Why Startups Choose PE Funding over Debt or Loan?
Entrepreneurial endeavors today are a tall block in the financing & investing realms. The possibility of overcoming the biggest obstruction – cash crunch - in a big way through private equity (PE) funding is electrifying for the emerging contemporary business generation. According to a NASSCOM report dated October 2015, US, UK, and India are leading the charts (in that order) for the maximum number of startups in the world last year. According to the Prequin’s Global Private Equity and Venture Capital (VC) report, 2016, 689 PE firms raised a cumulative capital of $288bn. Of these, a total of 9241 VC transactions worth $136bn were conducted by the end of 2015. The ‘dry powder,’ as per the report, shot up by 9% in comparison to 2014. Total dry powder in the PE slab stands at $755bn, as on June 2015. Clearly, a coordinated funding modality has been established between the startups and the investors, which kind of eliminates debt or loans as a financing option.
Today, many potential micro firms are able to set off and land firmly on the global business space. But, why do entrepreneurs prefer PE funding to loan? Why these newbies are willing to trade the company’s part ownership when a cut and dry, no obligations payback loan tool exists? Without foraging into the mechanics of the types of startup funding, I am delving here purely into the mindset and the possible logic of the entrepreneur’s financing preferences. As per my experience, observation, and analysis, the following are the key triggers:
- Large Capital Inflow: PE Funds are granted commensurate with the business potential and the possible requirements for scaling up. Investors understand a business’ ethos, its plan, envision its growth potential, and know that you need to go full force simultaneously to taste success. Bits and pieces, here and there are actually wasted resources. Accordingly, they setup the funding with adequate riches. A neat amount helps startups ride the growth curve with the market strategies implemented in desired spaces and at the right time. The entrepreneurs get financial feasibility to ‘run’ their ideas. On the other hand, banks or informal lenders (friends, family, etc.) may not extend the loan of that quantum and the cash issue may continue to persist.
- Management Expertise: Unlike loans, with investment, comes investors control as well. Since returns are driving the whole cruise, the investors go extra mile to help the startup succeed. Besides money, they bring their strategic competence and network to the table. This undoubtedly benefits the business. In fact, if things do not work out, they often even help make you a last strategic decision on exiting or on shut it all down. Though heartbreaking, it does save on any more resources drain at all levels. However, this ‘control’ is often considered as the biggest disadvantage of equity funding even though it may actually be a savior. Apple and Housing.com are concrete examples of things going all wrong between the owners and the investors. Ironically, the founders were made to walk out of their own business. Investment is a thorough financial deal and the involved business owners must understand that on ground, the practicality prevails and not love, emotions, and dreams you have for your business. Numbers and just numbers have to be your sole target when someone has trusted their money in you. Be responsible and try accommodate & honor business experience. Dot.
- Stress Free Money: With no liability of repayment like a loan EMI or mortgaging a property, PE funding lifts off a huge stress from the entrepreneurs. Whether or not you generate enough revenue, the lent out money has to be paid back as per the agreed schedule. Equity funding generously exempts the entrepreneurs from this angst. They are able to channelize their time, money, and mental space in trying out some innovative strategies as well, since failure will not mean you being a defaulter. The investors will recover their return if and as the business revenues push up. So, you work at growing the business and the ROI is the automatic side product.
- Saving the Failing Back: In February 2016, CB Insights featured a list of 156 funded US startups that failed for varied reasons like bad hire, wrong demand interpretation, etc. So, yes, despite all the business acumen and resources availability, several businesses see the setting sun. And this probability of shutting down ‘does’ occupy an indignant, dark corner in most entrepreneurs’ psyche. I think except for the likes of those seeking productive business partnership for scaling up the business, most entrepreneurs unfortunately, subconsciously focus on failure. Equity is their risk free tool in the event of business failing. The investor will not attach their property. All that the business partners on ground give up is a sinking business' equity in the worst case. Not much to lose technically for the entrepreneur if you see. The investors are the key risk takers here.
- Clouded Market Demand: When the businesses are not able to ‘realistically’ forecast the demand pattern in the near term, loans come packed with the scare of not being able to payback. There, we see the little analyzed and selfish rush sometimes to equity funding. Of course, the investors thoroughly grill the entrepreneurs and gather all the relevant facts before any financial commitment, still pre-funding, the inside story is best known to those running the show. And this sometimes work to the advantage of such business owners.
- Lifestyle Upgrade: Equity funding essentially formalizes the business structure. The entrepreneurs get converted to highly paid top management employees with a high stake in the company. If we see this in black & white, the entrepreneurs are able to evolve their living with no 'ultimate' stress of a financial liability. It totally boils down to something very intangible - human virtue - here. While for many, the funded businesses are a tool to lifestyle upgrade until it lasts, the genuine ones stay dedicated to their venture and failure sure is not an option for them.
The idea is not to be judgmental for or against equity funding or loans. The trick is to understand and sincerely utilize the immense advantage equity funding offers. In fact, this should be the trade in order to transition the global business map to higher gradients. -Rakhi Sinha, Founder, Owner, & CEO The Syntax Systems. (Her Blog: http://sinharakhitss.blogspot.in/)