What are the Different Methods of Fund Raise for SME (Small and Medium Enterprise) Start-ups
Importance of Fund Raise and Why fund raise is required?
Start-ups and growing companies specially SMEs, need to raise funds to achieve its goals and objectives. Fundraise serves as the primary means of financial support, enabling the organization to carry out its programs, initiatives, and services effectively.
Raising funds is a very important aspect of any company’s growth and sustainability. Whether you are a startup seeking initial capital or an established company looking to raise funds for expansion, understanding the various methods available can empower your company to make informed decisions. Each method has its own benefits and risks, so it's important to choose the one that works best for any corporation.
- Needs funds for Business Expansion- Raising funds allows companies to grow and scale operations. It helps increase production capacity, enter new markets, develop innovative products, and expand teams by hiring skilled professionals. This capital fuels growth and positions businesses for long-term success.
- Start- up funding- Start- ups need funds at various stages of its lifecycle. Different types of funding come into picture for different stages. Like at incubation or initial stage small amount of funding is required that usually comes from informal channels of funding. Then at seeding stage, Seed finance, Angel investors come into existence. After that funds are needed for business upscaling.
- Needs fund to Maintain Working Capital-Funds are essential for covering daily operational expenses, ensuring smooth cash flow, and preparing for unexpected financial challenges. Adequate working capital keeps the business running efficiently and reduces the risk of financial stress.
- For research and development- Companies require funds for developing proto types and testing, market research and product development also need funds to identify the product fit for various industries and innovate the product for customer delight.
- Project development- Funding is essential for project development as it covers all major costs like planning, resources, technology, and skilled labor. It ensures smooth execution, timely completion, and the ability to overcome unforeseen challenges. With proper funding, projects can achieve their goals and deliver successful outcomes.
Funds can be raised either through debt, equity or through a mix of both which is called hybrid financing.
In case of equity method of financing, generally a company/partnership firm invites investors to invest in its business and get an ownership in the company in return. Equity method of financing is used by the investors for wealth creation. Equity refers to selling some portion of ownership of the company to investors here called shareholders and allowing them to own shares, voting rights, and claims on future profits.
However, equity is infused at different stages in the growth cycle of a company and this means there are different methods of equity finance as per the requirement of funds.
Equity finance includes private equity financing, going public which is called IPO. IPO is listing of shares on stock exchanges like NSE and BSE. Now, SMEs can also be listed on NSE SME or BSE SME platform.
Here are the fund-raising methods through equity and debt as follows:
1. Private Equity
For companies that do not wish to go public, raising funds through private equity can be an effective way to secure capital. Private equity firms typically invest in businesses in exchange for equity ownership. In simple terms, private equity is a way for businesses to get investment from people or companies who want to own a part of the business and see it succeed, often with the aim of getting a high return on their investment. Private equity is of two types:
2. Angel Equity
Angel equity is funding from angel investors who invest in startups in exchange for ownership or share in company. They take high risks for potential high returns and often provide mentorship and connections to help the business grow. In addition to money, angel investors may offer mentorship, industry connections, and business advice to help the company succeed. Angel investing is usually suited for early-stage companies which are in need to raise some funds compared to venture capital. They usually invest at the seed stage or at concept stage.
3. Venture Capital
Venture capital is a form of private equity financing provided by venture capital firms to startups and small businesses with high growth potential. In exchange for their investment, venture capitalists usually require equity ownership and often take an active role in the company’s management. They usually invest in later stages such as series A and beyond.
4. Initial Public Offer (IPO)
An IPO is the process of offering shares of a private company to the public for the first time. This method allows companies to raise significant capital while gaining visibility and credibility in the market. For IPO, a company has to first fulfil the IPO eligibility criteria and IPO norms as laid down by SME listing platforms and SEBI. Understanding how to raise funds through IPO is crucial for companies considering this route. (Link of the Blog IPO process). Understanding how to raise funds through IPO is crucial for companies considering this route.
5. Follow-on Public Offer (FPO)
A Follow-On Public Offer (FPO) is when a company that is already listed on the stock exchange issues additional shares to the public to raise more money. Companies use FPOs to fund projects, pay off debt, or expand their business. Unlike an Initial Public Offering (IPO), which is for companies going public for the first time, an FPO is for companies that are already publicly traded.
What are the Steps involved in IPO process to raise funds?
A company must adhere to the IPO process as laid under SEBI ICDR Regulations. Merchant Bankers in India have the role to act as underwriters to the Issue. BRLM can be more than 1 depending on the IPO size; usually a mainboard IPO has more than one BRLMs. Here is a brief IPO process.
What are the Methods of Fund raise under Debt Financing?
Debt financing is the process of raising money by borrowing or issuing debt, like loans or bonds. In this arrangement, individuals, businesses, or governments borrow funds from outside sources and agree to repay the amount borrowed (principal) along with interest over time.
There are primarily following types of Debt Securities:
- Bank Loans: Traditional bank loans are a common way for businesses or individuals to get money. They borrow funds from commercial banks, which charge either a fixed or variable interest rate. The borrower agrees to repay the loan over a certain period of time, making regular payments until the full amount is paid off. These loans are a straightforward way to obtain financing for various needs. Bank loans can be secured or unsecured.
- Corporate Bonds and Debentures: Bonds are another type of debt financing. A bond is a certificate that includes the amount of money borrowed (principal), the time by which it must be repaid, and the interest rate. Debentures is a type of loan issued by a company or government to raise money. Investors who buy debentures lend money to the Issuer and receive interest payments until the loan is repaid.
- Convertible and Non-Convertible debt securities: Non-convertible debentures (NCDs) are fixed-income investment products that offer a specific interest rate for a specified period. Big companies issue them to raise money without giving investors the option to convert the debt into company shares. A convertible debt security is a financial instrument that can be converted into equity or common stock shares of the issuing company.
What is the Difference between debt and equity?
Here is the difference between Equity and Debt Funding:
|
Basis |
Equity Financing |
Debt Financing |
|
Meaning |
Equity financing involves raising funds by giving share in profits or dividends. |
Debt financing involves the borrowing of money and paying it back with interest. |
|
Risk to Investors |
Both risk and returns are higher. Though risk can be diversified. |
Both risk and returns are lower a s compared to equity |
|
Return to investors |
Returns are usually high as compared to debt products |
Return is fixed by company it is not related to company’s performance. |
|
Ownership |
Equity holders have ownership in the company. |
Debt holders have no ownership in the company. |
|
Control |
Equity holders may have voting rights and influence over company’s decisions. |
Debt investors have no control over company operations |
|
Duration |
In Equity financing Investor has an indefinite term unless shares are sold or the company is liquidated. |
Debt holders have a fixed term or maturity date. |
|
Priority at the time of Liquidation |
Equity holders are paid last, after debt obligations are met. |
Debt holders are paid first in case of liquidation. |
|
Types |
Angel Investors, Private Equity, Initial Public Offer etc. |
Bonds, Convertible and Non-Convertible Debt securities etc. |
What are NCDs and role of NCD (Non-Convertible Debentures) in fund raise?
NCDs can be termed as bonds issued by a corporation to raise funds from the capital market. They can either be listed on BSE or NSE stock exchanges of India or raised through private placements also. Listed NCDs are in the form of public Issue issued by high rated companies. As the name suggests, they are not convertible to equity or stocks. These type of debt comes with fixed tenure and interest payouts could be monthly, quarterly or annually. NCDs offer relatively a higher rates of interest than convertible debentures.
Bondholders do not have any ownership in the company. The company promises to pay back the money with interest but this investment does not give any ownership or shares in return.
In fundraising, NCDs are used to raise money without diluting ownership. Companies use this money for projects, expansion, or paying off other debts. Some investors prefer NCDs because they earn fixed interest, making it a relatively safe option compared to stocks.
The interest rates on NCDs are generally fixed, meaning they stay the same throughout the term. When the NCD matures, the investor gets back the original amount they invested, along with the interest earned.
Since NCDs are not backed by assets, only the company's reputation and financial health matter. Credit rating agencies provide ratings to help investors understand how safe the investment is based on the company's past performance and future outlook.
- Secured Debt:
It is backed or secured by collateral of any assets. If the borrower defaults, the lender can seize the asset. Because the lender's risk is lower, secured debt usually has lower interest rates. Examples include mortgages and car loans. - Unsecured Debt:
In such loans, no collateral is required. However, the business must have a good credit score in order for the loan to get approved. There are usually no restrictions to the usage of money within the business. They usually have a higher rate of interest.
What is the Role of IPO Advisors in the IPO process?
IPO Advisors play a crucial role in evaluating a company’s business to determine whether it meets the eligibility criteria for an IPO. They assess the company’s financial health, governance structure, and overall readiness to go public.
IPO advisors guide companies through the IPO process, helping with document preparation, regulatory compliance, and pricing strategies. Along-with lead managers, IPO Advisors assist to organize roadshows to attract investors and provide ongoing support after the IPO to ensure compliance with post-listing requirements. Their expertise ensures a smooth transition to the public market.
IPO Advisors play an important role in successful Pre IPO and then launch of IPO. Their advisory role ranges from IPO readiness, selecting the best merchant banker in India for Pre IPO/ SME IPO, various due diligence activities and IPO valuation. Consultants to IPO guides the company throughout the Pre IPO, Issue and listing process.
(link of IPO advisory blog)
Why do investors invest in a growing business?
Investors invest in a growing business because they see great potential for returns. In India, where the economy is rapidly expanding, businesses that are growing quickly often have great opportunities to scale, enter new markets, or introduce innovative products. These investments can be in the form of debt or equity or sometimes a hybrid of both.
Here’s why investors are willing to invest in such businesses:
- High Growth Potential: Investors often wish to invest in companies which have promise of becoming much bigger in the future. In India’s fast-growing market, businesses that are scaling up can offer significant returns as they capture more customers and expand their reach.
- Profit Opportunities: As businesses grow, they usually become more profitable. Investors are looking for companies that can generate strong profits over time, ensuring a good return on their investment.
- Early Advantage: By investing in a growing business early on, investors can get in at a lower valuation. If the business succeeds, they benefit from the increase in value.
- Impactful Ventures: In India, there are many emerging sectors in which investors are looking to invest and contribute to development in economy. A growing business with a strong mission can attract investors who want to make a positive impact while earning returns.
- Diversification of investment portfolio: By investing in different types of securities of different industries investor can diversify its risk which helps in minimizing the risk. By this investor can reduce the impact of any investment which is not performing good.
- Opportunity to invest in innovative companies: Investing in company which is developing a new innovative product or new technologies in market allows investors to be part of exciting industries and new technologies. Startups offer high growth potential and can diversify portfolios, making them a smart choice for investors seeking wealth growth and fresh opportunities.
- Opportunity of investment in a pre-IPO company: Investing in a pre-IPO company allows investors to buy shares before the company goes public, often at lower prices. This offers the potential for high returns if the company succeeds after its IPO. It’s a unique opportunity to support promising businesses early, though it comes with risks that need careful consideration.
In short, investors are excited to support businesses that are on the rise, as they offer the opportunity for financial rewards, growth, and positive impact in a booming economy like India’s.
Conclusion
Fundraising plays a crucial role in the growth and sustainability of businesses, particularly for startups and SMEs. It provides the financial foundation necessary for business expansion, maintaining working capital, research and development, and project execution. Companies can raise funds through various methods, including equity financing (e.g., private equity, angel investors, venture capital, IPOs) and debt financing (e.g., bank loans, corporate bonds, NCDs). Both approaches have their benefits and risks, and the right choice depends on the business stage, goals, and market conditions.
Equity financing offers opportunities for investors to gain ownership and share in profits, while debt financing allows businesses to secure funds without diluting ownership but with the obligation to repay. Raising funds via these methods enables businesses to scale, innovate, and remain competitive in their industries. IPO advisors and experts help businesses navigate complex processes, ensuring compliance and maximizing investment opportunities. Investors are drawn to growing businesses due to their potential for high returns, market expansion, and innovation, particularly in fast-developing economies like India.
In summary, fundraising is an essential tool for business growth, enabling companies to achieve their objectives, manage operational needs, and attract valuable investors. Understanding the various funding options available—whether through equity or debt—empowers businesses to make informed decisions that drive long-term success.
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