Banking Banking On Startup Success
While it is still early days for the Indian startup ecosystem, it is a great time to be an entrepreneur in Asia's third-biggest economy. For every aspiring entrepreneur toiling incessantly as nights blur into days, there is present a Venture Capital institution, an incubator or an angel invest or ready to foster their fledgling innovation. However, no economic success story can ever be complete without the fundamental role of banking institutions.
In this era of unicorns and soonicorns, it is easy to lose sight of startup failures. Reasons for these failures may be aplenty, but not knowing how to navigate through financial challenges is a recurring one. Owing to the idiosyncratic and continuously-changing nature of startups, banks can play varying roles at different stages of a startup's journey.
At an early stage, their significance could be defined by ease of banking and working capital management. Enter growth stage, and this would evolve into investment management, financial planning and end-to-end advisory services. Today, even growth-stage startups are keen to transcend international borders and having the right banking partner can greatly enable them to do so.
Let's look at this as an analogy. Think of the startup as a vehicle, funding as fuel for the vehicle and the bank as a well-informed mechanic. For short distances, the driver need only rely on a full fuel tank to cover the distance. This, however, changes when the driver must drive cross-country. Having a mechanic at your disposal, who understands the complexity of your vehicle, would help prepare for the endurance demands of an extended haul.
Similarly, startups must prioritize endurance and focus on long-term sustainability. It's imperative for founders to think beyond just sourcing capital. Banks recognize the many moving parts of a business and the plethora of challenges faced enroute. Consequently, they can play a pivotal role by ensuring access to
capital, money management tools, diligent insights, legal solutions, and more.
The Funding Landscape
Access to capital has been paramount for emerging growth companies in India. Equity financing breathes life into the startup during its early stages. In recent times, seed and early stage deal volume has increased considerably due to increased competition for deals, signaling healthy momentum. These accounted for 70% of the deal volume increase in 2019, according to Bain & Co. Equally critical is feasibility and flexibility of capital. As a startup evolves, so must its capital allocation and sources of capital.
To meet this need, Venture Debt has emerged as an integral part of an entrepreneur's arsenal. A complement to equity, venture debt has allowed entrepreneurs to allocate capital more efficiently and avoid diluting the fruits of their labor significantly. Yet, despite the rise of equity and debt financing, a parochial approach to capital has inhibited the ecosystem in some ways. There is excessive reliance on equity funding, and venture debt largely remains under penetrated and suffers from lack of innovation.
Putting our analogy into perspective, the tools and sources of capital must evolve as the business moves towards maturity with increasing complexity. A startup must not solely rely on subsequent rounds of equity funding or "one-size-fits-all" credit solutions to keep the engine running. Banks, albeit embryonic, have started emerging in this regard. Venture debt institutions employing methodical underwriting tools have served as a muse for some banks. In some instances, banks are partnering with these institutions, fostering creativity and versatility.
Businesses must balance the interests of the management, employees, investors and various other stakeholders in a transparent and objective manner
What Banks Look For
Startup land is unchartered territory for most banks in India. Hence, they tread cautiously on this land left fallow. There are four key characteristics that banks evaluate in a startup liquidity position, scalability of relationship, data integrity and corporate governance.
Firstly, understanding the liquidity position of the business. Efficient liquidity management and robust liquidity position signify financial prudence. Secondly, ascertaining the scalability of the relationship. Banks build a comprehensive working relationship and become well entrenched into the business as it scales. Thirdly, analyzing the protocols set by the company to ensure data integrity.
Without data integrity, information would at best be a diminished source. The relationship must be built on a strong foundation of trust. Lastly, understanding the corporate governance framework. The business must balance the interests of the management, employees, investors and various other stakeholders in a transparent and objective manner. High governance standards indicate how the affairs of the company are controlled and operated.
The landmark move by the central bank to grant `Priority Sector Lending' status to startups is key to further augment the ecosystem. The onus must be shared by entrepreneurs and bankers alike to cooperate, adapt, participate and build mutual trust for building an efficient ecosystem.