Legal Fund Raising Process for Startups in India

The Indian startup ecosystem has constantly evolved in the past few years through a growing number of angels, VC funds, incubators, and accelerators, as well as support from the Indian government initiatives such as Digital India, Startup India, and Smart Cities that will boost startup and investment activity across cities and new sectors. This growth in startup investments and the number of unicorns come because of the rapid increase in spending power, mobile internet usage, access to new consumer markets, social media adoption, technological innovations, and favourable consumer demographics.

Any business would have expenses and someone has to pay for those expenses. Capital, or money, is the key requirement for a business to grow. Without sufficient financing for business, the startup is at the risk of imploding or going nowhere. To solve this issue and limit risks, businesses usually seek financial help from the outside. A startup is a newly established business that is founded by an individual or a group of an individual having the same objectives. There are many ways through which a startup can raise funds for their business.           

Legal Steps Involved in Raising Funding for Start-up in India

The entrepreneur must have the patience and be willing to put in the effort that a successful fund-raising round requires. The fund-raising procedure includes the following steps:

1. Assessing Need for Funding

The startup requires to assess why the funding is required, and the correct amount to be raised. The startup should come up with a milestone-based strategy with clear timelines of what the startup desires to achieve in the next 2,4 and 10 years. A financial forecast is a carefully created projection of business development over a given time, taking into consideration projected sales data, as well as market and economic indicators. The cost of Production, Prototype Development, Research, Manufacturing, etc should be well planned. On the basis of this, the startup can determine what the next round of investment will be.

2. Assessing Investment Readiness

While it is essential to identify the requirement of funding, it is also equally important to decide if the startup is ready to raise funds. Any investor will take the entrepreneur seriously if they are convinced about entrepreneurs’ revenue projections and their returns. Investors are usually looking for the following in startups:

• Revenue growth and market position
•  Favourable return on investment
• Time to break even and profitability
• The distinctiveness of the startup and competitive advantage
• The entrepreneurs’ vision and plans
• Reliable, passionate, and talented team

3. Preparation of Pitch deck

A pitch deck is a comprehensive presentation about the startup outlining all the vital aspects of the startup. Constructing an investor pitch is all about reciting a good story. An entrepreneur’s pitch is not a series of individual slides but should flow like a story connecting all the elements. At the initial stage, the review committee, as well as investors are eager to understand if the concept addresses a real opportunity, if the business has a strong case, if the team is reliable, passionate, and talented, and if the traction that the team has been able to gain so far. Pitching events provides a good opportunity to interact with potential investors face-to-face. Pitch decks can be shared with Angel Networks and VCs on their email IDs.

4. Investor Targeting

All Venture Capitalist Firms have an Investment Thesis which is a strategy that the venture capitalist fund obeys. The Investment Thesis recognizes the stage, geography, focus of investments and differentiation of the company. One can evaluate the Investment Thesis of the company by going through their website, brochures, and fund description. To target the right group of investors, it is important to research the Investment Thesis, and their past investments in the market, and interact with entrepreneurs who have successfully raised equity funding.  The entrepreneur should be able to recognize active investors, their sector preferences, the average ticket size of funding, geographic location, level of engagement, and mentorship given to investee startups.

5. Due Diligence by Interested Investors

Angel networks and VCs conduct proper due diligence of the startup before finalizing any equity deal. They go through the startup’s past financial decisions and the team’s credentials as well as background. This is carried out to ensure that the startup’s claims regarding the growth and market numbers are true as well as to ensure that the investor can recognize any objectionable activities beforehand. If the due diligence is a success, the funding is concluded and completed on mutually agreeable terms.

6. Term Sheet

A term sheet is a “non-binding” list of propositions by a venture capital firm at the initial stages of a deal. It outlines the key points of engagement in the deal between the investor and the startup. A term sheet for a venture capital transaction in India usually includes four structural provisions; valuation, investment structure, management structure, and changes to share capital.

(i) Valuation

Startup valuation is the total worth of the business as estimated by a professional valuer. There are several methods of valuing a startup, such as the Cost to Duplicate approach, Market Multiple approach, Discounted cash flow (DCF) analysis, and Valuation-by-Stage approach. Investors decide the relevant approach based on the stage of investment and market maturity of the startup.

(ii) Investment Structure

It describes the method of venture capital investment in the startup, whether it is through equity, debt, or a combination of both.

(iii) Management Structure

The term sheet constitutes the management structure of the business which includes a list for the board of directors and prescribed appointment and removal procedures.

(iv) Changes to share capital

Every investor in startups has their investment timelines and accordingly, they seek flexibility while examining the exit options through subsequent rounds of funding. The term sheet consists of the stakeholders’ rights and obligations for subsequent changes in the business’ share capital.

Start-up Seed Fund Schemes

Easy availability of capital is important for entrepreneurs at the initial stages of the growth of a business. Funding from angel investors and venture capital firms becomes available to startups only after providing the proof of concept. The objective of the Startup India Seed Fund Scheme (SISFS) is to give financial assistance to startups for proof of concept, product trials, prototype development, market-entry, and commercialization. This would allow these startups to reach a level where they will be able to raise investments from angel investors or seek loans from commercial banks venture capitalists or financial institutions. A startup has to fulfill the following criteria to enjoy the SISFS:

1. A startup should be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT) and incorporated for a  maximum of 2 years at the time of application.

2. It is important that the startup has a business idea to develop a product or a service with a market fit, scope of scaling and viable commercialization.

3. The startup should utilize technology in its primary product or service business model distribution model or methodology to solve the targeted problem.

4. Preference would be given to startups building innovative solutions in sectors such as social impact, water management, financial inclusion, waste management, education, agriculture, railways, oil and gas, biotechnology, healthcare, energy, food processing, mobility, defense, space, textiles, etc.

5. The startup should not have obtained more than ten lakh rupees of monetary support under any other Central/State Government scheme. (Prize money from competitions and grand challenges, access to labs, subsidized working space, access to prototyping facility or founder monthly allowance are not included in the above explanation)

6. Indian promoters should be holding at least 51% shares in the startups at the time of application to the incubator for the scheme, as per the Companies Act, 2013 and SEBI (ICDR) Regulations, 2018.

7. The applied startup can utilize seed support in the form of debt/convertible debentures each once according to the guidelines of the scheme and grants.

Conclusion

New ventures or startups do not just have to deal with various procedures like gaining traction, ideation, expansion, etc. All these procedures need money and that money should be something that should be furnished to them at the right time so that the growth of the startup is not terminated. This is why startups go for startup funding. After obtaining the right amount of funds businesses must ensure that the money raised is used efficiently and effectively by using it at the right place and for the right purpose.

FAQs

1. For what seed fund can be utilized?

Startups should not utilize seed funds for the creation of any facilities and shall be used for the objective it has been granted for. A grant can be utilized for validation of Proof of Concept prototype development or product trials. A debt/convertible debenture can be utilized for Market entry, Commercialization, or Scaling up.

2. How to apply for SISFS?

An online call for applications is organized on an ongoing basis on the Startup India portal. startups that are recognised by the Department for Promotion of Industry and Internal Trade (DPIIT) can log in using the credentials which were used during the startup recognition procedure to apply for the scheme.

3. Why do investors invest in startups? 

Investors purchase a part of the business with their investment. They put down capital for equity in return: a part of ownership in the startup and rights to its future profits. Investors create a partnership with the startups they choose to invest in, if the business turns a profit, investors make returns proportionate to their amount of equity in the startup and if the startup incurs a loss, the investors lose the money they’ve invested.

4. What is a term sheet?

A term sheet is a “non-binding” list of propositions by a venture capital firm at the initial stages of a deal. It outlines the key points of engagement in the deal between the investor and the startup. A term sheet for a venture capital transaction in India usually includes four structural provisions; valuation, investment structure, management structure, and changes to share capital.

5. What is the Startup India Seed Fund Scheme?

Startup India Seed Fund Scheme (SISFS) furnishes financial assistance to startups for proof of concept, product trials, market-entry, prototype development, and commercialization. Eligible startups can register for the scheme on the Startup India portal. The Seed Fund will be allocated to selected startups through eligible incubators all over India.