The Hindu Business Line : A matter of capital

Business is all about people I had asserted in an earlier article. Once your business gets running, it will often seem to be all about money. In fact, without money or capital as the technical types call it, it is hard to keep people in mind or focus on nearly anything else.

That said, how much capital does your business truly need? Is there such a thing as too much money? In the context of entrepreneurs and start-ups, this is a surprisingly relevant question. You read the oft-quoted statistics of a majority of new companies failing within the first few years, most due to insufficient capital. Nevertheless, it is likely that as many failures occur because of too much money, most of it spent the wrong way. The dotcom era excesses were the most blatant, recent examples of too much money.

So how much money is right for your business to get started? If you are trying to start a small business such as desktop publishing, you may not need a lot — a few thousand dollars at best. However, if you are planning to start another Federal Express or Airtel, you may need tens if not hundreds of millions of dollars. Even if you start small, as Dell Computer did out of Michael Dell’s dorm room, knowing where you want to go and how much money you’d need before turning profitable or going public would help you manage your business better.

Company structure

An entrepreneurial business in India can take one of several forms including sole proprietorship, a partnership or a private (limited) corporation. The primary difference between these forms is in the extent and nature of capital and shareholding (restricted for the first two and wider for corporations), liability (unlimited in the case of proprietorship to limited in the case of a corporation) and statutory obligations (simplest for proprietorship to complex for a corporation). In fact, your firm potentially could begin in one form and evolve into another — it is better to give some thought to where you want to go as a business and keep it simple by picking the most appropriate one up front. This article focuses primarily on corporations, which are the most likely to raise significant capital from third parties.

Capital

Capital is nothing but the money or assets you raise or accumulate in order to run your business. Financial types refer to this as equity, as typically it is exchanged for shareholding in the company. Most entrepreneurial firms start on a shoestring (‘boot-strapped’) with the founders’ or family savings (the original angel funding mechanism). Technology firms also usually involve a fair amount of ‘sweat’ equity — contribution made by founders, employees and even service providers, who invest time and effort in exchange for equity rather than cash. While sweat equity helps get companies off the ground, build and demonstrate a prototype or a small quantity of products, it doesn’t pay the rent and electricity bills. For that, real money will be required such as those from angels.

Recently, formal angel funding, common in the US, has made its appearance in India. Angels are usually successful entrepreneurs or other high-net worth individuals, who invest small to medium sums either individually or in groups along with other angels. Angel investment accompanies or usually follows sweat equity by the founders and is a stepping stone to raising more capital subsequently from venture capitalists. In addition to capital, angels can bring their advice and Rolodex, which a start-up can sorely need. And unlike your uncle, they usually don’t feel they own your business just because they gave you some money. The Indian Angel Network, for instance, is one such group of angel investors.

Venture capitalists (VCs) are another source of capital for entrepreneurial firms. In Silicon Valley, California, they constitute the largest source of capital for start-ups. In India, venture capital is a relatively new phenomenon, though the last couple of years have seen the appearance of the large US players and consolidation amongst the Indian players. In mature markets, VCs have further segmented into early stage (smaller and riskier investments very early in a company’s life) and late stage (usually larger and somewhat less risky investments in companies that have already raised venture funds once or more). Typically, VCs tend to make larger investments than do angels and tend to focus their investments in specific focus areas. They also take board seats and preferred stock — it is therefore critical that entrepreneurs ensure vision and goal alignment with their VCs (or other investors) than just see them as walking dollar signs! The Indian Venture Capital Association is a good source of information on VCs in India.

You will notice that I have not mentioned banks as a source of equity. Banks are quite useful when it comes to organising working capital, which they usually provide as debt rather than as equity. They are also the most conservative of capital sources and therefore it is hardest to make them part with money in amounts and timelines that an entrepreneur needs or wants.

Debt and other forms of financing

Debt is a word imbued with much emotion for most people. We’ve all been taught debt is a bad thing, “You don’t want to carry debt or be indebted to someone else,” and many of us have learned this lesson the hard way with credit card debt or other borrowings. Yet, those amongst us who have bought houses, particularly, know that debt of the right kind can be empowering. We’d have never been able to buy that first car or apartment without a bank loan or debt. In my view, debt, like any other powerful tool such as fire or a sharp knife, needs some careful handling and when handled appropriately can make our businesses and us successful.

It is here that banks, despite their conservative nature, shine. They should be your lenders of first choice, rather than that seedy gentleman at the local pawn shop or your slick credit card issuer. Banks lend money to businesses under a variety of guises, starting with simple lines of credit (loans, often secured by company assets or personal guarantees within a limit), to others such as packing credit (against orders) or bills discounting (against invoices or bills raised against customers) often at preferential rates. Such debt instruments, regardless of the capital raised, can mean the difference between running out of cash (which is a very bad thing) or not (you get to live another day as a business).

Capital, in every form, is a great multiplier and would be needed sooner in instances of capital intensive industries such as pharmaceuticals or semiconductors or in truckloads if you are planning to roll out a national retail chain. Personally, I believe in boot-strapping. Most start-ups go through a phase of self-discovery, which is best done without investors fretting over your seeming indecisiveness. However, your company, like every other, is sooner or later going to need some serious infusion of capital — invariably you will find that you need more than you reckoned. At that point, as an entrepreneur, you should be concerned less about dilution of equity and more about what value can be created with new capital and who you are raising the capital from!

(The writer was founder and CEO of Impulsesoft Pvt Ltd, which grew from a bootstrapped organisation of two people to a global leader in Bluetooth wireless stereo music prior to being acquired by SiRF Technology Inc in 2006. Srikrishna, who has an MS and a PhD from the University of California in Berkeley, has more than 18 years of experience building and marketing semiconductor and software products. He writes for The New Manager on the travails and triumphs of being an entrepreneur. You can contact him at k-srikrishna@hotmail.com.)

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