Start-up founders are in a Catch 22 situation—in the absence of credit history and adequate collateral, they are unable to get the first line of credit and yet require timely financing to keep up with the high operational costs
In recent times, India's start-up scene has received much global attention. The country houses the third-largest start-up ecosystem in the world, with over 84,400 start-ups. 13 of these attained unicorn status in the first three months of 2022, which is a considerable jump up from eight in the first four months of the previous year.
Then came the phrase 'funding winter', which sent shivers down the spines of most entrepreneurs. A report by IVCA and EY showed that while growth and late-stage funding for Indian start-ups declined by 27 per cent as per, seed and bridge funding increased significantly by 11 per cent in 2022.
The growing number of start-ups in the country indicates that they are now recognised as essential engines of economic growth, digitisation and job creation. Given how the digital boom has eased the flow of cross-border investments, many global venture capital and private equity funds have been investing in Indian entities.
While the ecosystem has witnessed explosive growth in less than a decade, what is interesting is that the fundamentals of this burgeoning space are so strong that not even the pandemic-induced economic slump could hamper its growth. Start-ups in the country have become torchbearers for innovation and entrepreneurial spirit. As a result, they are rightly believed to be vehicles for socio-economic development in India.
As start-up founders work their way up to create a steady drumbeat of success, they are tasked with one too many challenges. They face considerable challenges from transforming a new idea into a thriving company and taking on incremental leadership responsibilities, especially with raising and managing working capital.
Amid global headwinds, as investors have become more cautious about deploying funding, start-ups need to shift their focus from fast-paced growth to building a more sustainable future. Scaling a start-up and making it sustainable requires a significant amount of capital.
In all this, working capital management becomes crucial for start-ups to unlock value, especially in their infancy stage, where financial constraints plague them. In times like these, the continued scarcity of capital can even lead to insolvency, challenging the business's financial viability.
Lack of access to credit and a steady flow of capital is holding back many small businesses, especially the early-stage and growth-stage start-ups, from experiencing growth. Due to the absence of credit history and adequate collateral, getting the first line of credit remains the greatest challenge for start-ups.
This leads to a 'Catch-22' situation, considering how with high start-up costs, entrepreneurs require timely financing to get off the ground. On the flip side, there has been a spate of defaults on business loans recently.
As a result, financial institutions are looking to digitise their credit appraisal mechanisms and bring more transparency to the credit risk assessment process. This will help them better mitigate risks and meet the rising capital needs of growing businesses.
While most lenders require collateral that they can seize, in the case of a default, businesses can now get an unsecured business loan, where credit is made available without collateral. Lenders usually impose stringent qualification requirements in such cases where there is no business asset backing the loan.
Getting an unsecured business loan to manage working capital requires a strategic approach. To begin with, start-ups need to make a strong case for their business. Presenting a comprehensive plan that outlines the business idea, market opportunity, process, and financial projections will help instill confidence in lenders.
They next need to clear pending debts and improve their credit score. For start-ups that are already repaying multiple loans, the chances of getting a new loan approved are bleak. Apart from ensuring that you have a good credit score of 750 and above, founders need to settle outstanding dues to improve their creditworthiness in securing a new loan.
While securing as much capital may seem ideal to give wings to ambitious start-up plans, it is important to estimate the right amount required and apply for a loan that can be justified and repaid with interest by the business in good time.
Additionally, start-ups need to leverage digital solutions to help them manage their finances better, make smart financial decisions, and meet their working capital requirements at scale. Today, with the advent of fintech players offering tailor-made digital solutions, there are many ways for them to fund their business needs. This includes invoice financing, merchant cash advances and business credit cards.
Start-up founders in India have realised emerging technologies to be one of the greatest factors for business growth. This explains why companies like Zerodha, who have intensified their capital investments to provide full-stack technology solutions, have recently become one of the most profitable unicorns in the country.
Despite having a great product-market fit, many B2B start-ups crash, burn, and face closure because of running out of fuel midway. For such entities, investor funding is crucial as they often face long sales cycles and credit-based payments. Having ample cash reserves is necessary for them to tide over cashless business transactions and periods of low sales.
At a time when capital is expensive and investors are cautious, B2B start-ups need to extend their cash runway by looking at means to generate new channels of revenue, streamlining the accounts receivable process and increasing the cash inflow, cutting costs and controlling accounts payables.
Moreover, making it a practice to have cash flow projections will give them an accurate picture of their cost-benefit analysis and help them plan better for the future. Re-evaluating the business model and reducing the sales cycle are vital strategies to extend the cash runway.
Access to real-time business data will give the management of these start-ups a better understanding of their financial health and help them make informed financial decisions. It will also arm them with the knowledge of the right time to make strategic investments.
In today's global economic setting, start-ups have had to change their optics as investors are now looking for profitability more than exponential growth. At the same time, operating in hypergrowth environments, entrepreneurs find it hard to control their skyrocketing expenses.
Therefore, businesses should look at spending smarter. For this, key working capital management principles need to be in place. This will help them identify and double down investments in areas where they receive the highest returns.
After all, as the old adage says, a bird in the hand is always better than two in the bush.