Startups should constantly raise money because approximately 38% of them fail because they run out of cash or don’t raise money on time. Both founders and investors must comprehend the nuances of the investment, such as each party’s rights, duties, and engagement while seeking money.
A firm may scale up and expand into new areas thanks to funding, among other factors. These elements increase revenue and help businesses build a solid presence in the market. As roughly 38% of businesses fail because they either run out of cash or fail to obtain funding on time, entrepreneurs should also aim to raise money periodically.
Given that India has the second-highest number of startups in the world and that 69% of all companies worldwide started as home-based enterprises, this issue is particularly crucial in the context of India. India has seen a rise in startup investment, with $42 billion raised by Indian businesses in 2021. As a result, understanding the idea of startup finance is now much more important as a result.
Self-funding, or bootstrapping, is the customary first stage, during which an entrepreneur decides how much money he or she can give out of pocket and asks family and friends for lower-interest loans. There are fewer obstacles and paperwork obligations at this level. In the second step, known as the seed stage, the actual fundraising starts. Entrepreneurs borrow money at this stage from institutions like incubators, microlenders, and accelerators, among others. This round’s investment will be used to carry out market research to understand consumer wants and preferences.
When a company’s goods or services are ready for sale, venture capital investment is needed after this level of funding. Series A, B, and C are three separate fundraising tiers for venture capital. In addition to receiving finance from lenders and incubators, business owners may also raise money by way of an IPO (IPO). A corporation can raise money by selling shares to the public, including institutional investors and private buyers.
Rights Related to Startup Financing
Legal agreements in startup fundraising are largely what govern the rights of the investors and firm owners. Investors often get certain benefits, such as a stock interest in the business. On the other hand, entrepreneurs have the right to get finance and assistance from investors within a predetermined time limit.
The Types of Instruments a Startup Can Issue to an Investor to Raise Money
Convertible Note
This is a device that changes the debt of a business into equity. This note may be converted into stock by the holder in the event that the business gets further funding. The holder of the note is entitled to repayment for the loan plus interest upon realization of the maturity date, as specified in the Convertible Note agreement if the company does not acquire further funding.
These notes also contain a “discount” and a “cap or goal value.” Regardless of the company’s valuation at the time the note is converted, the cap or target valuation indicates the greatest price that the startup will pay, whilst the discount represents the lowest valuation that the firm will pay. Startups in India may offer convertible notes to investors in quantities of more than INR 25 Lakhs in accordance with the Companies (Acceptance of Deposit) Rules, 2014.
Equity
In order to distribute equity, a corporation must first determine its value and the price per share based on that value before distributing shares to investors.
SAFE (Simple Agreement for Future Equity)
This kind of agreement commonly referred to as an “equity derivative contract,” transforms the original capital put into a startup into future shares of the business. It is more negotiable because it has no maturity date or interest rate. They also incorporate contingency events, indicating whether it is in the investor’s best interests to repay the principle or convert it into stocks based on the occurrence or non-occurrence of specific events.
According to sections 42, 55, and 62 of the Companies Act of 2013, read with the Companies (Share Capital and Debentures) Rules of 2014 and the Companies (Prospectus and Allotment of Securities Rules of 2014), SAFE notes may also be used in India in the form of Compulsorily Convertible Preference Shares (CCPS).
Both founders and investors should be aware of the complexity of the investment, as well as their respective roles and responsibilities while raising capital. It’s crucial to keep in mind that choosing the wrong kind of contract might have serious repercussions.
Edited by Prakriti Arora
