What is bootstrapping?
How to do bootstrapping for startups?
What is venture capital?
What are the stages for funding venture capital?
What are the risks in venture capital?
What are the characteristics of venture capital financing?
What are the steps involved in the venture capital process?
1.
Overview-What is bootstrapping?
Bootstrapping means
using personal finances or operating revenues of a new company to build a
company. Most startups make unnecessary expenses toward marketing,
promotion, office equipment, and working capital that are unaffordable. So, to curtail unnecessary expenditure bootstrapping is done.
2.
How to do bootstrapping for startups?
Most startup firms use the following method for bootstrapping:
a) Trade Credit: When your business is new, your supplier will not provide you with trade credit. You have to pay either by cash or credit card. However, you can get out of this situation when you have a well-crafted financial plan and good communication skills.
Another
important thing is the contact person. For small businesses, the contact person
may be the owner and for large firms, the contact person may be Chief Financial
Officer. After identifying the contact person you should visit the supplier's
premises.
Now,
you have to explain to the contact person about your business and your need to get
the first order on credit to launch the venture. The supplier may be ready to
give partial cash on delivery and the remaining on credit.
After
this, your financial tricks come into play. The trick here is to get the goods
shipped before one is obliged to pay for the goods. You can also borrow to pay
the amount if your interest cost allows you to do so.
Hence, trade credit is one of the important ways to reduce your working capital investments. This is mostly used in retail operations.
b) Factoring: When goods are sold on credit and the credit period is for 60 days, a factor pays the money upfront after deducting reserve at a specified rate. This is called factoring. By doing so, you have access to money to meet the day-to-day obligations until the whole amount is received.
Now,
the factor's responsibility is to collect receivables and perform the administrative
work that you were doing. The factor will charge you a commission for doing this
work. While the customers may not be aware that their accounts are sold up.
Factoring involves cost and yields some benefit. You should weigh the cost and benefit and decide to go for factoring when there's a net benefit. Factoring can be a very useful tool for raising money and keeping cash flowing to your company.
c) Leasing: Another method of bootstrapping is to take equipment on lease instead of outright purchase. This will reduce your capital cost and may give some tax savings.
In
leasing, you do not have to pay immediately instead you have to make a series of
small payments every year. The leased asset will be recorded as an asset in
your account and you can claim tax savings on depreciation on the leased asset.
In addition, you can claim tax savings on lease payments.
3.
What is venture capital financing?
Some investors prefer to invest in startups and small businesses with exceptionally high growth potential. Venture Capitalists take money from the pool of investors and place them in a strategically managed fund.
Venture capitalists invest with the expectation of taking an equity position in your company to help to carry out promising but higher-risk projects. In addition, venture capitalist expects a healthy return on their investment, particularly when the company starts going for public offerings.
Venture Capitalists generally
a) Finance new and rapidly growing companies
b) Require equity participation
c) Help in the development of new products or services
d) Add value to the company through active participation
4.
What are the characteristics of venture capital financing?
Venture capital is identified by the following characteristics:
a) Long time horizon: The time horizon in venture capital financing can extend from a minimum of three years to a maximum of 10 years.
b) Lack of liquidity: The venture capitalists assume that there would be less liquidity on the share it gets, so adjust the liquidity premium against the price and required return.
c) High risk: Venture capitalists work on the principle of high risk and high return. So if your startup has a high risk the VC may prefer to invest in your deal.
d) Equity Participation: The VC expects equity shares in consideration of their investments. This enhances their participation in management and board of directors. Their insights and decisions help the company to grow.
5. What are the advantages of venture capital financing?
-It
injects long-term equity into the company so that the company has a solid base
for the future growth
-Both
risk and rewards are shared by the VC. The rewards for VC may be success and
capital gain
-The
startups benefit from the experience, insights, and network of contact of the
VC
-Another
round of funding can also be expected from the VC in case of an adverse situation
during the starting phase
-VC can facilitate IPO, trade sale, and other
regulatory proceedings
5.
What are the stages of venture capital financing along with risk?
|
Financing
Stage |
Period
(yrs.) |
Risk
|
Activity
financed |
|
Seed Money |
7-8 |
Extreme |
Concept, idea,
R & D |
|
Start-Up |
5-9 |
Very High |
Prototype,
Product Development, and Marketing |
|
First Stage |
3-7 |
High |
Commercial
production and Marketing |
|
Second Stage |
3-5 |
Sufficiently
High |
Working Capital
and Expanding Market |
|
Third Stage (Mezzanine
Financing) |
1-3 |
Medium |
Market
Expansion, Acquisition, and Product Development |
|
Fourth Stage (Bridge
Financing) |
1-3 |
Low |
Facilitating
Public Issue |
6.
How venture capital financing along is done?
VC financing is done in the following steps:
a) Deal origination: VC operates directly or through intermediaries. Chartered Accountants, generally, work as intermediaries. VC would inform the intermediary about sector focus, stages of business focus, promoter focus, and turnover focus.
Here the company would give a detailed business plan including a business plan, financial plan, and an exit plan. Tentative valuation is also carried out. All these aspects are included in a document that is referred to as Investment Memorandum (IM).
b) Screening: The examination of the IM is done by a committee consisting of senior-level persons selected by the VC. After careful screening, the selection of the proposed company is done for further processing.
c) Due Diligence: The VC verifies the veracity of the documents to proceed further. This step is handled by consultants and generally, the VC is required to pay the consultants' fees. Sometimes fees are shared between the VC and startups depending on the veracity of the documents.
d) Deal Structuring: The deal is structured in such a way that it produces a win-win outcome. The structuring may include the condition that the promoter should retain the right to buy back the shares.
e) Post Investment Activity: The VC nominates a nominee to the Board of Directors. The company has to adhere to certain guidelines such as:
-Strong
MIS
-Strong
Budgeting System
-Strong
Corporate Governance
VC needs to be updated about these including certain milestones. If milestones have not been achieved, an explanation of this effect should be provided to the VC. In addition, the VC would require whether or not professional management is set up in the company.
f) Exit Plan: VC would also require a detailed exit plan. Exit plan may be in the following two ways:
-VCs
Portion of equity may be sold to a third party in the form of IPO or private placement
to the third party
-The
promoter is required to buy back the shares of VC at a predetermined rate.
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