There are many potentially great entrepreneurs with valid ideas, but often with little knowledge as to how to take the idea further with the limited resources they have available.
Luckily there are now a variety of ways to fund businesses. All these options may be confusing at first. However, depending on the type of business you have, there are some methods that are suitable to you and some methods that are not.
A good way to start is to look at your long-term strategy, since that may determine what funding methods are best for you. It’s important to have a positive attitude and respect capital – anyone who is going to invest in your company does not have unlimited resources either, so never expect money without making an effort at illustrating what benefits you bring to the investor. It should be clear that you can provide a return on their investment, and where their money goes. Also, a start-up or small business investment, to some degree, comes from personal interest and experience, so take this into account when deciding who to approach and how to approach them. For example, if you have a very technical software or hardware product, it may take longer to convince someone without the technical knowledge, without putting your product in a market context – but there are always way to make it more interesting.
Before venturing into the right approach, let’s look at the main funding options available:
- Bootstrapping simply means using your own funds to finance your business. Getting as far as you can with your own funds is a great strategy, it shows responsibility and commitment and demonstrates how you are able to invest your money wisely. It also prevents you from giving away too many shares early on as that may complicate your company structure in the future. In many cases it is the only option, as funds are difficult to raise at the idea stage. However, this depends very much on the sector you are in – investors tend to invest in some sectors earlier than in others, depending on the risk and the capital needed for product development. It also depends on your competitors and on the market: even though some businesses are not in urgent need of funds, they may need to develop faster to prevent competitors from getting ahead, or to ensure that they take advantage of market momentum. If there is demand for your product now, it does not mean that it will be the same in a few years, so plan ahead.
- Funds from Friends & Family – a good option to get you started, albeit only available to a few.
- Grants and subsidies are available for research-based projects, sustainable businesses, some types of innovative businesses and other special interest sectors. These are often country- or region-specific, so if your business’s success will strongly depend on the availability of grants, you can plan your location ahead, or in some countries, you can apply for a grant and if the application is successful, you can decide if you want to set up your business there.
- Incubator and Accelerators are varied, some may offer support in terms of business development and network, and some may help you with limited seed funding to get you to the next step. These are most suitable to potentially scalable start-ups. The aim here is to give you the necessary tools to get you started and develop your prototype or minimum viable product.
- Crowdfunding is the funding option of choice for many startups these days. It is potentially available to anyone and it can be faster than other methods. Some start-ups decide against it because they prefer privacy. It is important to know that crowdfunding is great for some companies and not suitable for others – and that you need to focus on effective marketing communication. Some sectors are ideal, as they present a concept or product that resonate well with the public – and even though there are all kinds of companies crowdfunding these days, if your business is very technical or very focused on B2B relationships, it will be harder to sell it to a crowd. Another important point to remember about crowdfunding is that it’s not enough to get the company listed on one of these platforms: depending on the campaign and the amount to raise, there may be significant work involved in mobilising investors and potential customers to participate in the fundraising process. As many already know, there are typically four crowdfunding models, with various platforms specialising in each of them:
- Donation-based crowdfunding usually applies when donating money for causes without getting back any return.
- Reward-based crowdfunding involves contributing money in exchange for a reward, usually a product or service of the company the crowd is backing. I personally would not consider this an investment, but rather an advance purchase of a company’s products. For this reason, the campaign here is mostly marketing-based. It is suitable when a company mostly requires financing for its inventory, but less so when you still need considerable money to complete the product’s development, as late deliveries may damage your brand at inception.
- Loan-based crowdfunding makes it possible for anyone to lend money to start-ups or projects and earn a fixed return. There are platform that specialise only in this type of instrument, and others that give the choice between investing in debt or equity. The repayment terms would usually be fixed by the platform. For start-ups this would commonly be convertible debt, which converts into equity at a future point in time.
- Equity-based crowdfunding allows anyone to become minority shareholders, especially some platforms that have an increasingly low minimum investment. Early investors in a start-up often earn a return only when the company exits or in some cases, at a future fundraising round.
- Business angels can pursue a variety of investment strategies. Some may actively invest in start-ups through crowdfunding platforms, some may contribute to a private investment round together with other business angels, and some may be able to contribute to a large investment round independently (the so-called super angels). Being an active business angel also means having an interest in and understanding of start-ups and the industry they are in – that leads to them sometimes taking an active role and contributing to the company’s early development. Other business angels may prefer investing indirectly through investment funds, syndicates and VCs.
- Banks are less commonly approached by start-ups. Mostly, they are able to invest debt in traditional and well-known business models and local businesses.
- Institutional investors include venture capital, private equity firms, mutual funds, hedge funds and others. Venture Capital firms are by far the most common investors in early-stage start-ups among these (less so in pre-revenue start-ups), as they have the means and strategies in place to benefit from early-stage investments. However, they are not the only ones: occasionally, other institutions and funds invest in early and growth stages as well. This usually happens in particular capital-intensive sectors, or for start-ups in more traditional sectors that may not benefit from the typical VC high-growth strategy.
- Corporate investors are leading industry players. Many of them grow through the acquisition of start-ups, but in some cases they also acquire minority shares, usually when the start-up is more established and the risk is diminished. In this case, the investment is highly strategic and the corporate investor may end up acquiring the remaining shares at a later stage. Some now have a corporate venture capital branch that helps them identify the hidden potential in risky companies and make earlier stage investments possible. Whether this is a good option or not, it depends on the founders’ long-term strategy.
- Stock markets can be an option for growth stage start-ups as well, listing requirements for growth capital markets are less stringent, and new early-stage stock markets are slowly emerging. The availability of capital through VCs and Private Equity has made this option less popular, since an IPO can be very costly. However, it is still a good medium-term option for some types of companies to pursue a market leadership strategy through acquisitions.
As a founder, you own common equity in your start-up. External investors, instead, often want to invest in the form of preferred equity or convertible debt, which carry different ownership rights. Investments in the form of common equity and loans also take place, but less often. Revenue-based or royalty financing, instead, is on the rise: here investors are entitled to a pre-defined portion of your revenue.
There are different ways of contacting each type of investor, as well as slightly different documents required by each. Before getting started, you need to have a strategy in mind, for your company and for the investors’ approach. There are effective ways of using online platforms and making each approach personal. Don’t look to needy or just ask for money without mentioning what you want to achieve with it. If you’re looking for a significant investment, you should have a good business plan and financials in place, with an effective executive summary – you need to explain to your audience what they are investing in. An investor-ready business plan, on top of explaining your strategy, should be tailored to the investor-type that you are approaching and include selling points and reasons that explain why your business is a good investment for them. To get the conversation started with an investor, however, a pitch deck is preferred.
Some investors may ask you about your valuation at the first meeting, some may only discuss it at advanced negotiations, it really depends. The actual value of your company, in itself, doesn’t matter much. What is behind that valuation, however, gives you invaluable insights. Your cash flows, the funding and exit market, your risk and return on investment all have features that can attract or deter some investors – but what they provide is a clearer investment roadmap for you and for the investor. After this, communicating the valuation and defending it becomes more straightforward. The valuation takes into account both your technical features and your qualities, and is highly dependent on the market – it effectively confirms your ‘start-up story’.
Independently of how ground-breaking your product or service is, experienced investors will measure your ideas against the market. Having a market for your product is the biggest success factor – so do your homework by answering the following:
- Who are your exact target customers and market size? How do they make decisions about buying your product? Who are the influencers?
- How are you going to set up your marketing strategy based on this information? How much does it cost to acquire new customers?
- What problem are you trying to solve – and are people willing to pay for a solution? What is your revenue model? How was this need validated in the market so far?
- How are you going to retain customers and keep ahead of competition? How do you differentiate from competitors? What else do you have in the pipeline?
- How fast is the market growing? What are the barriers to entry? Is the business scalable?
It is definitely not an easy task to lay down your strategy at such early stages, but it is very helpful to roughly know your direction, the best ventures are the ones that combine innovative products and market fit. It takes time to come up with a focused strategy, but the sooner that takes place, the more you are going to use your time and investments efficiently – this should be realistic and in line with your personal goals. Talk to someone who can guide you in taking important decisions.
Once you know your strategy, you can draw your medium-term financials – despite the high uncertainty, it is untrue that start-up financial plans are completely unreliable – they are only as unreliable as their strategy is. All this information can be accounted for in a valuation with both traditional and typical start-up valuation methods, it’s just a matter of knowing how to apply them with different company types.
Before any advanced analysis take place on the part of the investor, let’s not forget that the first thing to do is to create interest. For some people getting the attention of investors, when given the opportunity, is almost natural, for others it may help looking into storytelling techniques to make people want to know more. The message that you want to convey in your pitch can be of course used during pitch presentations, at networking events and when approaching a prospective investor by email. Some information that should not be forgotten is:
- Who you are and why you are doing this – your understanding and passion for the project should get through to the audience
- What your start-up does in a way that anyone could understand
- The problem you are trying to solve and for whom
- Your unique sales proposition and reasons why your solution is innovative
- Your traction and growth possibilities
- What you want from your audience – and why you chose them specifically
And last but not least, imagine all the challenging questions or doubts that you may receive, and practice your answers. Even when someone expresses interest (an angel investor or venture capital firm), it may take time to develop a relationship, and trust, with them – so leave at least 6-8 months for the fundraising process and raise enough money for you to meet your short-term goals. There are a few steps in the process before you will be able to receive the investment. Knowing what your strategy involves also means that you will not just sign any term sheet that you receive from an investor, but that you can be more selective and realistic about the terms that you agree to.
There are factors that generally increase the chances of being financed (or the lack thereof may hamper your chances): Traction or validation with customers, a large potential market, a proven technology or know-how, a disruptive/innovative business model in a popular and growing sector, an experienced, responsible and coachable team/ entrepreneur, exit possibilities and a focused strategy. Work on ticking all of these boxes and you will be ready to start planning your fundraising campaign.