange for a percentage of future revenues, which helps founders scale without equity dilution.
Convertible notes at their core are debt instruments. When investors give money to a startup, they are effectively lending funds, which the company is obligated to repay, usually with interest. However, unlike traditional debt, the goal of a convertible note is not for the company to repay the loan with cash. Instead, the note “converts” into equity (ownership shares) in the company, usually at a discount or with specific incentives for early investors, at a future date.
One of the main reasons startups choose convertible notes is to delay setting a valuation. Valuing a company in its early stages is challenging, as there might be limited traction or revenue. This instrument allows startups to raise funds without undergoing the valuation process until they are more established and can secure a higher valuation.
Flipkart, during its early rounds of fundraising, used convertible notes to secure funding from early investors. This helped them delay valuation negotiations until the company had gained more traction, which in turn allowed them to command a much higher valuation in future rounds.
For entrepreneurs, selecting the right financing strategy is critical for success. Bootstrapping can help maintain control and instill financial discipline, while debt financing allows for manageable growth without diluting ownership. Equity financing provides access to capital and expertise, although it requires careful consideration of investor relationships and potential ownership dilution. By understanding and implementing these proven financial strategies, entrepreneurs can navigate the challenges of business finance, balancing short-term needs with long-term growth potential.
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