Start Up Finance

Start Up Finance Page 1
Start Up Finance
Chapter 14

Question: What are the sources for funding a start up or What are the some innovative
ways to finance a start up?
Answer: Every start up needs access to capital for funding product development, acquiring
Capital assets or raw material, or paying salaries to its employee etc. The
innovative sources of funding focus on maximizing non-bank financing.
Some of the sources for funding a start up are:
a) Personal Financing
An entrepreneur shall put some money from his personal fund in the start up.
This helps the start up to get the trust of the investors in later stage of the
business when the business reaches the breakeven.
b) Personal Credit Lines
Another source is to use the personal credit efforts available from banks.
However, banks provide this facility only when the business has enough cash
flow to repay the line of credit.
c) Family and Friends
The family and friends are among the people who finance the start up in the
very initial phase. However, the loan obligations to friends and relatives
should always be in writing as a promissory note or otherwise.
d) Peer to Peer lending
Here, small and ethnic business groups  having faith or similar interest 
come together and lend money  to each other  to support each other in
their start up.
e) Crowd funding
Crowd funding is the use of small amounts of capital from a large number of
individuals to finance a new business initiative. This can be done through
social media or websites available as it requires accessibility to vast network
of people.
f) Microloans
Microloans are small loans that are given or issued by single individual or
group of individuals at a lower interest to a new business ventures.
g) Vendor financing
Vendor financing is the form of financing in which a vendor lends money to
the business such that it can buy products from the vendor itself.
It is provided only when manufacturers and distributors are convinced to
defer payment until the finished goods are sold by the business.
Here, the vendor takes shares in the start up.
h) Purchase order financing
Purchase order financing companies often advance the required funds

directly to the supplier. This allows the start up to fulfill the large order
without any cash requirement. In this way, transaction was completed and
profit to flow up to the new business.
i) Factoring accounts receivables
In this method, a facility is given to the seller (here start up) who has sold the
good on credit  to fund his receivables  till the amount is fully received.
Here, factor pays most of the sold amount up front and rest of the amount
later. In this way, a start up can meet his day to day expenses without waiting
for credit period.
Purchase Order Financing
[Reading Only]
Steps can be summarized as:
 Start Up receive a purchase order from customer
 Business obtain a proposal from the supplier regarding the estimates
 Business applies for PO financing and obtains approval from POF Co.
 The supplier is paid by POF Co.
 The supplier fulfils the customer’s order and deliver goods
 Start Up invoice the customer for the fulfilled order
 Customer makes payment to POF Co.
 The POF company remits the balance money to start up after deducting its margin
Question: Write a note on Pitch Presentation?
Answer: Meaning
Pitch deck presentation is a short and brief presentation (not more than 20 minutes
and basically using PowerPoint) to investors explaining about the
 Prospects of the company i.e. quick overview of business plan; and
 Why they should invest into the start up business i.e. convincing the investors
to put some money in business.

Mode of Pitch Presentation
Pitch presentation can be made either during face to face meetings or online
meetings with potential investors, customers, partners, and co-founders.
Approach towards a Pitch Presentation
a) Introduction
This relates to a short and sweet brief account of start up i.e. Who are you?
What are you doing?
b) Team
This include introduction of team members and should include a background
of promoter. Further, highlight past working of team and their significant
results achieved.
c) Problem and solution
Here, promoter should explain the problem in current scenarios and describe
the planning of company to solve the same.
Further the investors should be convinced that the newly introduced product
or service will solve the problem convincingly.
d) Marketing Sales
Here, market size of the product and profile of target customers must be
communicated to the investors. This also includes how promoter is planning to
attract customers.
If a business is already selling goods, the promoter can also brief the investors
about the growth and forecast future revenue.
e) Projection or Milestones
Since, the start up do not have long history, they must prepare and present
the projected financial statements to give investor a brief idea that whether
business is making profit or loss.
Financial projections include three basic documents that make up a business’s
financial statements i.e. income statement, cash flow statement and balance
sheet.
f) Competition
Here, investor must be informed about the potential competitors available in
the industry.
It needs to be highlighted that how the products or services are different from
their competitors.
If any of the competitors have been acquired, there complete details like
name of the organization, acquisition prices etc. should be also be highlighted
g) Business Model
A business model is the way in which a company generates revenue and
makes a profit from company operations.

It includes business process, target customers, offerings, strategies,
infrastructure, organizational structures, sourcing, trading practices, and
operational processes and policies including culture.
Investor makes it decision based on effectiveness and efficiency of a firm
business model. Thus it needs to tell how they should plan on generating
revenue.
Therefore, following needs to be included in pitch presentation:
 List of the various revenue streams for a business model and the
timeline for each of them.
 Competitor Price of the product v/s your product price
 Lifetime value of the customer
 Strategy to keep him glued to their product.
h) Financing
Here, if the start up has already raised the fund from few investors then it
must reveal the details of investor, fund raised and allocation of fund.
If no money has been raised an explanation can be made regarding how much
work has been accomplished with the help of minimum funding that the
company is managed to raise.
If a promoter is pitching to raise capital he should list how much he is looking
to raise and how he intend to use the funds.
Question: What are the modes of financing for a start up?
Answer: Boot Strapping
An individual is said to be boot strapping when he or she attempts to found and
build a company from personal finances or from the operating revenues of the
new company.
Investment by start ups from their own savings leads to cautious approach and
curbs wasteful expenditures.
3 Methods in which a start up firm can bootstrap:
a) Trade Credit
Trade Credit may be used to create a well crafted financial plan whereby a
start up communicate with its suppliers to provide raw material and
component on credit basis.
This plan can be executed via good communication skills. If vendor is a small
company, communication may be made to owner directly or with the CFO, if it
is a large firm.
The owner or financial officer may give half the order on credit with balance
due upon delivery.

b) Factoring
Factoring is a financing method where accounts receivable of a business
organization is sold to a commercial finance company to raise capital.
In this method, a facility is given to the seller (here start up) who has sold the
good on credit  to fund his receivables  till the amount is fully received.
Here, factor pays most of the sold amount up front and rest of the amount
later.
Advantages of using factoring is
 reduce costs associated with maintaining accounts receivable such as
bookkeeping, collections and credit verifications for the organization
 Factoring can be a very useful tool for raising money and keeping cash
flowing i.e. a start up can meet his day to day expenses without waiting
for credit period.
c) Leasing
Another popular method of bootstrapping is to take the equipment on lease
rather than purchasing it.
Leasing will reduce the capital cost for the start up organization and also help
lessee to claim tax exemption in form of lease rentals.
Angel Investor (also known as a private investor, seed investor, business angels, informal
investors or angel funder)
Meaning
 An angel investor is a high net worth individual who provides financial backing
for small start-ups or entrepreneurs, typically in exchange for ownership
equity in the company.
Who are they?
 Often, angel investors are found among an entrepreneur's family and friends.
 Angel investors usually represent individuals, the entity that actually provides
the funds may be a limited liability company (LLC), a business, a trust or an
investment fund, among many other kinds of vehicles.
Sources of funding
 Angel investors typically use their own money (unlike venture capitalists who take
care of pooled money from many other investors and place them in a strategically managed
fund).
 Some angel investors invest through crowd funding platforms online or build
angel investor networks to pool in capital.
Other Points
 The funds that angel investors provide may be a one-time investment to help
the business get off the ground or an ongoing injection to support and carry
the company through its difficult early stages.

 Angel investors provide more favourable terms compared to other lenders,
since they usually invest in the entrepreneur starting the business rather than
the viability of the business.
Risk Involved
 Angel investors may lose their investments completely, if the start up they
seed fails. Therefore, professional angel investors look for opportunities for a
defined exit strategy, acquisitions or initial public offerings.
Venture Capital Funds
Meaning
 Venture capital means funds made available for start up firms and small
businesses with exceptional growth potential.
How they work?
 Venture capital is money provided by professionals who alongside
management invest in young, rapidly growing companies that have the
potential to develop into significant economic contributors.
 Venture Capitalists generally:
 Finance new and rapidly growing companies
 Purchase equity securities
 Assist in the development of new products or services
 Add value to the company through active participation
 VC Firms are usually formed as Trust, company or LLP. Investors in VCF are
usually banks, financial institutions, pension fund, corporations and high net
worth individuals.
 Venture capitalists take care of pooled money from many other investors and
place them in a strategically managed fund.
Structure of Venture Capital Fund in India
 There are 2 types of fund that exist
(a) Domestic Funds
Domestic funds are funds which raises funds domestically. They are usually
structured as
 domestic vehicle for the pooling of funds from the investor; and
 a separate investment adviser that carries those duties of asset
manager
(b) Off Shore Funds
Two common alternatives available to offshore investors are
 Offshore structure: Under this structure, an investment vehicle
makes investments directly into Indian portfolio companies. Here,
assets are managed by an offshore manager, while the investment
advisor in India carries out the due diligence and identifies deals.

 Unified Structure: When domestic investors are expected to
participate in the fund, a unified structure is used. Overseas
investors pool their assets in an offshore vehicle that invests in a
locally managed trust, whereas domestic investors directly
contribute to the trust.
Question: What are the 4 characteristics of Venture Capital Financing?
Answer: a) Long time horizon: The fund would invest with a long time horizon whereby
minimum period of investment would be 3 years and maximum period can be
10 years.
b) Lack of liquidity: While making the investment choice and form of
investment, VC takes into account the liquidity factor. Based on liquidity, VC
adjust liquidity premium against the price and required return.
c) High Risk: VC works on the principle of high risk and high return. It sharing
both the risks and rewards. So, high risk investment project may not affect
the investment choice for a venture capital.
d) Equity Participation: VC may invest in the form of equity of a company. This
would help the VC to participate in the management and help the company
grow.
Question: What are the 5 advantages of bringing VC in the company?
Answer:  Provide a solid capital base for future growth by injecting long term equity
finance
 Provide practical advice and assistance to the company based on past
experience with other companies which were in similar situations.
 Has a network of contacts in many areas that can add value to the company
 Provide additional rounds of funding when required for finance growth
 Help in the process of preparing a company for an initial public offering (IPO)
of its shares onto the stock exchanges
Question: Discuss the entire Venture Capital Investment Process?
Answer: The entire VC Investment process can be segregated into the following 6 steps:
a) Deal Origination
It is basically related to sourcing the deal. There are two approaches for deal
sourcing:
 Company approaches VC directly: i.e. company will give a detailed
business plan which consists of business model, financial plan and exit

plan and tentative valuation in a document known as Investment
Memorandum.
 VC approaches to company i.e. VC operates directly or through
intermediaries like CAs.
Before sourcing the deal, the VC would inform the intermediary or its
employees about the following so that the sourcing entity does not
waste time :
 Sector focus
 Stages of business focus
 Promoter focus
 Turn over focus
b) Screening
Once the deal is sourced the same would be sent for screening by the VC. The
screening is generally carried out by a committee consisting of senior level
people of the VC. Once the screening happens, it would select the company
for further processing and send it for due diligence.
c) Due Diligence
This is the process by which the VC would try to verify the veracity (accuracy)
of the documents taken.
This is generally handled by renowned consultant’s i.e. external bodies. The
fees of due diligence are generally paid by the VC or may be shared between
the investor (VC) and Investee (the company) depending on the agreement.
d) Deal Structuring
After the case passes through the due diligence, the deal is structured and that
too in such a way that both the parties are in win-win situation.
There are different structures like
 Convertible structure which ensures that the promoter retains the
right to buy back the share; or
 Structure with tag-along clause whereby VC may put a condition that
promoter has also to sell part of its stake along with the VC.
e) Post Investment Activity
Here, the VC nominates its nominee in the board of the company to ensure
that professional management is set up in the company.
Also company needs to inform and update the VC about the milestones. If
milestone has not been met the company has to give explanation to the VC.
f) Exit Plan
At time of investing, VC discusses the Exit Plan with the promoter of the
company. There are 2 common ways to exit:
 Sell to third party in form of IPO or Private placement or to other
venture capital firm; or

 Promoter Buyback the shares from the VC at a pre agreed rate. The
promoter buyback is the first refusal method adopted i.e. the promoter
would get the first right of buyback.
Question: Discuss the 6 financial stages of funding for Venture Capital?
Answer: The stages and other related information like risk matrix related to funding for VC
can be summarized as:
Financial
Stages
Lock in
period
(in years)
Risk
Perception
Activities to be financed
Seed
Money
7-10
Extreme
High
 Low level financing needed to prove a
new idea
 For supporting a concept or idea or R&D
for product development
Start Up 5-9 Very High
 Early stage firms that need funding for
expenses associated with marketing and
product development
 Initializing prototypes operations or
developing
First
Stage
3-7 High
 Early sales and manufacturing funds
 Start commercials marketing production
Second
Stage
3-5
Sufficiently
High
 Working capital for early stage
companies that are selling product, but
not yet turning in a profit
 Expand market and growing working
capital need
Third
Stage
1-3 Medium
 Market expansion, acquisition &
product development for profit making
company
 Also called Mezzanine financing, this is
expansion money for a newly profitable
company
Fourth
Stage
1-3 Low
 Facilitating public issue
 Also called bridge financing, it is
intended to finance the "going public"
process
.

Question: Discuss the “Start Up India Scheme” initiated by Government of India?
or
What is a Start up to avail government schemes?
Answer:  Start up India scheme was initiated by the Government of India on 16th
January 2016.
 For the purpose of this scheme, Start Up means an entity
 Incorporated or registered as either a Private Limited Company or a
Partnership Firm or a Limited Liability Partnership in India
 Not prior to 5 years
 With annual turnover not exceeding Rs. 25 crore in any preceding financial
year and
 Working towards innovation, development, deployment or
commercialization of new products, processes or services driven by
technology or intellectual property.
 Further it is provided that
 Such entity is not formed by splitting up, or reconstruction, of a business
already in existence.
 An entity shall cease to be a Start up if its turnover for the previous
financial years has exceeded Rs. 25 crore or it has completed 5 years from
the date of incorporation/ registration.
 A Start up shall be eligible for tax benefits only after it has obtained
certification from the Inter-Ministerial Board, setup for such purpose.

Concept Jaan Lete hai
 Start up ek fancy term h – unn logo ke liye – jo business kar rahe hai – par unko business ki
knowledge ni h – like agar TATA koi naya business krti hai – toh woh business hi hota hai –
usse startup ni bolte – par agar ek naya banda suppose mein business karuga toh woh start
up hoga.
 Startup shuru krne wale ko entrepreneur bol dete hai – iss bande par experience ni hota –
na hota paisa – the only thing he believes is apni skills – iske pass skills hoti hai – jisme yeh
education and technology ka support leta hai – dheere dheere experience gain karta hai –
and startup ko successful banta hai – par obviously saare startup successful ho possible ni
hai.
 Sabse phle kisi bhi start up ya business ko shuru krne ke liye apko chahiye ek idea jis par aap
kaam krne wale ho – idea banate time 3 factors important hote hai –
o Suitability i.e. idea mere goals se match krta ho
o Feasibility i.e. mere liye idea ko implement krna possible ho - like mein socho ki oil
refinery open karuga jisme investment 500 crore chahiye toh yeh mere liye feasible
ni hai – bcoz mere pass utne paise ni hai.
o Acceptability i.e. ki society accept kre usse.
 Abb baat aati hai finance ki – 5 mode hote hai finance ke – general terms mein – sabse phla
hai – FFF i.e. family friends and fools – yeh basically means phle khud ke paise lo – fir family
ke lo – fir friends ke lo – isse bolte hai seed finance.
 Fir jab hum break even par pauch jate hai – toh bahar walo ka bharosa aa jata hai hum par –
and woh humko loan de dete hai subsidized rate par – iss bolte hai angel investors.
 Fir jab hum ek achi position mein aa jate hai – toh humara saath den aa jate hai venture
capitalist – venture means short term- matlb aise log jo short period ke liye hume bahut
paisa de dete hai via company mtlb hmri company ko deta hai – obviously series ya
tranches mein – aur humara naam karwa dete hai duniya mein – ultimately humari value ko
bahut high kr dete hai – bahut hi jyda.

 Par yeh venture capitalist koi equity hold ni krte humre mein – yeh ek period ke baad nikl
jate hai – bahar apna paisa le kar – lifetime ni rehte- yeh hum ko uss position mein laa dete
hai ki IPO nikl le hum apna – and uss IPO mein yeh sbse phle apna share public ko sell krte
hai
IPO ke liye investment banker ko late hai – par IPO ek bahut time consuming chiz hai –
bahut formalities hai – venture capital itne time ni rukta - usse toh paisa niklne ki hoti hai –
so IPO aane tak ke liye – yeh venture capital apna share sell kr deta hai – kisi financing
company – jo uss chote period ke liye company ko finance krti hai – and iss finance ko bolte
hai – bridge financing/Mezzanine.
Jab tak IPO ni aata tab tak yeh support krte hai – usually for a period of 1 year – fir IPO aa
jata – toh yeh apna share bech dete phle and paisa kuch bachta toh promoter ko de kar nikl
jate – fir humri company public deposits par chlti hai.
 Abb agar thoda detail mein baat karte hai venture capitalist par – kyuki iss pure process
mein sabse jyda importance issi ki lagti hai.
 Modus Operandi of VCF i.e. operation kaise krte hai
 As we said earlier, ki VCF series mein paise deta hai – toh har series ke payment ke time –
ya for very investment – revaluation of the startup firm is made. Yeh valuation koi
professional karta hai.
 Iss valuation ka bhi apna process hai. Valuation ka wahi principal hai – Present value of
expected future revenue – Discounting Method. Yaha sabse difficult kaam – future revenue
ko project karna hai. Generally trending revenue lete hai badhte hue and cost ko low trend
mein lete hai – and profit nikl lete hai – yeh trend past information se nikl lete hai.
 Abb valuation aate hi – VCF action leta hai – phle toh negotiate krega – ki jaa like 3 saal ke
liye deta hu paise – itna return de skte ho – ya equity de do – ya preference de do – kya de
skte ho tum mere ko – aisa startup se bolega. Ek type se conditional loan hota hai.
Fir yeh conditions zaruri ni hmesha rahe – ho skta hai – agar kaam pasand aaye toh
conditions kam kar de.

Further yeh bhi zaruri ni ki series A ki funding jis venture ne kari hai – wahi series B ki
funding bhi de – like Softbank se bole the – ki series A ka paisa khtm toh hum gaye ki series
B do – Softbank bola mere pass bhi ni hai – toh hum dusre VCF par jayegy.
Abb dusra wala – valuation kar ke paise dega – abb yeh naya wale ko ya toh promoter apna
share dega ya fir VCF1 ka share degy as per agreement – jo bhi decided hoga ki phle kon
share bechega.
 Abb yeh jo valuation hota hai – uske baad apne return ko dekhte hue – VCF paisa daalti hai
– nad uss according – ownership leti hai. Iss ownership and valuation ke 2 approach hai
 Ek hota hai – valuation from the perception of VCF – jisme calculation kuch aise hoti hai
Post Money Valuation = %
Pre Money Valuation = Valuation of entrepreneur fund or Balancing figure after calculating
Post Money Valuation
Practical
Question:
Calculation of degree of holding to be acquired by VCF to ensure its desired
return!!
A Start up has approached a VCF to invest 60 Crores in 5 years venture. The VCF
requires a return of 30% p.a. At end of 5 years, the start up will come out with an
IPO at an expected PE Multiple of 10 times. The expected earning of start up for
the 5th
year is Rs. 50 Crores.
Question: Find ownership %ge required by the VCF to get its desired return?
Solution:
Desired value of investment after 5 years = Rs. 60 Cr * (1.30)5
= Rs. 222.78 Cr.
MV of start up at end of 5 years = Earning * PE = Rs. 50 Cr. * 10 = Rs. 500 Cr.
Therefore,
Degree of holding to be negotiated = Rs. 222.78 Cr / Rs. 500 Cr = 44.56%
This implies that,
By giving Rs. 60 Cr; VCF would own 44.56% of the start up.
Question: What is the perceived value of start up now?
Solution:
For 44.56% ownership = Rs. 60 Cr to be invested
Therefore,
For 100% ownership = Rs. 60 Cr / 44.56% i.e Rs. 134.65 Cr. to be invested
Here,
 Rs. 134.65 Cr is the post money valuation of start up i.e. valuation of start up
with investment of VCF.
 Rs. 74.65 Cr (balancing fig. for entrepreneur) is the pre money valuation i.e.
valuation of start up without investment by VCF.

 Dusra approach hota hai – professional ka approach – or owner ka approach. Previous
approach mein kya hota tha – VCF aata bolta mere ko yeh return chahiye – and yeh
ownership – toh yeh tumhara valuation hai – aare bhai – meri firm mere se toh pucho ki
mera value kya hai – toh iss approach mein hum apne start up ka value kya hai – and
dispute na ho – isliye hum professional ki help lete hai.
 Abb uss professional ne sab kar ke btaya ki bhai – 100 Lakh value hai – toh VCF puchega – ki
mere se kitna chahiye – say hum bole 25 lakh bus. Abb VCF puchega – ki 100 Lakh mere
amount ko mila kar hai – ya mere amount ke bina:
Practical
Question:
A start up needs Rs. 25 lakhs from VCF by a professional value. Start up was
valued at Rs. 100 Lakhs. Now this value of 100 Lakhs can be understood as
Pre Money Valuation i.e. 100 lakh is excluding the effect of Rs. 25 Lakhs
Start Up Value 100 Lakh 80% of Holding
VCF 25 Lakh 20% of Holding
Total 125 Lakh 100% of Holding
Abb yaha holding mere hisab se aai – VCF ke hisab se ni.
Post Money Valuation i.e. 100 lakh is including the effect of Rs. 25 Lakhs
Start Up Value 75 Lakh 75% of Holding
VCF 25 Lakh 25% of Holding
Total 100 Lakh 100% of Holding
Abb yaha holding mere hisab se aai – VCF ke hisab se ni.

Practical
Question:
TMC A VCF received a proposal for finance of Rs. 45 Cr. which returned Rs. 600 Cr.
after 6 years, if successful. However, the project may fail at any time during the
period of 6 years.
Year 1 2 3 4 5 6
Probability 0.28 0.25 0.22 0.18 0.18 0.10
In the above, probability of failure of project, in the second year is given that it has
survived throughout the first year and so on. TMC is considering an equity
investment, the “Beta” of this type of project is 7 times. Rm = 8% and Rf = 6%.
Advice, TMC on acceptability of this project.
Solution: Working Note 1: Calculation of Probability of success [Important]
Year Calculation Probability of Success
1 1 – (0.28) 0.7200
2 0.72 * 0.75 0.5400
3 0.72 * 0.75 * 0.78 0.4212
4 0.72 * 0.75 * 0.78 * 0.82 0.3454
5 0.72 * 0.75 * 0.78 * 0.82 * 0.82 0.2832
6 0.72 * 0.75 * 0.78 * 0.82 * 0.82 * 0.90 0.2549
Therefore,
Probability of success over 6 years = 0.255
Probability of failure over 6 years = 0.745
Working Note 2: Calculation of Return of Equity (ke)
Ke = Rf + (Rm - Rf)*β = 6% + (8% - 6%)*7 = 20%. Therefore Cost of equity is 20%
Working Note 3: Calculation of NPV of project, if successful
PV of Cash Inflow = 600/(1.2)6
201
Less: Net Investment (45)
Net Present Value 156
Working Note 4: Calculation of NPV of project, if fail
PV of Cash Inflow 0
Less: Net Investment (45)
Net Present Value (45)
Therefore,
Expected NPV = (156 * 0.255) + (-45 * 0.745) = 6.255 Cr. Thus Project is viable.
.

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