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Investor, Partner or Direction: Choosing the source of funding and the strings that come attached

Equity is often less daunting than debt – we all know that. However, equity often comes with hidden costs and strings that can be tougher to traverse than debt – especially if you do not understand what kind of investor your company actually needs.

Broadly speaking, equity funding is usually divided into two broad areas i.e. strategic funding and pure equity funding.

The former is fairly self explanatory – it entails a strategic investment which provides either forward or backward linkages to both entities.

A strategic investor by definition will look beyond the numbers – he will look at synergies. Often, the strategic investor will see value in processes, customers, markets, employees or technology. A lot of these will be intangible in nature and will be changed as a result of the strategic tie-up. This sort of investor will inherently be involved in the daily functioning and will want a say in how your business is run- a big say. 

More often than not, people issues and organizational synergies become the biggest stumbling blocks in strategic relationships’. This is because after the I’s have been dotted and T’s crossed, the implementation is a people driven , operational process and core values, organizational culture and dynamics has the biggest role to play.

If the synergies are strong enough and the implementation noise manageable, this is one of the fasted ways for an organization to grow – since it is actually two strategies, a new vision and double resources (almost) that can expand to new markets, customers , etc at a pace which is unmanageable through regular growth patterns.

The second type of funding i.e. pure equity funding comes in a variety of forms. The broad investor type that you are looking for will depend on the stage of your business cycle.

The earliest forms of funding are angel and seed funding wherein small amounts of money are given to start-ups. These almost always come coupled with expertise and a hand-holding program to ensure the start-up takes off as expected. This is the best form of funding if you are looking for significant value add and are comfortable with a lot of attached strings – tangible and intangible. The biggest upsides are that once angel of seed funded, a set up minimizes its start up risk. Also, the next few rounds of funding for growth are a lot easier if you have an angel or seed fund backing you up. Often these funds give you the option of a combination of debt and equity investments. Debt is almost always available if you approach an incubator facility for your start-up.

The other option is venture capital funding which are more pure-play financial investors and look primarily for quick financial returns. The usually part with relatively larger amounts of money but their requirements are far more aggressive. They need fast returns and fast exits from your business so the pressure is tremendously high. The upsides are similar to angel funding with the addition of more autonomy in daily functioning - as long as you remember the aggressive strings attached and high standards that they will usually put forward.

Finally, there is traditional private equity funding wherein larger amounts are invested and the time frames for exit are also longer. Depending on the nature of the industry that the fund is interested in, they are often willing to wait for over seven years for an exit. As with all forms of funding this will entail giving a board seat (the number depends on the equity share that they hold). Some PE funds work like strategic investors i.e. they like to be closely involved which majority play the role of a financial adviser. They often invest across industries and usually enable synergies between their investments. The strings attached differ with the investment size but by and large they bring in professionalism, business relationships and a lot of direction the set up.  

Of course, you need to be sure you are ready for an equity investment and prepare your organization. Once that’s done, an equity relationship is a play of equity share, the value they assign, the value they get and whether you can deliver on your plans – because once you sign, the strings are expensive to break.


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