Alternative Sources of Finance
Alternative Sources of Finance: Basics
Meaning: Funding channels beyond conventional bank lending and public capital markets. |
Why needed: Startup funding, growth, innovation, infrastructure and diversification. |
Equity: Angel investment, VC, PE. |
Debt: Private credit. |
Platform-based: Crowdfunding. |
Purpose-based: Infrastructure and social-impact financing. |
Startup funding: Umbrella covering multiple funding sources. |
Indian ecosystem: SIDBI, Startup India, FFS, SEBI, NABARD, NIIF. |
Debt vs Equity Financing
Core concept: Equity = ownership; Debt = borrowing. |
Equity: No compulsory repayment or fixed interest; dividends/capital gains for investors; ownership dilution. |
Debt: Principal repayment + interest; no ownership dilution; increases financial risk. |
Major advantage: Equity reduces repayment pressure; debt preserves ownership. |
Major disadvantage: Equity dilutes control; debt creates fixed repayment obligations. |
Key terms: Leverage = use of debt; Gearing = debt-equity relationship; Collateral = security for loan; Dilution = reduced ownership percentage. |
Interest is generally tax-deductible subject to tax rules; dividends are not deductible business expenses. |
Angel Investment
Core concept: Wealthy individuals invest their personal money in early-stage startups. |
Stage: Pre-seed, seed and early stage. |
Form: Equity or convertible instruments. |
Returns: Capital appreciation through startup growth or exit. |
Additional support: Mentorship, expertise and business networks. |
Pre-seed: Funding at the idea/concept stage. |
Seed funding: Initial capital to develop a product or prototype. |
Exit: Investor realises returns through sale, acquisition or IPO. |
Angel investors take high risks because startups have uncertain survival and returns. |
Key distinction: Angel = individual’s own money; VC = professionally managed investment fund. |
Venture Capital
Core concept: Professionally managed funds invest pooled capital in high-growth, high-risk startups. |
Stage: Seed, early-stage and growth-stage businesses. |
Form: Equity / equity-linked instruments. |
Returns: Capital appreciation through eventual exit. |
Process: Pitch → Due diligence → Valuation → Term sheet → Investment → Monitoring → Exit. |
Due diligence: Detailed examination before investment. |
Valuation: Estimated worth of the startup. |
Term sheet: Preliminary document outlining investment terms. |
Portfolio company: Company in which the fund invests. |
Follow-on investment: Additional investment in an existing portfolio company. |
Dry powder: Committed but uninvested capital. |
Unicorn: Privately held startup valued at USD 1 billion or more. |
Exit: Sale of investment to realise returns. |
Funding rounds: Series A → Series B → Series C and subsequent rounds. - Series A: Scaling a business model with initial market traction. - Series B: Expanding operations and market reach. - Series C onwards: Larger expansion, acquisitions or preparation for an exit. |
Stages of VC Financing
Stage Purpose
> Seed Develop idea, prototype and proof of concept
> Startup Product development and initial marketing
> Early stage Begin commercial production and sales
> Growth stage Expand operations, market share and capacity
> Late stage Scale operations before IPO or acquisition
Private Equity (PE)
Core concept: Investment in privately held companies, generally established businesses. |
Form: Equity / equity-linked instruments. |
Objective: Improve company value and exit at a profit. |
Involvement: Management, governance, restructuring and strategic decisions. |
Major types: Buyout, LBO, Growth Capital, Distressed Investment, Minority Investment. |
Important keywords
- Buyout: Acquisition of a controlling stake.
- LBO: Leveraged Buyout, Acquisition financed substantially through borrowed funds.
- Growth Capital: Funding expansion of established businesses.
- Turnaround: Reviving a struggling business.
- Value Creation: Increasing business value through operational/strategic improvements.
- Exit: Sale, acquisition or IPO.
Startup Funding
- Core concept: Capital raised by startups to develop, launch, operate and expand.
- Funding lifecycle: Bootstrapping / Pre-seed → Seed → Early stage → Growth → Late stage.
- Sources: Own funds, Friends & Family, Angels, VC, Bank Loans, Government Grants, Crowdfunding, Incubators/Accelerators.
Important keywords
- Bootstrapping: Using personal funds / internally generated revenue.
- Incubator: Supports early-stage startups with mentoring and infrastructure.
- Accelerator: Fixed-duration programme to speed up startup growth.
- Burn Rate: Rate of cash consumption.
- Runway: Time available before cash runs out.
- Product-Market Fit: Product satisfies genuine market demand.
- Bridge Financing: Short-term funding until the next funding round or financing event.
- Valuation: Estimated worth of the startup. |
Formula: Runway = Available Cash ÷ Net Monthly Burn Rate.
Key distinction: Incubator nurtures; accelerator speeds up growth.
Recall trick: Startup funding = Funding needs across the entire business lifecycle.
Crowdfunding
- Core concept: Raising funds through small contributions from a large number of people, usually via online platforms.
Four types
- Donation-based: No financial return.
- Reward-based: Product / reward in return.
- Equity-based: Shares / ownership.
- Debt-based: Loan repayment with interest.
Advantages: Wider access to capital, market validation, publicity and reduced dependence on traditional finance.
Risks: Funding target may not be met, fraud, platform fees, IP exposure and regulatory concerns.
Important keywords
- All-or-nothing: Funds released only if target is achieved.
- Keep-it-all: Amount raised retained even if target is missed, subject to platform terms.
- P2P Lending: Direct lending through an online intermediary platform.
- Funding Target: Amount campaign aims to raise. |
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