Equity Funding for Startups and MSMEs: A Primer
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Alastair Pavrey
Many entrepreneurs find
themselves in a dilemma when it comes to raising funds and deciding between
equity and debt. There are lot of common concerns regarding equity with respect
to losing control and giving up equity stake which leads them towards debt
funding, ignoring the risks inherent with that strategy. Although sometimes
viable and effective, taking on debt at the wrong time can be a death wish to
most startups and put them on a path to failure. Most importantly, many MSMEs
are not very enthusiastic and aware of the various other financing options
available.
Private equity funding from a
credible investor has many positives for MSMEs such as increasing the Net worth
and strengthening the books, guidance to better endure the volatile business
environment, flexibility in structuring return of investment, access to
high-level intellectual capital, etc. Further, raising private equity is easier
as compared to raising money from public issue with respect to regulatory
compliances. An easy way to deal with the misconception of dilution through
equity funding is this - owning 35% of 100 Crore built overtime through
value-add private equity management is better than 90% of a 1 crore firm
through your own sweat, blood and tears.
This article will breakdown the
different stages of a startup and where the PE comes in as a strategic investor,
the various funding rounds, and the current PE scenario (including the SME IPO
landscape) along with emerging ecosystems for MSMEs
Startup Life-Cycle
Every large business was once a small
business. Understanding the capital lifecycle of the small business right from
self-funding to the eventual IPO stage is useful to find the right solutions
for your business.
A typical investment
lifecycle can be illustrated below with the typical investment strategies used
Funding Rounds
SEED
Capital acquired from this round
goes towards developing a startup’s founding team, funding product development,
and in some cases, even facilitating early revenue generation.
Wrapped-up within seed investment
are expectations that strong signs of Product/Market Fit, and some degree of
traction (in the form of a growing wait list, or month-on-month revenue growth)
will begin to emerge, paving the way for later fundraising.
Traditionally, seed rounds were
the reserve of angel investors, but the proliferation of cash-rich VC funds and
a huge range of startups to invest in has attracted more venture capital firms
into seed round investment.
Recent Examples
SERIES A
Revenue growth is the name of the
game in Series A. By this point, a startup is expected to have clear and
growing evidence of Product/Market Fit, translating into significant revenue growth
from new customers and increasing ARPA (Average Revenue per Account).
It's here that marketing and
sales become more important. Until this point, growth has often been driven by
a single (and not always scalable) channel.
To keep growing at a rapid rate,
it's necessary to develop new sales and marketing processes, identify new
channels, and get to grips with your target customer.
Recent examples
SERIES B
In Series B, investors
are looking for the next stage of growth: the ability to take everything you've
learned, and make it work at scale.
In practical terms, Series B
investment might allow a startup to make expansive hires (across business
development, strategic accounts, marketing and customer success), expand into
different market segments or experiment with different revenue streams, and in
dramatic instances, even buy-out businesses that offer a competitive advantage.
Recent Examples
SERIES C+
Series C rounds are
raised to fuel large-scale expansion, like moving into a new market (commonly
international expansion), or to fuel acquisitions of other businesses.
After Series C, there's
theoretically no limit to the number of investment rounds a startup can raise:
some companies will go on to raise investment through Series D, E and beyond.
Given the relatively low number
of startups that make it to this point, there's also a huge amount of variance
in the amounts raised, with investment determined on a case-to-case basis.
The funding rounds can be summarized as follows:
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| Data in the above table has been collated from the article https://www.investopedia.com/articles/personal-finance/102015/series-b-c-funding-what-it-all-means-and-how-it-works.asp |
NSE Emerge – The SME IPO
platform
Small and medium enterprises
(SME) have outrun their bigger rivals in the race to raise funds, with their
stocks often faring significantly better than those with more fancied names. This
shows a good option for SMEs looking to raise capital through a reliable and
effective platform.
Spurred by investor interest, 132
small and medium enterprises (SMEs) raised a record Rs. 1,785 crore through
initial public offerings (IPO) in 2017, which was more than three times the
funds raised in the preceding year.
Funds raised were used
for business expansion plans, working capital requirements, and other general
corporate purposes.
The IPO chart in the year is led
by Zota Healthcare which raised Rs. 58.50 crore, followed by Euro India Fresh
Foods Ltd, which mopped up Rs. 51.26 crore. Geographically, Gujarat continued
to dominate the IPO space by contributing 51 firms on SME bourses, followed by
Maharashtra (39), Madhya Pradesh (11), Delhi (8), Rajasthan (6), Telangana (4),
West Bengal (3) and two companies each got listed from Andhra Pradesh and
Punjab.
The companies which got listed
during the period under review represent diverse industry base such as media
and entertainment, manufacturing, textiles, engineering, finance, chemicals,
agriculture, food processing and construction.
The typical listing requirements can be better understood
when compared to the Main Board listing requirements as follows:
Current Private Equity
scenario in India
2017 has seen mostly late-stage
deals take off with concerns raised with respect to early stage, which remains under
stress, even as funding remains concentrated in Bengaluru, Delhi-NCR and
Mumbai. 2017 closed with a record $13.7 billion being invested into the Indian
startup ecosystem across 820 deals.
The value of investments is
higher this year compared to 2016 and 2015, when funding was at $4.06 billion
and $8.4 billion respectively. However, 2016 and 2015 saw a larger number of
deals, at 1,034 and 913 respectively.
Note: Emerging Ecosystems
Several fintech startups have
leveraged technology to build scalable solutions to connect SMEs to potential
lenders for tailored requirements.
In addition to connecting lenders
to SMEs, these marketplaces provide several value-added services like primary
underwriting, risk assessment, rule-based matching, and seamless
payment-settlement engine to enable a win-win for MSMEs and investors.
PE and SME: How
can they work together
Indian SMEs and startups can be
said to have a typical behavior such as:
- Take systems and processes very lightly
- Promoter-driven SMEs tend to score high in the
skill set which can be closely related to the promoter itself. The promoter’s
core competency becomes the company’s
- Clients are acquired through a close network,
sometimes these are few clients acquired in the initial phase of growth
- Scaling the operations beyond the base level of
clients tend to be limited which ultimately stagnates the growth of the company
Building on the base level of
growth is where PE can be effective. Potential value creation is what is needed
at this stage which can have an incremental effect on all aspects of the
organization.
Thus, it is clear that for such
SMEs, significant element of value creation happens through:
- Acquiring new clients to add to revenues
- Systems and processes that are efficient, which
ensure optimum utilization of organizational resources
- Aligning employees through motivation and
defining clear goals
This is where
the expertise of operational private equity funds can act as a significant
value creator for SMEs.
Technology
interventions that bring cost leadership, HR intervention to ensure the hiring
of the best possible talent in the industry and demand generation through
cost-efficient marketing mediums are some examples of how value creation is
possible through private equity.
MSMEmitra.com provides
financial consultancy and business advisory to start-ups and businesses which
do not have an in-house financial management mechanism in place. For such businesses,
MSMEmitra.com offers assistance in assessing the actual funding requirement,
finding out the most suitable funding option available – debt or PE or a combination of both, and in
sourcing funds. MSMEmitra.com also provides assistance to start-ups and MSMEs
in identifying and availing the benefits of the applicable schemes and subsidies.
If you are a business
owner, and need our assistance for the funding requirements of your business,
connect with us at support@msmemitra.com
Make an informed
decision about the best funding options available for your business, and find
out how to avail the benefits of the schemes and subsidies applicable for your
business, by visiting https://msmemitra.com
Thank you for reading.
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About the
Author: Alastair Pavrey is a Finance
and Investment professional experienced in transaction-based financial
advisory to buy-side and sell-side participants, with a keen interest to
understand and contribute to the Indian Private Equity, Venture
Capital and SME ecosystem. You can follow
Alastair Pavrey on Twitter - @alastairpavrey.
Disclaimer:
The views expressed in the article are the
author’s own. This write-up has been collated from various publicly available
materials and secondary data, and MSMEmitra.com cannot guarantee the accuracy
of the content. The opinions and expectations arrived at in this article, are
based upon the analysis of the Industry by the author and the editorial team at
MSMEmitra.com. Readers are requested to check the authenticity of the data at
their end, before making any decisions with inherent financial risks.
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