No matter the stage or sector of a startup, fundraising is one of its biggest challenges because it is critical for the survival of the business. Choosing the right investment route is just as crucial for startups as finding the right investor. In India, with over 39K active startups this year, the ecosystem has matured tremendously over the past five years. Today, startups have multiple options to raise funds, ranging from institutional investors, personal savings, venture capitalists, angel investors, friends and family, bank loans, crowdfunding, convertible notes, initial coin offerings, venture debts and a lot more.
“Often startups are wary of giving away equity or stake in their company to investors, which means they have to look at alternate ways of raising money. This is when startups have the option of turning to the debt market, including or other routes such as ECBs.” says Prakash Jaiswal, Country Head of Business Banking, HSBC India.
Among the various ways startups can raise funds, an upward trend has been seen for venture debt or external commercial borrowings from foreign entities. These alternative means of fundraising have opened up new doors and opportunities for startups at the right time, just as the startup ecosystem is taking strides towards maturity.
Navigating India’s Complex FDI Policy
FDI or foreign direct investment is a very popular method of raising big ticket funds from foreign entities, but a lot of the startups and sectors are left out of the fold due to stringent government norms around FDI. Even when FDI is allowed, there are a lot of conditions and stipulations on the kind of business model startups can adopt.
The best example of this is the ecommerce sector, where the FDI rules have impacted the businesses of Flipkart and Amazon as seen earlier this year. The minister for commerce and industry, Piyush Goyal, recently announced that India would not allow FDI in multi-brand retailing.
Foreign investments are ideal for growth stage startups looking for a big capital infusion, as it opens doors for international expansion and can be a big boost to any startups runway and roadmap of development. It comes at the cost of equity that founders have to give away to investors as part of the stake sale.
When Venture Debt Is The Ideal Investment Route
While equity financing means selling stake to investors, startups have other ways to raise money without diluting their shares. Startups are expected to raise between INR 1500-1800 Cr of venture debt in 2019, which will be a healthy 25-30% growth over 2018, which saw the likes of Swiggy, BYJU’S, OYO, Myntra, Big Basket and Yatra raise money through venture debt.
This is usually provided to early and growth stage VC-backed companies, which have shown good promise or have a proven track record in their sector, based on the projections for their business, user and revenue growth. Venture debt typically consists of a two to three year term loan or equipment lease, depending on the sector the startup operates in.
Startups are starting to prefer venture debt over stake selling, as it results in less equity dilution for entrepreneurs and investors than FDI or VC funding. It also does not require a startup to have a pre-existing valuation from previous funding rounds, while the due diligence procedure is also typically less time consuming, which can lead to a quicker fundraising process.
Why Startups Need To Consider ECB
Unlike venture debt or FDI, ECBs are essentially a loan availed by a startup from recognised non-resident entities such as foreign commercial banks and other institutions. AD Category-I banks such as HSBC support startups in raising funds through ECB under the automatic route. ECBs include commercial bank loans, buyers’ credit, suppliers’ credit, as well as other securitised instruments. In this context, HSBC plays the role of a knowledge partner to help startups understand ECBs and assists in regulatory reporting.
ECBs for startups was introduced earlier in 2019 and was mostly open to the traditional manufacturing sector. The RBI allows startups to raise up to $3 Mn or an equivalent amount in a financial year through ECBs. More importantly, conversion into equity is permitted, subject to regulations applicable for foreign investment in startups. ECBs have emerged as a major form of foreign capital alternative as they are known to be dependable and easier to obtain with the right banking partner.
Easy Access To Working Capital
When a business grows, the need to manage cash and trade flows more efficiently becomes more and more significant. Working capital solutions offered by banks help startups unlock funds trapped in inventory or receivables to keep the supply chain moving. The bank also offers access to short-term and long-term loans designed to meet specific working capital needs.
HSBC’s dedicated startup team offers in-depth knowledge to help startups assess market, payments, operational, so startups can bridge the gap between settlement and payments.
“To conduct business with confidence and to have enough fuel for expansion, startups can turn to banking partners and use their platform to free up working capital and get guidance and support to raise funds for their next stage of expansion,” adds Jaiswal
To know more about HSBC India’s dedicated solutions for startups click here.