Money is the primary catalyst for movement in the business world. All businesses must generate revenue to survive. However, for a business just starting, initial funding might be necessary to gain initial momentum. How can startup business owners ensure that their business has a solid foundation for growth? In this article, some of the funding options for startups, from the seed stage to the growth stage, are introduced.
What is the Seed Stage?
The seed funding stage is the initial stage in which startups gain the first amount of capital to begin the journey of bringing a service or product to market. During the seed stage, the goal of the investor is to find someone who will give an unproven commodity a shot to begin planting a “seed” to grow. Common types of funding for investors during the seed stage include bootstrapping (family and friends), crowdfunding, and angel investors.
Bootstrapping
Borrowing from family and friends to start a business is commonly known as bootstrapping. The seed money from the bootstrapping route can come from personal savings or loans, money from initial sales, or private funds from friends and family. Several successful companies like MailChimp, Shuttershock, GoPro, and Shopify started as bootstrapped startups.
The upside to bootstrapping is that the owner maintains control of the whole business. There are no investors to sit on the decision board, and startup owners can focus on building the company without having to worry as much about external take over or influential control. Bootstrapping funding can also be advantageous in that if the amounts are rationally based, then the risk of financial exposure can be managed and kept sizable.
The downside to bootstrapping, however, is the personal risk that comes with borrowing from those close to the founder. Founders might be under more pressure to deliver results and can cause strain during family and friend gatherings. Additionally, bootstrapped startups are hindered by the lack of connections that partnering with an established investor might bring to promote the company’s growth.
Crowdfunding
In crowdfunding, investor convince as many potential donors as possible to contribute through donation, rewards, debt, or equity. Crowdfunding has gained traction in the past ten years as multiple websites have been created to allow for people to donate to passion-project owners pitching their ideas. Donation crowdfunding occurs when people donate funds in exchange for nothing. Rewards-based crowdfunding allows donors to contribute funds in exchange for non-financial benefits like merchandise and services. Debt crowdfunding is when backers pledge a loan at a lower cost than what is offered by banks. In equity crowdfunding, backers can invest money in exchange for shares in the business.
Crowdfunding is a great way to garner traction for your business, primarily through online platforms. The solution attracts potential customers and investors and begins building loyalty to the brand immediately. Crowdfunding also is a relatively low-risk proposition to gather funding and do some preliminary “market testing” to see what the feedback and reaction is of the interested service/product holders. Social media allows for much more real-time conversation between business owners and consumers.
The downside to crowdfunding is that most sites require investors to meet their donation goal for the money to be received. If the donor does not reach the target goal, some sites will return all money back to the donors, which would become a publicly searchable record of the inability to gain initial funding. Moreover, placing an idea onto a website that has yet been developed has to be safeguarded for any poaching of intellectual property that could occur if the brand is not trademarked and invention not patented. Crowdfunding also takes a long time to prepare, and a carefully crafted incentive structure must be set up to be as attractive as possible to potential donors.
Angel Investors
Angel investors are private investors or groups who offer finances in the early stages of a company in exchange for equity. These individuals are often experts in the business field who can also offer mentorship and a broader business network. Typically, angels invest around $25,000 to $100,000 and often take around 20% to 25% of equity.
Angel investors can be found in social media, networking events, and platforms such as AngelList, Angel Capital Association, and Angel Forums. Angel investors benefit from gaining a large amount of equity for a company that is still in its initial stages, which puts the angel investor in a position with potentially huge gains. However, Angel investors can also be picky as many companies who take angel investor money often can never get out of the initial funding stage and may even require more money from the angel investor.
Angel investors are flexible sources of capital because they provide finances from their own costs as these funds/individuals are designed to do targeted research and investment in individuals with promise. When backed by an angel, founders get access to a vault of business wisdom and relationships that can vault a company’s chance at success.
The downside is that angel investors often will want a large amount of equity, especially if the business owner is still an unproven founder. Angel investors gain more control of the company as more equity is given up. If things go awry, some may sell their shares as an exit strategy. Angels might also add undue pressure to grow fast so that the investor can get a return on investment as soon as possible.
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What is the Growth Stage?
The growth stage is when startups are maturing and are starting to gain capital to raise revenue and expand their business. In the growth stage, most startup-ups have already shown a proof-of-concept and need larger amounts of capital to take the business to the next level.
Venture Capital
If angel investors use their own money for funding, venture capitalists use significantly larger sums of money from established financial institutions to finance startups that have long-term growth potential. Like angel investors, VC funds exchange capital for equity in a business. However, venture capitalists are more likely to perform rigorous due diligence before giving up a large amount of capital. Due diligence will require a large effort to prove to the venture capitalist that startup’s business and legal foundations are as advertised. The average capital given by venture capitalists to startups in an initial funding phase is $7 million.
Venture capitalists’ activities are more regulated by the Security Exchange Commission (SEC) and other financial governance given the large amount of money being placed into a company. They also provide expertise in the field and networks for business growth to founders.
With large amounts of money comes formality. Venture capitalists will want company to have a sound corporate structure. For example, a board of directors must be assembled of which some members must come from the venture capitalist firm. The founder could become at-risk of losing the power to run the company if the board of directors place a vote of no-confidence in the founder.
Incubators and Accelerators
Incubators and accelerators have the goal of providing guidance and mentorship to startups. The difference between the two is that incubators focus on helping new startups while accelerators target already developed ones. Incubators, which are normally funded by government institutions, typically also offer non-financial resources such as office spaces, mentorship, and a direct line to investors. On the other hand, accelerators, which are typically privately funded, often provide the same resources but with additional legal guidance and seed capital in exchange for equity.
Incubators and accelerators are specifically designed for promising startups. They usually work with startups for extended periods of time and maintain connections even after the mentorship program has ended. Accelerators specifically offer networking opportunities and demo days that can attract potential customers.
While incubator programs are welcoming, they typically will be limited in the funding offered, which can be a dealbreaker for some. Conversely, while accelerator programs do offer capital, they can be challenging to get into as they are highly competitive. Accelerators also can have rigidly structured timelines that places pressure on the founder to meet deliverable expectations.
Business Loans
Like any business, one option for founders is to approach the bank for a private loan. These can be useful if for founder who want upfront funds while still retaining equity. Business loans are often more favorable for startups than traditional bank loans because the lending limit is higher.
Business loans allow startups to obtain enough funds from a single loan to cope with business expenses. Founders get to maintain complete control and do not have to worry about what the bank thinks in the day-to-day operations of running the business.
The difficulty with business loans is that banks typically want collateral in guess the loan cannot be repaid. Business loans have a high qualification standard and can require a good credit score, a good debt-to-income ratio, a good business plan, assets on-hand, etc. Business loans also take a long time to process and may require a considerable amount of paperwork. Lastly, business loans are typically paid back with interest, so the founder takes on both a large financial risk exposure and also a responsibility to pay back more than what was borrowed.
More Options Are Available for Founders
While some of these options may be more attainable than others for startup founders, the good news is that the options for startups to find funding continues to expand. Founders should not be discouraged at hearing no and continue working every avenue possible. With the advent of social media, more and more businesses have found ways to connect directly with consumers and raise funds organically.
Continue to research what options might be available for your startup. Below are some links to get you started. Good luck!
References:
- Harroch, R. (2021, December 10). 20 Things All Entrepreneurs Should Know About Angel Investors. https://www.forbes.com/sites/allbusiness/2015/02/05/20-things-all-entrepreneurs-should-know-about-angel-investors/?sh=258d1801c1aa
- Johnson, S. (2021, December 1). What Is Crowdfunding? Business News Daily. https://www.businessnewsdaily.com/4134-what-is-crowdfunding.html
- Renner, R. (2022, April 14). How to Use Angel Investor Funding for Your Business. Business News Daily. https://www.businessnewsdaily.com/9078-angel-investor-funding-reasons.html
