CHAPTER 6

1
FUNDING & VALUATION

LEARNING OUTCOMES
By the end of this chapter, students will be able to:
 Understanding basics of Startup Funding & where to get investment
 Prerequisite of Startup Funding
 Quantifying the seed capital
 Financial Modelling for the Startups
 How to approach Angel Investors & VC Firms
 Understanding Term Sheet, Investor Agreement and Equity Dilution,
the science behind 'Startup Valuation'

© The Institute of Chartered Accountants of India

 6.2 ENTREPRENEURSHIP & START-UP ECOSYSTEM

CHAPTER OVERVIEW

Startup Funding Where to Get Funding

Prereuisites of Funding Steps Involved in getting funds

Funding & Valuation

Quantifying Seed Capital

Financial Modelling for Startups

Approaching Angel Investors and

Term Sheet
Venture Capital Firms

Understanding Startup Funding Investor Agreement and Equity

Elements Dilution

Science of Valuation

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.3

Securing funding for a startup is a challenging and multifaceted process that requires entrepreneurs
to navigate a complex landscape of investors, markets, and competition. While the idea of receiving
financial support may seem straightforward, the reality is far from easy. Entrepreneurs must first
develop a compelling business concept that addresses a genuine market need or problem. This
entails conducting thorough market research to understand consumer preferences, industry trends,
and potential competitors.
Once the business idea is solidified, entrepreneurs often create a detailed business plan that outlines
their vision, target market, revenue model, and growth strategy. This document serves as a roadmap
for both the entrepreneur and potential investors, demonstrating the viability and potential of the
venture.
With a business plan in hand, entrepreneurs begin the challenging task of seeking funding. This
process typically involves identifying and approaching various sources of capital, including venture
capital firms, angel investors, accelerators, and crowdfunding platforms. Each of these funding
sources has its own requirements, preferences, and investment criteria, making it essential for
entrepreneurs to tailor their pitches accordingly.
Pitching investors is a critical step in the funding process. Entrepreneurs must effectively
communicate their business ideas, showcasing its potential for growth, scalability, and profitability.
This often requires compelling storytelling, persuasive presentation skills, and a deep understanding
of the market and industry dynamics.
However, even with a compelling pitch and solid business plan, securing funding is far from
guaranteed. Investors face a myriad of investment opportunities and must carefully evaluate each
potential investment to mitigate risks and maximize returns. As such, entrepreneurs must be
prepared to answer tough questions, address concerns, and negotiate terms to secure the funding
they need.
Beyond the initial funding round, entrepreneurs must also demonstrate their ability to execute their
plans and deliver results. This often involves meeting key milestones, achieving revenue targets,
and continuously iterating and improving their product or service.
While funding a startup is not easy, it is possible with meticulous planning, relentless perseverance,
and a compelling vision. By understanding the intricacies of the funding process and effectively
navigating the challenges, entrepreneurs can increase their chances of securing the financial
support they need to bring their innovative ideas to life.

© The Institute of Chartered Accountants of India

 6.4 ENTREPRENEURSHIP & START-UP ECOSYSTEM

6.1 UNDERSTANDING BASICS OF STARTUP FUNDING

Entrepreneurs seeking funding for their startup may have various purposes in mind, such as
launching a new product, scaling operations, expanding into new markets, or bolstering research
and development efforts. It's crucial for entrepreneurs to have clarity on their funding needs and
objectives.
Before approaching investors, founders should meticulously craft a detailed financial and business
plan outlining their goals, revenue projections, market strategy, and how the funds will be utilized.
This preparation not only demonstrates professionalism and commitment but also increases the
likelihood of securing investment by instilling confidence in potential investors regarding the startup's
vision and viability.
Source : https://www.startupindia.gov.in/content/sih/en/funding.html

6.1.1 Why do Startups Need Funding

Adequate funding enables entrepreneurs to develop their ideas into viable products or services,
conduct market research, and build a skilled team. Without sufficient capital, startups may struggle
to navigate challenges such as product development, market validation, and initial customer
acquisition.
Moreover, funding provides a runway for startups to survive the initial stages where revenue
generation may be limited or non-existent. Additionally, having access to funds allows startups to
invest in essential resources like technology, infrastructure, and marketing, which are instrumental
in establishing a competitive edge and attracting further investment. Overall, initial funding is vital
for startups to establish a solid footing, fuel growth, and ultimately, realize their long-term vision.

Let us explore some important areas of funding needs for startups;

Legal &
Prototype Product
Team Hiring Working Capital Consulting
Creation Development
Services

Raw Material & Licenses & Marketing & Office Space &
Equipment Certifications Sales Admin Expenses

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.5

♦ Prototype Creation: Developing a prototype is crucial for startups to validate their product
concept and attract potential investors or customers. Funding allocated to prototype
creation covers expenses related to designing, testing, and refining the initial product
iteration. This includes costs associated with materials, manufacturing processes, and
prototype iterations, ensuring that the final product meets quality standards and addresses
user needs effectively.
♦ Product Development: Funding for product development encompasses the entire process
of bringing a concept to market-ready fruition. It covers expenses such as research and
development, design, engineering, and manufacturing. This funding enables startups to
iterate on their product, incorporate user feedback, enhance features, and ensure
scalability and market readiness. Investing in product development is essential for startups
to create innovative solutions, differentiate themselves from competitors, and meet evolving
customer demands effectively.
♦ Team Hiring: Building a talented and dedicated team is critical for startup success. Funding
allocated to team hiring covers expenses related to recruiting, salaries, benefits, and
training. Investing in human capital enables startups to assemble a skilled workforce
capable of executing the company's vision, driving innovation, and achieving strategic
objectives. Hiring the right team members early on fosters a positive company culture,
enhances productivity, accelerates growth, laying a strong foundation for long-term
success.
♦ Working Capital: Working capital is essential for covering day-to-day operational
expenses and ensuring smooth business operations. Funding allocated to working capital
supports activities such as inventory management, rent, utilities, payroll, and supplier
payments. Having adequate working capital enables startups to maintain liquidity, seize
growth opportunities, and weather unexpected challenges or fluctuations in cash flow
effectively. It also provides the flexibility needed to adapt to changing market conditions
and invest in strategic initiatives that drive business growth.
♦ Legal & Consulting Services: Legal and consulting services are indispensable for startups
to navigate complex regulatory requirements, protect intellectual property, and access
expert guidance. Funding allocated to legal and consulting services covers expenses such
as legal counsel, compliance fees, intellectual property filings, and professional advisory
services. Investing in these services ensures that startups operate within the bounds of the
law, mitigate legal risks, and make informed decisions that support long-term success and
sustainability.

© The Institute of Chartered Accountants of India

 6.6 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Raw Material & Equipment: Funding allocated to raw materials and equipment is essential
for startups involved in manufacturing or product-based industries. It covers expenses
related to sourcing raw materials, purchasing equipment, and maintaining production
facilities. Investing in quality materials and equipment ensures product consistency,
efficiency, and scalability, while also optimizing production processes and reducing costs
per unit.
♦ Licenses & Certifications: Obtaining the necessary licenses and certifications is critical
for startups to operate legally and gain credibility in their industry. Funding allocated to
licenses and certifications covers expenses such as permit fees, regulatory compliance
costs, and certification programs. Investing in obtaining these credentials demonstrates a
commitment to quality, safety, and compliance, instilling trust and confidence in customers,
partners, and investors.
♦ Marketing & Sales: Funding allocated to marketing and sales is essential for startups to
build brand awareness, generate leads, and drive revenue growth. It covers expenses
related to advertising, digital marketing, public relations, sales personnel, and promotional
campaigns. Investing in marketing and sales activities enables startups to attract
customers, communicate value propositions effectively, and differentiate themselves in
competitive markets. Strategic marketing initiatives help startups establish a strong market
presence, acquire new customers, and nurture existing relationships, ultimately driving
business success and profitability.
♦ Office Space & Admin Expenses: Establishing a physical workspace and covering
administrative expenses are essential for startups to operate efficiently and professionally.
Funding allocated to office space and admin expenses covers costs such as rent, utilities,
office supplies, equipment, and administrative personnel salaries. Investing in a conducive
work environment fosters collaboration, creativity, and productivity among team members,
while also providing a professional setting for client meetings and business operations.
Further, having a dedicated workspace and effective administrative support enables
startups to streamline operations, focus on core business activities, and maintain a positive
organizational culture conducive to long-term success.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.7

6.1.2 Types of Startup Funding

Types of Equity Financing Debt Financing Grants
Capital

Brief Equity financing Debt financing A grant is an award,

involves selling a involves the usually financial, given by
portion of a borrowing of money an entity to a company to
company's equity in and paying it back facilitate a goal or
return for capital. with interest. incentivize performance.

Nature There is no Invested Funds to be There is no component of

component of repaid within a repayment of the invested
repayment of the stipulated time frame funds
invested funds. with interest

Risk Financer: There is Financer: The lender Financer: There is a risk

no guarantee has no control over of the startup not meeting
against his the business's the goal or objective for
investment. Startup: operations. Startup: which the grant has been
Startups need to You may need to provided. Startup: There
give up a portion of provide a business is a risk of the startup not
their ownership to asset as collateral. receiving a portion of the
shareholders. grant due to several
reasons.

Threshold of While startups are Startups need to Grants are distributed in

Commitment under lesser constantly adhere to different tranches w.r.t
pressure to adhere repayment timeline the fulfillment of the
to a repayment which results in more corresponding milestone.
timeline, investors efforts to generate Thus, a status is
are constantly trying cash flows to meet constantly working to
to achieve growth interest repayments achieve the milestones
targets laid down.

Return to Capital growth for Interest Payments No Return

Investor investors

Involvement in Equity Investors Debt Fund has very No direct involvement in

Decisions usually prefer to less involvement in decision making
involve themselves decision-making
in the decision-
making process

© The Institute of Chartered Accountants of India

 6.8 ENTREPRENEURSHIP & START-UP ECOSYSTEM

Sources Angel Investors Banks Non-Banking Central Government

Self-financing Financial Institutions State Governments
Family and Friends Government Loan Corporate Challenges
Venture Capitalists Schemes Grant Programs of
Crowd Funding Private Entities
Incubators/Accelera
tors

6.1.3 Stages and Sources of Startup Funding

Startups can secure funding from various sources tailored to their specific needs and growth stage.
Angel investors, affluent individuals who invest personal funds in exchange for equity, often provide
early-stage capital, offering mentorship and expertise alongside financial support. Venture capital
firms specialize in funding startups with high growth potential, injecting larger sums of capital in
exchange for equity and a role in strategic decision-making.
Additionally, crowdfunding platforms allow startups to raise funds from a large pool of individual
investors, leveraging online campaigns to garner support. Government grants and programs offer
non-dilutive funding to startups, particularly in innovative or strategic industries. Corporate
partnerships and strategic investors provide funding, resources, and potential distribution channels,
aligning with startups that complement their business objectives.
Each funding source has its advantages and considerations, and entrepreneurs must carefully
evaluate their options to secure the most suitable funding for their startup's needs and goals.

Ideation
Validation
Early Traction
Scaling
Exit Options

Stage 1 : Pre-Seed Stage

In the Pre-Seed Series stage, startups are in the earliest phases of their journey, often with just an
idea or concept. Funding at this stage is crucial for conducting initial market research, developing a
prototype, and laying the groundwork for the business.
Pre-seed funding rounds are typically led by the founders themselves, with contributions from
friends, family, and early supporters. This initial capital is used to validate the business idea, gather

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.9

feedback from potential customers, and refine the product or service offering. Success in the pre-
seed stage sets the stage for further fundraising and progress towards the seed stage.

During the pre-seed stage, entrepreneurs are in the process of conceptualizing and initiating their
ideas. Typically, the financial requirements are modest at this point. Moreover, avenues for funding
are limited and mostly informal during the nascent stages of startup development.

♦ Self-Financing or Bootstrapping: Bootstrapping involves growing a startup with minimal

external investment, relying instead on personal savings and generated revenue. This
approach is commonly favored by entrepreneurs initially, as it allows them to maintain
control over their venture without the pressure of repayment to investors.
♦ Support from Friends and Family: Entrepreneurs often turn to friends and family for
financial support in the early stages. The advantage of this funding source lies in the
existing trust and relationship between the entrepreneurs and their investors.
♦ Participation in Business Plan Competitions: Entrepreneurs can also access funds
through business plan competitions and pitching events, where institutes or organizations
offer prize money, grants, or other financial benefits. While the amounts awarded may not
be substantial, they are typically sufficient for idea-stage startups. Success in these events
hinges on presenting a well-developed business plan.
Stage 2 : Seed Stage
In the Seed Series stage, startups are in the early phases of development, typically with a prototype
or minimum viable product (MVP) in hand. Funding at this stage is crucial for validating the business
idea, conducting market research, and refining the product or service.
Seed funding rounds are often led by angel investors, venture capital firms, or startup accelerators,
providing capital in exchange for equity. Startups utilize seed funding to further develop their product,
build initial traction with customers, and attract top talent to their team. Success in the seed stage
sets the foundation for subsequent growth and fundraising rounds.
At this juncture, the startup engages in field trials, tests the product with a select group of potential
customers, recruits’ mentors, and assembles a formal team. To secure funding, the startup may
explore several avenues:
♦ Incubators: Incubators are organizations established to support entrepreneurs in
launching their startups. In addition to providing valuable services such as office space,
utilities, and administrative and legal assistance, incubators may offer grants, debt, or
equity investments.

© The Institute of Chartered Accountants of India

 6.10 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Government Loan Schemes: Various government loan schemes provide collateral-free

debt to assist aspiring entrepreneurs in accessing low-cost capital. Examples include the
Startup India Seed Fund Scheme and SIDBI Fund of Funds.
♦ Angel Investors: Angel investors are individuals who invest in promising startups in
exchange for equity. Startup founders can connect with angel networks such as Indian
Angel Network, Mumbai Angels, Lead Angels, Chennai Angels, or relevant industrialists.
♦ Crowdfunding: Crowdfunding involves raising funds from a large number of individuals,
each contributing a small amount, typically through online crowdfunding platforms.
Stage 3 : Series A Stage
In the Series A stage, startups have typically proven their concept, demonstrating initial market
traction and revenue growth. This funding round focuses on scaling operations, expanding the
customer base, and further developing the product or service. Venture capital firms are primary
investors in Series A rounds, providing substantial capital in exchange for equity.
Startups utilize Series A funding to solidify their market position, invest in marketing and sales
efforts, and build out their team and infrastructure. Success in Series A funding rounds is crucial for
startups as it lays the foundation for future growth and establishes credibility in the eyes of investors
and the market.

Startups here seek funds to further expand their user base, enhance product offerings, and
potentially enter new markets. Common sources of funding utilized by startups at this stage include;
♦ Venture Capital Funds: Venture capital (VC) funds are professionally managed
investment vehicles dedicated to investing in high-growth startups. Each VC fund operates
based on its investment thesis, which encompasses preferred sectors, startup stage, and
funding amount. VCs typically acquire equity in startups in exchange for their investments
and actively participate in mentoring their portfolio companies.
♦ Banks/Non-Banking Financial Companies (NBFCs): Formal debt financing can be
obtained from banks and NBFCs during this stage, leveraging the startup's market traction
and revenue to demonstrate its ability to fulfill interest payment obligations. This form of
funding is particularly relevant for addressing working capital needs. Some entrepreneurs
may favor debt financing over equity as it does not entail dilution of equity ownership.

♦ Venture Debt Funds: Venture debt funds are private investment vehicles that primarily
provide funding to startups in the form of debt. These funds often complement angel or VC
investments, allowing startups to access additional capital while minimizing equity dilution.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.11

Stage 4 : Series B,C,D & E Stage

In the Series B, C, D, and E stages of startup funding, companies have typically moved beyond the
early growth phase and are focused on scaling their operations, expanding into new markets, and
solidifying their market position. At this juncture, funding rounds are characterized by larger
investment amounts aimed at fueling rapid growth and further consolidating the company's market
presence.
Series B funding rounds often involve venture capital firms and institutional investors, providing
startups with significant capital injections to accelerate growth and capitalize on emerging
opportunities. As startups progress to Series C, D, and E stages, funding rounds may involve a mix
of venture capital, private equity, hedge funds, and strategic investors, each contributing substantial
amounts to support the company's continued expansion and innovation efforts. These later-stage
funding rounds are critical for startups as they seek to achieve market dominance, enhance product
offerings, and prepare for potential exits or public offerings. Series B, C & D and so on happens
generally when company has become massive in size but still wants to stay private or IPO is far off.
Such companies raises generally high funds at multi million dollar valuations and likely to have heavy
amount of cash requirement either for acquisition or burn. For example Ola has raise multiple rounds
of funds and now soon they are planning to go for an IPO
Typical funding channels employed by startups during this phase include;
♦ Venture Capital Funds: Venture capital (VC) funds, particularly those targeting substantial
investments, cater to late-stage startups. It's advisable for startups to approach these funds
once they have established considerable market traction. Sometimes, a consortium of VCs
may collaborate to fund a startup.
♦ Private Equity/Investment Firms: While private equity/investment firms traditionally focus
on established companies, there's a recent trend of some of these entities extending
funding to rapidly growing late-stage startups with a proven track record of consistent
growth. PE firms generally tend to go for undervalued so they can get some expertise and
get proper valuation for these
Stage 5 : Exit or Scale Up (Optional)
The Initial Public Offering (IPO) marks a significant milestone in the life cycle of startups,
representing their transition from private to public ownership. During this stage, startups offer shares
to the public for the first time, listing them on a stock exchange.
IPOs provide startups with access to a broader investor base, increased liquidity, and the ability to
raise substantial capital to fuel further growth and expansion initiatives. Additionally, going public

© The Institute of Chartered Accountants of India

 6.12 ENTREPRENEURSHIP & START-UP ECOSYSTEM

enhances the company's visibility and credibility in the market, attracting potential customers,
partners, and employees.

The exit stage of startups refers to the point at which investors realize their returns on investment.
Common exit strategies include mergers and acquisitions (M&A), where the startup is acquired by
another company, or secondary offerings, where existing investors sell their shares to new investors.
IPOs also serve as exit opportunities for early investors, allowing them to monetize their investments
and exit the startup.
Successful exits validate the startup's business model and generate significant returns for investors,
founders, and employees.
♦ Initial Public Offering (IPO) : An IPO denotes the moment when a startup becomes
publicly listed on the stock exchange for the first time. Given the complex and regulatory
nature of the public listing process, it is typically pursued by startups with a strong track
record of profitability and sustained growth.
♦ Mergers & Acquisitions: Investors may opt to divest their portfolio company in another
entity in the market. Essentially, this involves the amalgamation of two companies, either
through the acquisition of one by another (or a portion thereof) or through one company
being acquired (either wholly or partially).
♦ Selling Shares: Investors have the option to offload their equity or shares to other venture
capital or private equity firms.
♦ Buybacks: Startup founders may also repurchase shares from the fund or investors if they
possess liquid assets for the purchase and desire to regain control of their company.

6.2 PREREQUISITE OF STARTUP FUNDING

The entrepreneur must be willing to put in the effort and have the patience that a successful fund-
raising round requires. The fund-raising process can be broken down into the following steps;

1. Assessing Need for Funding

2. Assessing Investment Readiness
3. Preparation of Pitch Deck

4. Investor Targeting
5. Due Diligence by Interested Investors
6. Term Sheet

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.13

Assessing
Need for
Funding

Assessing
Term
Investment
Sheet
Readiness

Prerequisite to
Funding

Due
Diligence Preparatio
by n of Pitch
Interested Deck
Investors

Investor
Targeting

1. Assessing Need for Funding:

The startup must thoroughly analyze the reasons behind its funding needs and determine the
appropriate amount to be raised. It's imperative to establish a milestone-driven strategy, delineating
specific objectives and timelines for the upcoming 2, 4, and 10 years.
Crafting a meticulous financial forecast is essential, projecting the company's development trajectory
over the specified period. This forecast integrates anticipated sales figures and factors in market
dynamics and economic indicators. Effective planning of expenses such as production costs,
prototype development, research, and manufacturing is paramount.
These considerations serve as the foundation for the startup's decision-making regarding
subsequent rounds of investment. By aligning funding requirements with strategic goals and
accurately forecasting financial needs, the startup can optimize its resource allocation and position
itself for sustainable growth and success in the long term.
Generally for tech startups, securing funding is essential for several critical areas of focus;
♦ Product Development: Funding is crucial to fuel the development of innovative products
or technologies. This includes investing in research and development, hiring skilled

© The Institute of Chartered Accountants of India

 6.14 ENTREPRENEURSHIP & START-UP ECOSYSTEM

engineers and developers, and acquiring necessary tools and resources to build and refine
the product.

♦ Scalability and Growth: Startups need funds to scale their operations and grow their
customer base. This involves expanding infrastructure, optimizing processes, and investing
in marketing and sales efforts to increase market penetration and reach new customers.

♦ Talent Acquisition: Access to funding enables startups to attract top talent and build a
skilled team. This includes hiring experts in technology, product management, marketing,
and sales, who can contribute to the company's growth and innovation.
♦ Market Expansion: Funding facilitates the expansion of tech startups into new markets or
geographical regions. This may involve localization efforts, adapting products to suit
different markets, and establishing partnerships or distribution channels to reach a broader
audience.
2. Assessing Investment Readiness
Startups must not only recognize their funding needs but also assess their readiness to secure
investment by addressing the criteria that investors prioritize. Recognizing the need for funding is
crucial for startups, but equally significant is gauging their readiness to seek investment. Convincing
investors hinges on demonstrating solid revenue projections and potential returns.

Typically, investors seek several key attributes in prospective startups;

♦ Revenue Growth and Market Position: Investors are drawn to startups showing promising
revenue growth and a strong position in their target market. Demonstrating market traction
and scalability enhances the appeal to potential investors.
♦ Favorable Return on Investment: Investors prioritize ventures with the potential for
attractive returns. Startups must articulate a compelling value proposition and growth
strategy to attract investment interest.
♦ Time to Break-Even and Profitability: Investors assess a startup's timeline for achieving
profitability and breaking even. Clear financial projections and a viable business model are
essential to instill confidence in potential investors.
♦ Uniqueness and Competitive Advantage: Startups with innovative solutions and a
distinctive competitive edge are more likely to attract investment. Highlighting the
uniqueness of the product or service and its market differentiation can enhance investor
interest.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.15

♦ Entrepreneurial Vision and Future Plans: Investors seek founders with a clear vision for
the future and a strategic roadmap for growth. Articulating a compelling vision and
demonstrating strategic foresight can inspire investor confidence.
♦ Reliable, Passionate, and Talented Team: Investors place significant emphasis on the
startup's team, seeking individuals who are reliable, passionate, and possess the
necessary skills and expertise to execute the business plan successfully. A talented and
cohesive team enhances investor trust and credibility.
By aligning with investor expectations and demonstrating readiness for growth and success, startups
can enhance their appeal and increase their chances of securing funding.
4. Preparation of Pitch Deck
A pitch deck is a critical tool for startups seeking funding, serving as a visual presentation that
succinctly communicates the company's value proposition, business model, market opportunity, and
growth strategy to potential investors. The pitch deck typically consists of several key slides:
♦ Introduction: A compelling opening slide that captures the attention of investors and
provides an overview of the startup's mission and vision.
♦ Problem Statement: Clearly articulate the problem or pain point that the startup addresses
and the market opportunity it represents.

♦ Solution: Present the startup's innovative solution to the identified problem and how it adds
value to customers.
♦ Market Opportunity: Provide data and insights on the target market size, growth potential,
and competitive landscape.
♦ Business Model: Explain how the startup plans to generate revenue and sustainably
monetize its offerings.
♦ Traction: Showcase any key milestones, achievements, or customer traction to date to
validate the startup's progress and market traction.
♦ Team: Introduce the founding team members, highlighting their expertise, experience, and
relevant qualifications.
♦ Financial Projections: Present realistic and data-driven financial projections, including
revenue forecasts, expenses, and key metrics.

♦ Ask: Clearly outline the funding amount and how the investment will be utilized to
accelerate growth and achieve key milestones.

© The Institute of Chartered Accountants of India

 6.16 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Call to Action: Conclude with a strong call to action, inviting investors to engage further
and expressing readiness to discuss investment opportunities.

A well-crafted pitch deck effectively conveys the startup's story and value proposition, capturing
investor interest and laying the groundwork for meaningful discussions and potential investment
opportunities.

5. Investor Targeting
Each Venture Capitalist Firm operates according to an Investment Thesis, a strategic framework
guiding its investment decisions. This thesis outlines the firm's preferred stage of investment,
geographic focus, sector emphasis, and unique value proposition.
Understanding a firm's Investment Thesis is crucial for aligning with potential investors. To assess
a firm's thesis, thorough examination of its website, brochures, and fund description is
recommended.
Targeting the right investors entails researching their Investment Thesis, reviewing their past
investments, and engaging with successful entrepreneurs who have secured equity funding. This
process aids in:
♦ Identifying active investors within the target sector.
♦ Understanding their sector preferences and geographic preferences.
♦ Determining the average ticket size of their investments.
♦ Evaluating their level of involvement and mentorship provided to portfolio startups.
Pitching events present valuable opportunities for face-to-face interaction with potential investors.
Additionally, sharing pitch decks with Angel Networks and Venture Capitalists via their designated
contact email addresses can facilitate further engagement. By meticulously researching and
understanding investors' Investment Theses, startups can tailor their pitches and target the most
suitable investors for their growth journey.
6. Due Diligence by Interested Investors
Before sealing an equity deal, both Angel networks and Venture Capitalists (VCs) meticulously
conduct due diligence on startups. This comprehensive examination delves into various aspects,
including the startup's historical financial decisions and the credentials and backgrounds of its team
members. Such scrutiny serves multiple purposes: to validate the startup's assertions regarding its
growth trajectory and market figures and to enable investors to uncover any potentially objectionable
activities in advance.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.17

Following a thorough due diligence process, if both parties are satisfied with the findings, funding
agreements are finalized on terms mutually acceptable to all involved. This marks the culmination
of the investment process and signals the beginning of the partnership between the startup and its
investors.
Successful due diligence instills confidence in investors, ensuring transparency and trust throughout
the investment process.
7. Term Sheet
A term sheet is a “non-binding” list of propositions by a venture capital firm at the early stages of a
deal. It summarizes the major points of engagement in the deal between the investing firm/investor
and the startup. A term sheet for a venture capital transaction in India typically consists of four
structural provisions: valuation, investment structure, management structure, and finally changes to
share capital.
While a term sheet is typically non-binding, it serves as a roadmap for negotiating and finalizing the
definitive agreement. It's important for both parties to review and understand the terms carefully
before proceeding with the transaction.
We will discuss more about it in succeeding topics.

6.3 QUANTIFYING THE SEED CAPITAL

Seed capital is a critical aspect for startups embarking on their entrepreneurial journey. Quantifying
seed capital is a strategic and iterative process that requires careful planning, budgeting, and
resource allocation. Startups should spend time accurately assessing their financial needs, exploring
diverse funding sources, and setting achievable milestones, to effectively navigate the seed phase
and position themselves for long-term success in the competitive startup ecosystem.
Seed capital represents the initial funds required to kickstart operations, develop prototypes, conduct
market research, and lay the groundwork for future growth. Quantifying seed capital involves
meticulously assessing the startup's financial needs and allocating resources effectively to achieve
key milestones.
Firstly, startups must evaluate their immediate financial requirements based on various factors
such as business model, industry, market size, and competitive landscape. This involves identifying
the essential costs associated with product development, market validation, legal and administrative
expenses, and initial marketing efforts.

© The Institute of Chartered Accountants of India

 6.18 ENTREPRENEURSHIP & START-UP ECOSYSTEM

Secondly, startups should develop a comprehensive budget that outlines the specific expenses
and funding requirements for each stage of the seed phase. This budget serves as a roadmap for
allocating resources and ensures that funds are utilized efficiently to achieve strategic objectives.
In quantifying seed capital, startups must also consider potential sources of funding available
to them. These may include personal savings, contributions from friends and family, angel investors,
venture capital firms, crowdfunding platforms, and government grants or startup accelerators. Each
funding source has its advantages and considerations, and startups must carefully evaluate their
options based on factors such as dilution of equity, investor expectations, and funding timelines.

Furthermore, startups must factor in contingency planning and risk mitigation strategies when
quantifying seed capital. This involves identifying potential risks and uncertainties that may impact
the startup's financial health and developing strategies to address them effectively. By building a
buffer for unforeseen expenses and challenges, startups can safeguard their operations and
maintain financial stability during the seed phase.
Quantifying seed capital also requires startups to establish clear and measurable milestones that
serve as benchmarks for progress and success. These milestones may include product development
milestones, customer acquisition targets, revenue projections, and key performance indicators. By
setting tangible goals, startups can track their progress, demonstrate traction to investors, and
secure additional funding as needed to fuel further growth.

6.3.1 Ways to Quantify Seed Capital

There are several ways to quantify seed capital which depend on entrepreneur to entrepreneur and
can be really creative as well as technical, based on how confident the startup is about its future.
Some of the general ways are;
♦ Cost-Based Approach: Start by identifying all the expenses associated with launching and
operating the startup. This includes costs such as product development, marketing, legal
fees, salaries for founders and early employees, office space, equipment, and overhead
expenses. By estimating these costs, startups can arrive at a rough figure for their seed
capital needs.

♦ Milestone-Based Approach: Break down the startup's development roadmap into key
milestones, such as completing product development, acquiring the first customers,
reaching revenue targets, or achieving specific traction metrics. Estimate the funding
required to reach each milestone and aggregate these amounts to determine the total seed
capital needed. In larger R&D projects start ups tend to give milestones rather than

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.19

timelines to achieve something. There maybe a complex solutions of engineering or

medical which cannot be called solution till its proven which may take months or years, to
assess such start ups one must need to adopt milestone based valuation which shows
progress of product
♦ Market Analysis: Conduct market research to understand the competitive landscape,
customer needs, and potential market size. Based on this analysis, estimate the amount of
funding required to penetrate the market, acquire customers, and establish a foothold in
the industry.

♦ Financial Projections: Develop detailed financial projections that forecast the startup's
revenue, expenses, and cash flow over a certain period, typically the first 12-24 months.
These projections should take into account factors such as sales forecasts, pricing
strategies, customer acquisition costs, and operational expenses. By analyzing these
projections, startups can determine their funding requirements to sustain operations until
they achieve profitability or secure additional funding.
♦ Scenario Analysis: Consider different scenarios and potential outcomes to assess the
startup's financial needs under various circumstances. This may involve creating best-case,
worst-case, and most-likely scenarios to account for uncertainties and risks. By quantifying
seed capital needs across different scenarios, startups can develop a more robust funding
strategy and contingency plan.
♦ Professional Advice: Seek guidance from financial advisors, mentors, or industry experts
who can provide valuable insights and assistance in quantifying seed capital. These
professionals can offer expertise in financial planning, valuation, and fundraising strategies,
helping startups accurately assess their funding needs and develop a solid financial plan.
Cost-Based
Approach

Professional Milestone-Based
Advice Approach

Scenario Analysis Market Analysis

Financial
Projections

© The Institute of Chartered Accountants of India

 6.20 ENTREPRENEURSHIP & START-UP ECOSYSTEM

6.4 FINANCIAL MODELLING BASICS FOR STARTUPS

Funding for startups begins with a deep understanding of financial concepts, making financial
modeling a fundamental tool in their journey. Financial modeling enables startups to translate their
business strategies into quantifiable projections, offering insights into revenue streams, cost
structures, and cash flow dynamics. By building comprehensive financial models, startups can
assess the feasibility of their business plans, evaluate various growth scenarios, and make data-
driven decisions to optimize resource allocation and mitigate risks.
Modern financial models serve as communication tools, allowing startups to articulate their financial
strategy and potential returns to investors and stakeholders. They provide a roadmap for fundraising
efforts, helping startups demonstrate their value proposition, growth potential, and financial viability
to secure funding.
Ultimately, financial modeling empowers startups to navigate the complexities of the business
landscape with confidence, ensuring sound financial management and maximizing their chances of
success in the competitive market.
Let us explore some core financial modeling basics that every entrepreneur and their core team
should know and learn;

Revenue
Forecasting

Valuation Expense
Modeling Modeling

Financial
Modelling

Scenario Cash Flow

Analysis Projection

Profitability
Analysis

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.21

♦ Revenue Forecasting: Revenue forecasting is the process of predicting future income

streams based on market analysis, sales projections, and pricing strategies. Startups
analyze factors such as customer demand, market trends, and competitive dynamics to
estimate potential sales volumes and revenues. Accurate revenue forecasting helps
startups plan their resources effectively, set realistic financial goals, and make informed
business decisions.
♦ Expense Modeling: Expense modeling involves estimating the various costs associated
with running a startup, including production, marketing, salaries, rent, utilities, and
administrative overhead. Startups create detailed expense models to track and manage
their expenditures, identify cost-saving opportunities, and ensure financial sustainability.
♦ Cash Flow Projection: Cash flow projection entails forecasting the inflows and outflows of
cash over a specific period. Startups analyze factors such as sales receipts, expenses,
loan repayments, and capital expenditures to predict their cash position and ensure they
have sufficient liquidity to meet their financial obligations. Cash flow projections help
startups manage working capital, plan for growth, and avoid cash shortages.
♦ Profitability Analysis: Profitability analysis involves evaluating the company's profitability
by comparing revenue with expenses and calculating key metrics such as gross profit
margin, operating profit margin, and net profit margin. This analysis helps startups assess
their financial performance and make adjustments to improve profitability.
♦ Scenario Analysis: Scenario analysis entails conducting sensitivity analysis and modeling
different scenarios to assess the impact of various variables and assumptions on financial
outcomes. Startups evaluate best-case, worst-case, and base-case scenarios to identify
potential risks and opportunities, enabling them to make informed decisions and develop
contingency plans.
♦ Valuation Modeling: Valuation modeling involves estimating the value of the startup based
on factors such as revenue projections, market size, growth potential, and comparable
company analysis. Valuation models help startups negotiate investment terms, assess exit
opportunities, and attract potential investors.
♦ Financial Statements: Financial statements include documents such as the income
statement, balance sheet, and cash flow statement that provide a snapshot of the
company's financial performance and position. Startups use financial statements to track
their revenues, expenses, assets, liabilities, and cash flows, enabling them to monitor their
financial health, make strategic decisions, and communicate their financial status to
stakeholders.

© The Institute of Chartered Accountants of India

 6.22 ENTREPRENEURSHIP & START-UP ECOSYSTEM

6.4.1 Modern Tools for Financial Analysis

Modern tools for financial analysis empower startups to streamline their financial management
processes and make data-driven decisions. These tools often leverage advanced technology,
automation, and data analytics to provide valuable insights into a startup's financial health. Some
popular modern tools for financial analysis for startups include:
♦ Accounting Software: Platforms like QuickBooks, Xero, and FreshBooks offer cloud-
based accounting solutions tailored to startups. These tools automate bookkeeping tasks,
track expenses, manage invoices, and generate financial reports, enabling startups to
maintain accurate financial records and comply with accounting standards.

♦ Financial Planning and Analysis (FP&A) Software: FP&A software such as Adaptive
Insights, Anaplan, and Planful help startups create detailed financial models, perform
budgeting and forecasting, and conduct scenario analysis. These tools facilitate strategic
planning, scenario modeling, and decision-making by providing insights into future financial
performance.
♦ Business Intelligence (BI) Tools: BI tools like Tableau, Power BI, and Looker enable
startups to visualize and analyze their financial data in real-time. These platforms integrate
with various data sources to create interactive dashboards and reports, allowing startups
to identify trends, patterns, and anomalies in their financial metrics.
♦ Financial Dashboards: Custom-built or pre-designed financial dashboards provide
startups with a visual overview of key financial metrics such as revenue, expenses, cash
flow, and profitability. Tools like Klipfolio, Geckoboard, and Google Data Studio allow
startups to monitor their financial performance in real-time and track progress towards
financial goals.
♦ Forecasting and Modeling Tools: Advanced forecasting and modeling tools like Finbox,
Trefis, and Domo enable startups to create sophisticated financial models, analyze complex
scenarios, and predict future financial outcomes. These tools incorporate machine learning
algorithms and predictive analytics to enhance accuracy and reliability.

♦ Expense Management Software: Expense management platforms such as Expensify,

Receipt Bank, and Divvy automate the process of tracking and categorizing expenses,
capturing receipts, and managing reimbursements. These tools help startups control costs,
improve efficiency, and maintain compliance with expense policies.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.23

♦ Financial Analytics Platforms: Comprehensive financial analytics platforms like Fathom,

Float, and Pulse offer startups advanced analytics capabilities, including benchmarking,
trend analysis, and financial ratio analysis. These tools provide actionable insights into
financial performance, profitability, and operational efficiency.

6.4.2 India specific Tech Tools available to Startups

For startups in India, there are several tools specifically tailored to their financial analysis needs.
Here are some notable ones available to startups;
♦ Tally ERP 9: Tally ERP 9 is one of the most popular accounting software used by startups
and small businesses in India. It offers features such as accounting, inventory
management, payroll processing, GST compliance, and financial reporting.
♦ Zoho Books: Zoho Books is a cloud-based accounting software designed for small
businesses and startups. It provides features like invoicing, expense tracking, bank
reconciliation, and financial reporting. Zoho Books also integrates with other Zoho
applications for comprehensive business management.
♦ ClearTax: ClearTax is a comprehensive tax and compliance platform for businesses in
India. It offers solutions for GST compliance, income tax filing, TDS management, and
financial planning. ClearTax helps startups stay compliant with Indian tax laws and
regulations.
♦ Razorpay: Razorpay is a leading fintech company in India that offers payment solutions
for startups and businesses. It provides payment gateway services, recurring billing,
invoicing, and other financial tools to manage online transactions seamlessly.
♦ ProfitBooks: ProfitBooks is an accounting and invoicing software designed for small
businesses and startups in India. It offers features like double-entry accounting, GST
invoicing, expense tracking, inventory management, and financial reporting.

♦ Quicko: Quicko is a tax planning and compliance platform that helps startups manage their
taxes efficiently. It offers solutions for income tax filing, GST compliance, tax planning, and
investment tracking. Quicko simplifies tax compliance for startups and ensures adherence
to Indian tax laws.
♦ SahiGST: SahiGST is a GST compliance platform that helps startups manage their GST
filings, returns, and invoices. It provides automated GST reconciliation, e-way bill
generation, GST registration, and compliance advisory services for startups in India.

© The Institute of Chartered Accountants of India

 6.24 ENTREPRENEURSHIP & START-UP ECOSYSTEM

6.5 HOW TO APPROACH ANGEL INVESTORS & VC FIRMS

Startups can find angel investors and venture capital (VC) firms through several avenues.
Participating in startup events and pitch competitions, such as those organized by TiE (The Indus
Entrepreneurs) chapters or NASSCOM, provides opportunities to network with angel investors and
VCs.
Joining startup incubators and accelerators like Y Combinator, Techstars, or Indian-based ones such
as T-Hub or Nasscom 10,000 Startups can also facilitate connections with investors. Online
platforms like LetsVenture, AngelList India, and Indian Angel Network provide access to networks
of angel investors actively seeking investment opportunities in Indian startups.

Additionally, seeking introductions through mutual connections, mentors, or industry associations

can help startups identify potential investors interested in the Indian startup ecosystem.
♦ Attend Startup Events and Conferences: Participate in startup events and conferences
held across India, such as TiECON, Nasscom Product Conclave, or India Internet Day.
These events provide opportunities to network with angel investors and VC firms active in
the Indian startup ecosystem.
♦ Leverage Online Platforms: Utilize online platforms like LetsVenture, AngelList India, and
Indian Angel Network to connect with angel investors and VC firms. These platforms cater
specifically to the Indian startup ecosystem, making it easier to find potential investors
interested in Indian startups.
♦ Seek Introductions from Local Networks: Tap into local entrepreneurial networks,
industry associations, and startup communities in cities like Bangalore, Mumbai, and Delhi-
NCR. These networks often host events, pitch sessions, and investor meetups where you
can meet potential investors and seek introductions.
♦ Apply to Indian Startup Accelerators and Incubators: Apply to Indian startup
accelerators and incubators like T-Hub, Nasscom 10,000 Startups, or Startup India. These
programs not only provide mentorship and support but also connections to angel investors
and VC firms with a focus on the Indian market.

♦ Craft a Compelling Pitch and Direct Outreach: Develop a well-crafted pitch deck tailored
to the Indian market, highlighting your startup's unique value proposition, market
opportunity, and traction. Reach out directly to targeted angel investors and VC firms
through email, LinkedIn, or other communication channels, showcasing your startup's
potential and requesting meetings or introductions.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.25

6.5.1 Step by Step Guide to Approaching Investors

A step-by-step guide for startups to approach investors, simplified for easy understanding.
1. Prepare Your Pitch
 Clearly define your business idea and its value proposition in simple language.
 Highlight the problem your startup solves and why it matters to your target
customers.
 Explain how your solution is unique and better than existing alternatives.
2. Research Investors
 Identify potential investors who have a track record of investing in startups similar to
yours.
 Research their investment preferences, such as industry focus, investment stage, and
geographic location.
 Look for investors who align with your startup's values and vision.
3. Craft a Compelling Pitch Deck
 Create a concise and visually appealing pitch deck that tells your startup's story.
 Include slides on your problem, solution, market opportunity, business model, traction,
team, and financial projections.
 Use simple language, visuals, and data to make your pitch easy to understand.
4. Reach Out to Investors
 Send personalized emails or LinkedIn messages to your targeted investors.
 Introduce your startup briefly and express your interest in discussing investment
opportunities.
 Attach your pitch deck and offer to provide more information or schedule a meeting.
5. Pitch Your Startup
 When meeting with investors, focus on communicating your startup's value proposition
and potential.
 Use storytelling to engage investors and make your pitch memorable.

© The Institute of Chartered Accountants of India

 6.26 ENTREPRENEURSHIP & START-UP ECOSYSTEM

 Be prepared to answer questions about your market, competition, business model,

team, and financials.

6. Follow-Up and Close the Deal

 After your pitch, follow up with investors to address any additional questions or
concerns they may have.

 Be proactive in providing requested information and scheduling follow-up meetings.

 Once you've generated sufficient interest, negotiate investment terms and work
towards closing the deal.
Entrepreneurs must remember that approaching investors is a process that requires patience,
persistence, and preparation. By following these steps and staying focused on building relationships,
startups can increase their chances of securing investment to fuel their growth journey

Patience

6.5.2 Some interesting stories from Startup Funding across the Globe
WhatsApp
In 2009, WhatsApp, the messaging app founded by Brian
Acton and Jan Koum, was struggling to generate revenue and
cover server costs. Despite this, Acton and Koum persisted
and focused on growing their user base. Eventually, they
caught the attention of venture capitalist Jim Goetz from
Sequoia Capital. After several meetings and discussions,
Goetz was impressed by WhatsApp's simple interface and
rapid user growth. In 2011, Sequoia Capital invested $8
million in WhatsApp, which helped the company scale its
infrastructure and expand its team. This investment played a

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.27

crucial role in WhatsApp's journey to becoming one of the most popular messaging apps globally,
leading to its eventual acquisition by Facebook for $19 billion in 2014.

Uber
Uber's co-founders, Travis Kalanick and Garrett Camp,
faced numerous rejections from investors when they initially
pitched their ride-hailing concept. However, they continued
to refine their business model and build traction in the
market. In 2011, at a technology conference in Aspen,
Kalanick met Chris Sacca, an angel investor known for his
early investments in Twitter and Instagram. Sacca was
impressed by Kalanick's vision for Uber and decided to
invest $25,000 in the startup. This initial investment helped Uber gain momentum and attracted
further funding from prominent venture capital firms, propelling its rapid expansion into new markets
worldwide.
Airbnb
In 2008, Airbnb's founders, Brian Chesky, Joe Gebbia, and Nathan Blecharczyk, were struggling to
keep their startup afloat. Facing financial difficulties, they decided to leverage the 2008 Democratic
National Convention in Denver by renting out air mattresses in
their apartment to conference attendees. This creative
approach caught the attention of Paul Graham, co-founder of Y
Combinator, a startup accelerator. Graham invited the founders
to join Y Combinator's accelerator program and provided them
with $20,000 in seed funding. This initial investment helped
Airbnb survive and grow, leading to subsequent funding rounds
from prominent investors and its eventual success as a global
hospitality platform.
Chai Point's Tea Pitch
Chai Point, a popular chai delivery startup in India, once
famously pitched their business idea to investors over cups
of chai. The founders, Amuleek Singh Bijral and Anirudh
Sharma, believed that the best way to convince investors
about the potential of their business was to immerse them
in the experience. So, they invited potential investors to their

© The Institute of Chartered Accountants of India

 6.28 ENTREPRENEURSHIP & START-UP ECOSYSTEM

office and served them their signature chair while pitching their business model. This unique
approach not only showcased their product but also left a lasting impression on the investors,
ultimately leading to successful fundraising rounds.
RedBus' Bus Ride Pitch
When Phanindra Sama, Charan Padmaraju, and
Sudhakar Pasupunuri, the founders of RedBus, were
struggling to secure funding for their online bus
ticketing platform, they decided to take matters into
their own hands. Instead of traditional pitch meetings,
they organized a pitch event on a bus journey from
Bangalore to Hyderabad. They invited potential
investors to join them on the bus ride and pitched
their business ideas while on the move. This
unconventional approach caught the attention of investors and resulted in successful funding rounds
for RedBus.
OYO's Budget Accommodation Pitch
Ritesh Agarwal, the founder of OYO Rooms, once shared
a humorous anecdote about his early days of pitching the
idea of budget accommodations to investors. He recalled
how, during one pitch meeting, an investor asked him why
he was focusing on budget hotels when there were luxury
hotels available. Ritesh's witty response was that while
everyone dreams of owning a Lamborghini, most people
end up buying a Maruti. This humorous analogy helped
break the ice and conveyed the value proposition of OYO
Rooms effectively, leading to successful funding rounds for
the startup.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.29

6.6 UNDERSTANDING TERM SHEET, INVESTOR

AGREEMENT AND EQUITY DILUTION; THE SCIENCE
BEHIND 'STARTUP VALUATION'

Investor
Term Sheet
Agreement

Equity Science of
Dilution Valuation

6.6.1 Term Sheet

A term sheet is a foundational document that outlines the key terms and conditions of an investment
deal between a startup and an investor. It serves as a roadmap for negotiations and provides clarity
on the rights, obligations, and expectations of both parties. Here's an in-depth look at the
components and significance of a term sheet:

1. Introduction and Summary: The term sheet typically begins with an introduction that
outlines the parties involved, the type and amount of investment, and the proposed terms. It
provides a summary of the key terms agreed upon in principle.
2. Valuation and Investment Details: One of the most critical aspects of a term sheet is the
valuation of the startup and the amount of investment. This section specifies the pre-money
valuation, the amount of funding to be raised, and the post-money valuation.

3. Investment Structure: The term sheet defines the structure of the investment, whether it's
through equity, convertible notes, or preferred shares. It outlines the rights and preferences
associated with the investor's stake in the company, such as voting rights, liquidation
preferences, and anti-dilution provisions.

© The Institute of Chartered Accountants of India

 6.30 ENTREPRENEURSHIP & START-UP ECOSYSTEM

4. Founder Vesting: Founder vesting provisions may be included in the term sheet to ensure
that founders continue to be committed to the success of the startup. This typically involves
a vesting schedule that outlines the timeline over which founders' equity vests.
5. Governance and Control: The term sheet may address governance matters, such as board
composition, voting rights, and control mechanisms. It specifies the rights of investors to
appoint board members and participate in major decisions affecting the company.
6. Rights and Protections: Investors may be granted certain rights and protections to
safeguard their investment. These may include information rights, protective provisions, drag-
along rights, and anti-dilution mechanisms.
7. Exit Strategy: The term sheet outlines the potential exit options for investors, such as
acquisition or IPO. It may include provisions related to the distribution of proceeds upon exit
and the rights of investors in such scenarios.
8. Legal and Regulatory Considerations: The term sheet may include boilerplate language
related to legal and regulatory compliance, jurisdiction, confidentiality, and dispute resolution.

9. Conditions Precedent: The term sheet may specify conditions precedent that must be met
before the deal can be finalized. This may include due diligence, regulatory approvals, and
the execution of definitive agreements.

10. Expiration and Binding Nature: The term sheet typically has an expiration date after which
it becomes invalid. It also clarifies whether it is binding or non-binding, and the extent to which
it is enforceable.
In addition to the fundamental components mentioned earlier, term sheets may include various
professional topics and provisions aimed at protecting the interests of both parties and
clarifying the terms of the investment deal. Here are some additional professional topics commonly
covered in term sheets:
1. Anti-Dilution Provisions: These provisions protect investors from dilution of their ownership
stake in the event of future equity financing rounds at a lower valuation.

2. Liquidation Preferences: Liquidation preferences outline the priority in which proceeds from
a liquidation event, such as an acquisition or IPO, are distributed among shareholders.
Investors with liquidation preferences are entitled to receive their investment back before
other shareholders.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.31

3. Conversion Rights: Conversion rights specify the conditions under which convertible
securities, such as convertible notes or preferred shares, can be converted into equity in the
company.
4. Redemption Rights: Redemption rights give investors the option to redeem their shares for
a specified price after a certain period, providing them with an exit option if the company fails
to meet certain milestones.
5. Information Rights: Information rights grant investors access to certain financial and
operational information about the company, allowing them to monitor their investment and
make informed decisions.
6. Board Representation: Investors may negotiate the right to appoint one or more
representatives to the company's board of directors, giving them a voice in strategic decision-
making.
7. Founder Restrictions: Term sheets may include restrictions on founders, such as non-
compete and non-solicit clauses, to prevent them from engaging in activities that could harm
the company or compete with its interests.
8. Employee Stock Option Pool: Term sheets often specify the size and allocation of an
employee stock option pool, which is set aside for granting equity incentives to employees
and key team members.
9. Pre-emption Rights: Pre-emption rights give existing shareholders the opportunity to
purchase additional shares in future financing rounds to maintain their ownership percentage.
10. Dispute Resolution Mechanisms: Term sheets may include provisions outlining the process
for resolving disputes between the parties, including arbitration or mediation procedures.

6.6.2 Investor Agreement and Equity Dilution

An investor agreement is a legally binding contract between a startup and an investor that outlines
the terms and conditions of an investment deal. One crucial aspect addressed in investor
agreements is equity dilution, which refers to the reduction in the ownership percentage of existing
shareholders, including founders and early investors, as a result of the issuance of new shares to
incoming investors. Here's an in-depth look at investor agreements and equity dilution:
Investor Agreement
An investor agreement, also known as a shareholders' agreement or subscription agreement, is a
comprehensive document that governs the relationship between the startup and its investors. It

© The Institute of Chartered Accountants of India

 6.32 ENTREPRENEURSHIP & START-UP ECOSYSTEM

typically covers a wide range of topics, including investment terms, rights and obligations of the
parties, governance structure, and mechanisms for dispute resolution.

Key Components of an Investor Agreement

♦ Investment Terms: The agreement specifies the amount of investment, the type of
securities issued (e.g., common stock, preferred stock, convertible notes), and the
valuation of the startup.
♦ Rights and Protections: Investors are granted certain rights and protections to safeguard
their investment, such as information rights, board representation, anti-dilution provisions,
and liquidation preferences.
♦ Governance Structure: The agreement outlines the composition of the board of directors,
voting rights, and decision-making processes, ensuring that investors have a voice in
strategic decisions affecting the company.
♦ Founder Restrictions: Founders may be subject to restrictions, such as non-compete and
non-solicit clauses, to protect the interests of investors and prevent conflicts of interest.
♦ Exit Strategy: The agreement addresses potential exit options for investors, such as
acquisition or IPO, and specifies the distribution of proceeds among shareholders in such
scenarios.
Equity Dilution
Equity dilution occurs when a startup issues additional shares of stock, either through a new
financing round or employee stock option grants, thereby reducing the ownership percentage of
existing shareholders. Equity dilution is a natural consequence of raising capital and incentivizing
employees through equity incentives.
Factors Contributing to Equity Dilution
♦ New Financing Rounds: When a startup raises capital from new investors, it typically issues
new shares of stock, diluting the ownership stakes of existing shareholders.
♦ Employee Stock Options: Startups often grant equity incentives, such as stock options, to
attract and retain talented employees. As employees exercise their options, new shares
are issued, leading to dilution of existing shareholders.
♦ Convertible Securities: Convertible securities, such as convertible notes or preferred stock,
may convert into equity at a future date, resulting in dilution if the conversion price is lower
than the valuation of the startup at the time of conversion.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.33

♦ Anti-Dilution Provisions: Anti-dilution provisions, commonly included in investor

agreements, protect investors from dilution by adjusting the conversion price of convertible
securities in the event of a down-round financing.
Managing Equity Dilution
♦ While equity dilution is inevitable in the growth trajectory of a startup, there are several
strategies for managing its impact:
♦ Negotiate Favorable Terms: Startups can negotiate favorable investment terms, such as
valuation caps and participation rights, to minimize the dilutive effect on existing
shareholders.
♦ Implement Equity Incentive Plans Strategically: Startups should carefully manage their
equity incentive plans, balancing the need to attract and retain talent with the impact on
existing shareholders.
♦ Communicate Transparently: Founders should communicate openly and transparently with
existing shareholders about the company's fundraising activities and the potential impact
on equity ownership.
♦ Focus on Growth and Value Creation: Ultimately, startups should prioritize growth and
value creation, as increased valuation can mitigate the dilutive effect of future financing
rounds.
Hence, investor agreements play a crucial role in governing the relationship between startups and
investors, including addressing the complex issue of equity dilution. By negotiating favorable terms,
implementing equity incentive plans strategically, and focusing on growth and value creation,
startups can effectively manage the impact of equity dilution on existing shareholders while securing
the capital needed to fuel their growth and success.

6.6.3 The Science behind Startup Valuation

Startup valuation is both an art and a science, involving a combination of quantitative analysis,
industry research, and subjective judgment. While there is no one-size-fits-all approach to valuing
startups, several methods and frameworks are commonly used to determine their worth.

There are certain nuances and factors specific to the Indian startup ecosystem that influence
valuations. Some key aspects of how startups are valued in India in conjunction to Global Valuation
methodologies;

© The Institute of Chartered Accountants of India

 6.34 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Market Potential: Investors assess the market potential of the startup's product or service
within India's rapidly growing market. Factors such as the size of the addressable market,
growth trends, and competitive landscape play a significant role in determining valuation.
♦ Revenue and Growth Metrics: Revenue generation and growth trajectory are crucial
indicators of a startup's value. Investors closely scrutinize revenue streams, customer
acquisition rates, retention metrics, and other key performance indicators (KPIs) to assess
the startup's growth potential and scalability.
♦ Technology and Innovation: India's startup ecosystem is known for its innovation and
technology-driven solutions. Startups leveraging cutting-edge technologies, such as
artificial intelligence (AI), machine learning (ML), blockchain, and fintech, may command
higher valuations due to their disruptive potential and competitive advantage.
♦ Investor Sentiment: Investor sentiment and market dynamics also influence startup
valuations in India. Factors such as macroeconomic conditions, regulatory environment,
investor appetite for risk, and trends in venture capital funding can impact valuation
multiples and deal terms.
♦ Sector-Specific Considerations: Valuation methodologies may vary based on the sector
or industry in which the startup operates. For instance, e-commerce, edtech, healthtech,
and fintech startups may be valued differently due to sector-specific growth prospects,
regulatory frameworks, and competitive dynamics.
♦ Global Comparisons: Indian startups are often benchmarked against global peers and
comparable companies in other markets to assess relative valuation metrics and multiples.
International expansion plans and the ability to compete on a global scale may positively
impact a startup's valuation.

♦ Stage of Development: The stage of development of the startup, whether it's early-stage,
growth-stage, or mature, also influences valuation. Early-stage startups may be valued
based on their potential market opportunity and technology innovation, while growth-stage
startups may be assessed on revenue traction and scalability.
♦ Exit Opportunities: Investors consider potential exit opportunities, such as acquisitions or
initial public offerings (IPOs), when valuing startups. The attractiveness of exit options and
potential returns on investment factor into the valuation decision.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.35

Market Potential

Revenue and Growth Metrics

Technology and Innovation

Investor Sentiment

Sector-Specific Considerations

Global Comparisons

Stage of Development

Exit Opportunities

6.6.4 Some Aspects that Entrepreneurs can refer while Negotiating their
Startup Valuation
Valuation is all about negotiations; the harder one negotiates the better valuation they score. While
Entrepreneurs are really passionate and emotional about their business, they may use the following
technical metrics to make their negotiation stronger.
♦ Leverage Cash Flow Dynamics: As an entrepreneur, understanding your startup's cash
flow dynamics empowers you to showcase its financial health during valuation negotiations.
By providing robust cash flow projections and estimates, one can demonstrate the viability
and sustainability of your business, thereby influencing its valuation positively.
♦ Mitigate Risks with Discount Rates: By conducting a thorough risk assessment and
applying appropriate discount rates, one can address potential investor concerns and
minimize perceived risks associated with your startup. This strategic approach not only
enhances investor confidence but also supports a more favorable valuation for the
company.
♦ Highlight Growth Potential: Emphasizing on the startup's growth potential and the size of
its target market positions the business as an attractive investment opportunity. By
articulating the scalability and market reach of the startup, entrepreneurs can drive up its
perceived value and negotiate a higher valuation with investors.

© The Institute of Chartered Accountants of India

 6.36 ENTREPRENEURSHIP & START-UP ECOSYSTEM

♦ Utilize Comparative Analysis: Incorporating comparative analysis into the valuation

discussions enables one to benchmark the startup against industry peers and competitors.
By showcasing favorable valuation metrics and multiples relative to similar companies, one
can justify a higher valuation for the startup and strengthen the negotiating position.
♦ Tailor Valuation to Stage of Development: Recognizing the stage of development of the
startup allows an entrepreneur to tailor the valuation strategy accordingly. Whether your
startup is at the early stage or more mature, understanding the specific considerations and
methodologies for valuation empowers you to advocate for a valuation that accurately
reflects your company's growth trajectory and potential.
♦ Align Valuation with Exit Strategies: Demonstrating how your startup's valuation aligns
with potential exit strategies and investor returns is key to negotiating favorable terms. By
illustrating attractive acquisition opportunities, IPO prospects, or other liquidity events, you
can justify a higher valuation and secure better terms for yourself and your investors.

SUMMARY
Understanding the basics of startup funding involves grasping the various sources of investment
available to entrepreneurs, ranging from bootstrapping and friends/family funding to venture capital
and angel investors. Prerequisites for startup funding include a clear understanding of the business
model, market potential, and financial projections. Quantifying seed capital requires meticulous
financial planning and modeling to determine the initial funding needed for prototype development,
team hiring, and other expenses. Approaching angel investors and venture capital firms involves
networking, crafting a compelling pitch, and demonstrating the startup's growth potential.
Understanding term sheets, investor agreements, and equity dilution entails navigating the
complexities of investment contracts, valuation methodologies, and shareholder rights. This involves
a blend of financial acumen and negotiation skills to ensure favorable terms and equitable
agreements for all parties involved in the investment deal.

© The Institute of Chartered Accountants of India

 FUNDING & VALUATION 6.37

TEST YOUR KNOWLEDGE

Multiple Choice Questions (MCQs)

1. Mayank wanted to identify potential risks and opportunities, enabling the team to make
informed decisions and develop contingency plans. Which of the following modeling analysis
would be most suitable here?
(a) Cash Flow Projection
(b) Profitability Analysis

(c) Scenario Analysis

(d) Valuation Modeling
2. The US Federal Bank released a report where the global interest rates were marked to rise
by 15% thus leading to a lot of capital becoming costly. Which of the following factors would
this relate to in relation to impact on startup valuations?
(a) Market Potential
(b) Investor Sentiment
(c) Sector-Specific Considerations
(d) Global Comparisons
3. The investors of Gongo Mobile Games wanted to ensure that founders continue to be
committed to the success of the startup. Which of the elements of the Term Sheet would help
ensure this?
(a) Investment Structure
(b) Founder Vesting
(c) Governance and Control

(d) Rights and Protection

4. The engineers at Funda Maths Classes, an online mathematics coaching startup wanted to
implement Tableau for better reporting of consumer data to help improve the UI and overall
student rating. Which of the following tool groups would this tool fall under?
(a) Accounting Software

© The Institute of Chartered Accountants of India

 6.38 ENTREPRENEURSHIP & START-UP ECOSYSTEM

(b) Financial Planning and Analysis (FP&A) Software

(c) Business Intelligence (BI) Tools
(d) Forecasting and Modeling Tools
5. Help Sujata in sequencing the right steps as she wants to prerequisite her Pickle Startup’s
funding.

(a) Assessing Investment Readiness, Assessing Need for Funding, Investor Targeting,
Preparation of Pitch Deck, Due Diligence by Interested Investors, Term Sheet
(b) Assessing Need for Funding, Due Diligence by Interested Investors, Assessing
Investment Readiness, Preparation of Pitch Deck, Investor Targeting, Term Sheet
(c) Assessing Investment Readiness, Assessing Need for Funding, Investor Targeting,
Term Sheet, Due Diligence by Interested Investors, Preparation of Pitch Deck
(d) Assessing Need for Funding, Assessing Investment Readiness, Preparation of Pitch
Deck, Investor Targeting, Due Diligence by Interested Investors, Term Sheet

Answers to Multiple Choice Questions (MCQs)

1. (c) 2. (b) 3. (b) 4. (c) 5. (d)

© The Institute of Chartered Accountants of India