It wasn’t too long ago that funding options available to startups were limited, to say the least. In recent years, the landscape has changed significantly, and in a good way.
There are now multiple sources of funding available to entrepreneurs across different stages of a startup’s lifecycle, be it seed, growth, or Series A to Series C. This increase in capital is the result of the creation and development of alternative financing platforms, such as crowdfunding, investment syndicates and fresh venture capital firms; all bringing different approaches to the market.
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However, investment isn’t something that happens overnight. When starting a business, startups need to spend time looking at their business idea objectively to determine whether they have a compelling argument for why their product deserves investment.
If you’re a startup looking for investment, choosing who to receive funding from and taking the time to understand the investor’s strategy and value-add is essential, as it’s a decision that will long-term implications on both sides.
Below is a simple guide to the different rounds of investment available to you, with the help of several experts in the field, to explain what the terms mean and how to choose the right type of funding for you. James Oakes, entrepreneur-turned-investor and director at ZEAL investments, has also provided the pros and cons for each, to make the process easier.
Funding for startups
Friends and family
Once you believe your product has market viability, personal networks can be a successful route when it comes to finding your first wave of investment. Assuming you have previous experience in your field, consider the contacts you already have and their wider network.
Michael Gould, Founder and CTO at Anaplan, says: “Contacts in a new market can be a huge help – having trusted colleagues which you can rely on and trust in their local knowledge is hugely beneficial.”
However, it’s important to not let close contacts affect your decision making: something that can be tricky to manage, especially when a friendship is at stake.
Pros: Can be easy to raise money
Cons: Unsophisticated investors could cause problems later down the line. Personal relationships could cloud judgement.
Crowdfunding for startups
Crowdfunding has unlocked the door for anyone to raise funds for any idea by turning to the “crowd” instead of asking banks or venture capitalists. Thanks to platforms, such as Indiegogo and Kickstarter, crowdfunding has become one of the most popular ways for entrepreneurs all over the world to raise funds.
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Joel Hughes, UK and Europe Director at Indiegogo explains there are two key types of crowdfunding available: rewards-based and equity: “Rewards-based campaigns means campaigners offer special perks as a way to attract potential backers,” he says. “These incentives can be anything from a ‘VIP’ exclusive discount or a once in a lifetime gift. Equity crowdfunding simply gives backers partial ownership of the business they invest in.”
But while crowdfunding can be a great way of raising awareness of your business and building an engaged community of advocates, the danger is that it can over-value your business. This is because businesses end up giving away a small number of shares for a vast sum of money – say 10% of the business to raise £1m.
You could find those shares will be devalued significantly at the next investment round.
The other consideration is that, with crowdfunding, you’ll have a lot more investors to answer to and communicate with, so you need to think about how you are going to manage that.
Pros: If you get the pitch right you can raise money relatively easily. Good use of technology with easily accessible information. If structured well, crowdfunding has none of the downsides of ‘friends and family’ investment.
Cons: Much like friends and family investment, the money isn’t always from well-informed investors.
Third-party investors
Working with third-party investors, such as business angels or venture capital firms, is a less risky option than many of the other types of investment available. Andrew Clough, founder and managing director at East-London co-working space The Brew, believes this is because they don’t usually require you to provide security or personal guarantees, which means if the business fails, you won’t need to pay the money back.
“Although it can be much more intense in terms of reporting and the amount of free-rein you’ll have with business decisions,” he says.
Venture Capital (VCs)
With venture capital firms, you’re dealing with a much more hard-nosed approach. They’ll want to see strong returns in around five years. This can put a lot of pressure on business owners as you have to be careful not to give away too much equity – you can end up losing control of your business if you’re not careful.
“If the VC firm ends up with a controlling stake – more than 50 percent – they ultimately have the power to get rid of you,” adds Clough. “That’s why, whether you’re seeking investment from angels or VCs, it’s vital to spend time finding the right fit and ensure you can get on with each other. Remember, it’s a two-way street; you have to want to work with them, as much as they want to invest in you.”
However, Alex Kayyal, Europe Head at Salesforce Ventures, says VC funding is a more attractive option to consider.
“A good VC will offer long-term support with the resources needed to grow and scale a business quickly,” he says. “At Salesforce Ventures, we seek to provide our companies with access to the world’s largest cloud ecosystem, as well as advice and know-how on how to scale. Ultimately, it’s this combination of a strategic and financial investor base working together that can drive a lot of impact for entrepreneurs.”
Pros: VC’s are professional and experienced. They have often been successful. A vital part of the funding system.
Cons: If VC’s stall, until companies are big enough, they can miss out on big opportunities because startups have achieved the money themselves.
Angel Investors
Angel investors are a great source of capital to test an initial hypothesis. From there, if an entrepreneur has big ambitions, they can scale quickly. Working with angel investors also means you also gain an ambassador or mentor for your company, as they typically have experience and enthusiasm.
However, angels are generally limited in what they can invest, so are perhaps better for seed funding than when you want to scale up. They also often want a seat on the board and a salary to go along with it, so be prepared for that.
Pros: Great for guys who try live their dream through your business
Cons: Not mega wealthy. Typically have a few million after building and selling a business. Success can be hit or miss
Business Loans and grants for startups
The advantage of bank loans is that you can source the funds you need while keeping 100% of the equity (ownership) in your business. However, bank finance is arguably the bigger personal risk as most lenders now ask for a personal guarantee, which means you are personally liable if your business fails.
“Signing for a business loan also means you’re committed to paying back the debt immediately, which can put unwelcome pressure on your cash flow as you’re growing,” adds Clough.
Pros: Easier for a franchise.
Cons: Typically difficult to secure. Risk in lending to startups is high. Difficult to get a loan for a genuine startup.
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Images: Flickr
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