4 ways of sourcing funds for SME owners
Business segment covered by SMEs in India are on growth trajectory coupled with globalization of Indian Economy. Let’s analyse the potential sources of funding under various category –
Equity funding : In India apart from traditional funding avenues from friends and close associates, there is growing trend in terms of institutionalization of this funding sources. At present one can source funding via Angel investors – either HNIs individually or wealth management business family set-ups or angel groups like Mumbai angels, IAN ( Indian angel network), etc. Lot of city based HNIs are now forming angel groups to fund the local entrepreneurs and SME business set-ups.
There are number of Venture Capital (VC) funds in India as well apart from Private Equity (PE) funds which funds slightly with higher ticket size. Following table best illustrate the business type funding scenario in terms of equity options –
|Business segment||Type of Investor||Funding amount ticket size|
|Start-ups/Early stage||Angels/HNI’s/Family set-ups||Up to INR 5 cr.|
|Early stage growth with proven market product/services||VC Funds + PE funds or in isolation||From INR 5 cr. Onwards to INR 50 cr.|
|Hyper growth venture to establish SME business owners||Private Equity Funds||Upward of INR 10 cr. Plus onwards|
In addition to this, joint venture and collaborations with foreign partners is another way to raise capital based on capital availability.
Debt Funding – In India, there are number of debt options available based on the stage of business. While there are number of Govt. formulated schemes like Collateral free loan up to INR 1 cr. Or SIDBI funded SME loans etc. however conventional norms in terms of lending & business feasibility guided by apex banks Non Performing Asset ( NPA) norms are always on top of the mind with these Institutions.
Typical debt funding for working capital are available via various credit lines like bill discounting, traditional bank overdraft, securitization of receivables, working capital term loan, factoring finance (against receivables though not very popular), commercial paper issuance by banks for sound rating SMEs, etc.
For export business owners, there are pre-shipment and post-shipment credits available in LIBOR based highly competitive interest rate regime and this should be explored fully to neutralize the foreign exchange exposure against receivables.
Many times overseas suppliers also offer competitive credit facility to Indian buyer to promote the trade and export between both the countries. These facilities are available via buyers’ credit which in turn is funded by overseas buyers’ bank.
Off late, Indian SMEs can also avail external commercial borrowing subject to RBI guideline to fund its requirement.
For capital expenditure (capex), apart from Indian banks there are number of NBFCs which offers credit against capex proposals via term loans or operating/financial lease with various derivative products around them.
Mezzanine debt funding – In India, there are some Institutions (Domestic as well Foreign) which offers these kind of funding which is very often a product around mix of equity and debt. Some of the instruments are like convertible debentures, preference stocks with convertible options or senior debt with participating options at later date in equities via warrants etc. There are quite a few NBFCs which offer venture debt backed up by PE funding or back to back PE funding round.
Grants – Bilateral trade ties between India & other countries in developed world’s trade/ finance association offers financial grants to sun rising and technologically proven/ upgrade sectors and to take advantages of hyper growth prevailing in these sectors. For example, many of the solar power or bio-gas power sectors enjoy financial grants from various overseas trade associations.
To summarise below – here is a table
|Typical Structure||Revolving Debt||Debt with warrants||Equity||Award|
|Investment Horizon||Short||Long / Medium||Long||Long|
|Coupon||Floating/Fixed||Structured||Dividend/ Bonus shares||One time|
|Rate||Prime||Risk adjusted||Valuation & Dilution driven||NA|
|Customization||Standard||Rigid||Flexible on business drivers||Sector specific|
|Liquidity||High||Medium||Low ( Exit is difficult)||NA|
To conclude, Indian market for SME funding is growing in terms of players and products around them to suit requirement of business owners and stage of SME business owner to absorb its business & finance structure in terms of cost and funding options.
List of 10 funding options for startups that will help you raise capital:
1) Bootstrapping your startup business:
Self-funding, also known as bootstrapping, is an effective way of startup financing, especially when you are just starting your business. First-time entrepreneurs often have trouble getting funding without first showing some traction and a plan for potential success. You can invest from your own savings or can get your family and friends to contribute. This will be easy to raise due to less formalities/ compliances, plus less costs of raising. In most situations, family and friends are flexible with the interest rate.
Self-funding or bootstrapping should be considered as a first funding option because of its advantages. When you have your own money, you are tied to business. On a later stage, investors consider this as a good point. But this is suitable only if the initial requirement is small. Some businesses need money right from the day-1 and for such businesses, bootstrapping may not be a good option. Bootstrapping is also about stretching resources – both financial and otherwise – as far as they can.
2) Crowdfunding As A Funding Option:
Crowdfunding is one of the newer ways of funding a startup that has been gaining lot of popularity lately. It’s like taking a loan, pre-order, contribution or investments from more than one person at the same time.
This is how crowdfunding works – An entrepreneur will put up a detailed description of his business on a crowdfunding platform. He will mention the goals of his business, plans for making a profit, how much funding he needs and for what reasons, etc. and then consumers can read about the business and give money if they like the idea. Those giving money will make online pledges with the promise of pre-buying the product or giving a donation. Anyone can contribute money toward helping a business that they really believe in.
Why you should consider Crowdfunding as a funding option for your business:
The best thing about crowdfunding is that it can also generate interest and hence helps in marketing the product alongside financing. It is also a boon if you are not sure if there will be any demand for the product you are working on. This process can cut out professional investors and brokers by putting funding in the hands of common people. It also might attract venture-capital investment down the line if a company has a particularly successful campaign. Keep in mind that crowdfunding is a competitive place to earn funding, so unless your business is absolutely rock solid and can gain the attention of the average consumers through just a description and some images online, you may not find crowdfunding to work for you in the end.
3) Get Angel Investment In Your Startup:
Angel investors are individuals with surplus cash and a keen interest to invest in upcoming startups. They also work in groups of networks to collectively screen the proposals before investing. They can also offer mentoring or advice alongside capital. Angel investors have helped to start up many prominent companies, including Google, Yahoo and Alibaba. This alternative form of investing generally occurs in a company’s early stages of growth, with investors expecting a upto 30% equity. They prefer to take more risks in investment for higher returns. Angel Investment as a funding option has its shortcomings too. Angel investors invest lesser amounts than venture capitalists (covered in next point).
4) Get Venture Capital For Your Business:
This is where you make the big bets. Venture capitals are professionally managed funds who invest in companies that have huge potential. They usually invest in a business against equity and exit when there is an IPO or an acquisition. VCs provide expertise, mentorship and acts as a litmus test of where the organization is going, evaluating the business from the sustainability and scalability point of view.
A venture capital investment may be appropriate for small businesses that are beyond the startup phase and already generating revenues. Fast-growth companies like Flipkart, Uber, etc with an exit strategy already in place can gain up to tens of millions of dollars that can be used to invest, network and grow their company quickly.
However, there are a few downsides to Venture Capitalists as a funding option. VCs have a short leash when it comes to company loyalty and often look to recover their investment within a three- to five-year time window. If you have a product that is taking longer than that to get to market, then venture-capital investors may not be very interested in you.
They typically look for larger opportunities that are a little bit more stable, companies having a strong team of people and a good traction. You also have to be flexible with your business and sometimes give up a little bit more control, so if you’re not interested in too much mentorship or compromise, this might not be your best option.
5) Get Funding From Business Incubators & Accelerators:
Early stage businesses can consider Incubator and Accelerator programs as a funding option. Found in almost every major city, these programs assist hundreds of startup businesses every year. Though used interchangeably, there are few fundamental differences between the two terms. Incubators are like a parent to to a child, who nurture the business providing shelter tools and training and network to a business. Accelerators so more or less the same thing, but an incubator helps/ assists/ nurtures a business to walk, while accelerator helps to run/ take a giant leap.
These programs normally run for 4-8 months and require time commitment from the business owners. You will also be able to make good connections with mentors, investors and other fellow startups using this platform.
6) Raise Funds By Winning Contests:
An increase in the number of contests has tremendously helped to maximize the opportunities for fund raising. It encourages entrepreneurs with business ideas to set up their own businesses. In such competitions, you either have to build a product or prepare a business plan. Winning these competitions can also get you some media coverage.
7) Raise Money Through Bank Loans:
Normally, bank is the first place that entrepreneurs go when thinking about funding. The bank provides two kinds of financing for businesses. One is working capital loan, and other is funding. Working Capital loan is the loan required to run one complete cycle of revenue generating operations, and the limit is usually decided by hypothecating stocks and debtors. Funding from bank would involve the usual process of sharing the business plan and the valuation details, along with the project report, based on which the loan is sanctioned.
Almost every bank in India offers SME finance through various programs. For instance, leading Indian banks – Bank Of Baroda, HDFC, ICICI and Axis banks have more than 7-8 different options to offer collateral free business loans. Check out the respective bank sites for more details.
8) Get Business Loans from Microfinance Providers or NBFCs
What do you do when you can’t qualify for a bank loan? There is still an option. Microfinance is basically access of financial services to those who would not have access to conventional banking services. It is increasingly becoming popular for those whose requirements are limited and credit ratings not favored by bank.
Similarly, NBFCs are Non Banking Financial Corporations are corporations that provide Banking services without meeting legal requirement/definition of a bank.
9) Govt Programs That Offer Startup Capital:
The Government of India has launched 10,000 Crore Startup Fund in Union budget 2014-15 to improve startup ecosystem in India. In order to boost innovative product companies, Government has launched ‘Bank Of Ideas and Innovations’ program.
Government backed ‘Pradhan Mantri Micro Units Development and Refinance Agency Limited (MUDRA)‘ starts with an initial corpus of Rs. 20,000 crore to extend benefits to around 10 lakhs SMEs. You are supposed to submit your business plan and once approved, the loan gets sanctioned. You get a MUDRA Card, which is like a credit card, which you can use to purchase raw materials, other expenses etc. Shishu, Kishor and Tarun are three categories of loans available under the promising scheme. Learn more about MUDRA.
Also, different states have come up different programs like Kerala State Self Entrepreneur Development Mission (KSSEDM), Maharashtra Centre for Entrepreneurship Development, Rajasthan Startup Fest, etc to encourage small businesses.
SIDBI – Small Industries Development Bank Of India also offer business loans to MSME sector.
If you comply with the eligibility criteria, Government grants as a funding option could be one of the best. You just need to make yourself aware of the various Government initiatives.
10) Quick Ways To Raise Money For Your Business
There are few more ways to raise funds for your business. However, these might not work for everyone. Still, check them out if you need quick funds.
Product Pre-sale: Selling your products before they launch is an often-overlooked and highly effective way to raise the money needed for financing your business. Remember how Apple & Samsung start pre-orders of their products well ahead of the official launch? Its a great way to improve cash flow and prepare yourself for the consumer demand.
Selling Assets: This might sound like a tough step to take but it can help you meet your short term fund requirements. Once you overcome the crisis situation, you can again buy back the assets.
Credit Cards: Business credit cards are among the most readily available ways to finance a startup and can be a quick way to get instant money. If you are a new business and don’t have a tons of expenses, you can use a credit card and keep paying the minimum payment. However, keep in mind that the interest rates and costs on the cards can build very quickly, and carrying that debt can be detrimental to a business owner’s credit.