One of the first hurdles in creating a startup is raising the capital money for it. Capital money or in general ‘capital’ for a business is the money required to start the business for selling our product and services. Calculating the requisite capital for our startup is half the hurdle and acquiring it is the other half.
I am often asked, “How to create a startup without having money but an excellent startup idea”; since I’ve already discussed at length about startup ideas, I will write about money today.
I will state outright that, I don’t have a magic potion for raising capital. At the risk of sounding condescending I would say, If you are broke then creating a startup is the last thing you should be looking at and I would suggest looking for a stable income for a sustainable lifestyle before thinking about starting a business. The rags to riches story in the modern startup ecosystem are often exaggerated and with plenty of misinformation.
On the other hand, if you are someone who has planned diligently to create a startup, saved enough money to sustain current lifestyle, to support family and also invest in your company; then the following pointers could be very useful.
Capital amount requirements vary widely according to the field of business, a single person Internet startup can be virtually started with just the investment of time by the founder and where as starting a semiconductor fabrication plant for the latest generation requires $20 Billion or more.
Whether our startup is capital intensive or not, the following factors should be accounted for calculating the budget for the capital.
Setup costs for a startup comprises of fixed costs and variable costs. Fixed costs include mandatory capital amount specified by the government for the type of company under which the startup is incorporated, costs for licenses, permits and incorporation. Variable costs include building rent down payment, auditor fees, company board, seals, invoice books; some of which may be mandatory under the incorporation rules of our govt.
Expenses incurred for procuring an asset whose benefits are received for a long period such as buying a building, furniture, equipment (e.g. computers), tools and acquisition of intangible assets like patents.
Expenses for running the startup should accommodate the amount of money required to sustain the company till it starts to generate stable revenue and becomes self-reliant.
Expenses for day-to-day activity in a startup generally include,
+ Wages - Salaries for regular employees and payments to the contract employees. + Training - Payment made towards training for the employees. + Insurance - Payments made towards employee health insurance, office insurance, tools insurance etc. + Building rent - Rent to the office building. + Electricity - Payment made towards electricity consumption. + Telephone - Payment made towards telephone bill. + Internet - Payment made towards Internet bill. + Water - Payment made towards water consumption. + Catering - Payments made towards food and beverages. + Sanitation - Payments made towards office housekeeping. + Office supplies - Payments made towards stationery items, printer ink etc. + Instalments for tools, machinery - Monthly dues made towards instalments for tools, machinery. + Research and Development (R&D) - Expenses incurred during research and development of a product or service. + Marketing and Advertising - Payments made towards marketing and advertising of the product, service. + Taxes - Payments made towards sales tax, income tax etc. + Subscription - Payments made towards subscription services such as hosting, software, magazines etc. + Accounting fees - Payments made towards book-keeping, compliances. + Legal fees - Payments made towards legal support. + Security - Payments made towards office security.
The total of setup costs, capital expense and operating expenses till our startup is expected to break-even i.e. the point at which expenses and revenue from product, services are equal; should give us the capital budget. It is generally advised to have a buffer runway(time left to run the business deepening upon cash balance) of at-least 12 months since break-even.
Depending upon one’s economic situation, there are number of ways one could raise the capital for their startup; I will list some of the most common ways to raise the capital.
This is the recommended (of-course not by investors) way to build the capital for a startup, often the method of choice for the serial entrepreneurs for a reason. Investing own money on our startup from the savings, which we have been building to launch a startup gives us a sense of fulfilment and ownership. Not borrowing money for capital means lesser dilution of ownership in a startup and so more freedom in running our startup.
Also, raising appropriate seed capital for a startup is much harder than raising investments on a later stage(more on that below); so less time is wasted on raising capital which we can spend on building our product if we invest our own money in our startup.
But, not every wannabe entrepreneur could save enough money to meet the capital budget (or) confident enough to put in all their life’s savings
Into their startup and would like to minimize the risk; In that case, one could match their investment with other methods of raising capital.
When we borrow money for our capital money, it is call debt financing. Traditional lending institutions such as banks or NBFC (Non-Banking Financial Companies) don’t generally provide unsecured loans for a startup capital, so often the loan is taken by the founder in their personal capacity.
Country’s company laws needs to verified in this case as some prohibit taking personal loan for a business capital.
Though debt financing is common, a startup should balance debts with revenue in-order to prevent re-payment schedules from becoming a burden and if the loan is taken in founder’s personal capacity, income from startup should be appropriate to repay the interests and the principal amount.
This, as the name suggests is to sell the startup’s shares for raising capital money. Apart from the downside of diluting ownership, the amount of money which can be raised by a startup for its capital is less due to its low initial valuation.
Equity financing is a good option to raise capital if the equity is sold to the co-founders as them taking ownership is better for the health of the company than an outside investor. Selling shares for raising capital money is straightforward, so investors generally look upon it favourably provided all other conditions for investment are met.
Several successful startups today were started this way. Money can be borrowed from friends and family either by the way of debt financing or equity financing.
Debt financing from friends and family often has the added advantage of being interest free and being unsecured doesn’t need assets for liability; So, startups can take loans in their own name.
Equity financing from friends and family creates more value for their money and peace of mind for the founders since the ownership is shared with people they trust.
But, one shouldn’t make their friends or family members co-founders in a company just because they have invested their money; a co-founder or as a matter of fact any team member in a startup should be the one who is qualified to do the job.
Most governments around the world are looking forward to capitalize on the startup ecosystem by announcing schemes to make creating and running startups easier. Some of them include seed money to create startups with innovative ideas to solve their country’s problems.
Some govt. schemes also enable easy debt financing for startup capital via banks, which may not be possible other ways.
Best way to learn about such schemes is to approach our local state and federal government’s business/entrepreneurial departments.
As I’ve mentioned before, raising seed capital although generally lesser in amount value; is generally harder as there’s nothing to showcase for as a startup. So the early stage startup capital investments by seed funds and angel funds are made on the people who would run the startup and not for their startup idea.
If we can exhibit a formidable team, then there are several such seed and angel fund agencies who would be ready to invest in us. Care should be taken to vet such agencies by looking at their investment portfolio and investors they represent before accepting investment from them.
Investment via seed and angel funds are done through equity financing.
It’s a good strategy to hedge our capital investment needs between aforementioned mechanisms, by what ever means we raise our investment it doesn’t affect the value of our startup according to the Modigliani–Miller theorem(M&M) theorem.
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