Today’s startup founders have a heart for pragmatic vision. They are able to create elegant solutions for real-world problems while dealing with tactical issues such as as scale, accessibility and reliability. It can be difficult to find the right way to finance your startup. We have 11 sources of funding you can use to fund your startup.
- Self-Funding / Bootstrapping
- Friends and Family Investors
- Lenders/Credit Cards/Debt
- Angel Investors
- Grants for small businesses
- Commitment By a Major Customer
- Venture Capitalists
You need money to make a great idea a reality. But “money doesn’t grow on trees” so you don’t have thousands of dollars to spend.
How can you make your dream a reality? These are the top options.
Before you talk to investors, consider protecting your intellectual property. Often investors won’t sign NDAs that protect your trade secrets. Since patent rights can be forfeited if you disclose sensitive patent information before filing for patent protection, the first step should be to file for patent protection and then talk to investors and third parties such as bankers, consultants, and advisors, among others.
Self-Funding / Bootstrapping
Entrepreneurs often start out with some self-funding. Also known as bootstrapping, future investors will likely want to see that there is some risk involved. Even if you only have a small amount of money to put into your venture, the benefits are worth it. You don’t have the worry of keeping investors happy. Profits can also be kept more to your own benefit. Many founders put off taking a salary. Instead, tap into your 401(k), and/or take on a part-time job while you get your business started. Also, instead of depending on future funding rounds, you can also use your initial profits for future growth.
Friends and Family Investors
Friends and Family investors are the easiest to reach out to. However, be careful of the worst case scenario of losing all your relative’s money as you will have to face your friends and family for a long time. Also, be aware of the dangers your startup may face – although your family and friends may be willing to support you, they won’t force you through all the hoops.
To protect your relationship and yourself, you should have a written agreement that clearly outlines the repayment terms. You should also confirm whether any securities restrictions are applicable to the arrangement, even if it is informal. One option to minimize lawyer fees is to use a standard investment template called a SAFE agreement. Y Combinator introduced the SAFE (simple agreement for future equity) in late 2013, and since then, it has been used by almost all YC startups and countless non-YC startups as the main instrument for early-stage fundraising.
Crowdfunding has become a very popular way to fund a startup. The traditional crowdfunding approach offers a first-run product, or other incentive in return for a monetary contribution. Contributors do not receive equity, and they are not eligible to be repaid.
The process can be seen as a pre-sale and not an investment in many cases. It is not regulated under the federal Securities and Exchange Commission. Due to the pre-sale nature of crowdfunding, this can invalidate patent right in many countries since the sale of the patented product can trigger the on-sale bar for patent applications. As such it is vital that you file patent applications before initiating crowdfunding. Equity crowdfunding is a more recent option that’s made possible by the Jumpstart our Business Startups Act. This allows you to get small investments from a large group of investors. A crowdfunding platform allows you to list your company, much like a traditional crowdfunding campaign. However, your investors are now shareholders. This includes voting rights and dividend rights, as described in the shareholder agreement.
Incubators and accelerators provide space, advice, training and funding for startups. These programs are often sponsored by universities or industry organizations. This arrangement provides support for each startup and offers networking opportunities. The incubator or accelerator might also get equity shares, especially if funding is provided.
In most cities, there are incubators and accelerators that cater to local businesses. Some well-known Accelerators or Incubators include:
- Y Combinator
- 500 Startups
- Amplify LA
- Chicago New Venture Challenge
- DreamIt Ventures
- Capital Factory
- Launchpad LA
According to Investopedia, an angel investor (also known as a private investor, seed investor or angel funder) is a high-net-worth individual who provides financial backing for small startups or entrepreneurs, typically in exchange for ownership equity in the company. Often, angel investors are found among an entrepreneur’s family and friends. The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing injection to support and carry the company through its difficult early stages. There are many benefits to this relationship, including mentoring and close personal relationships. An angel investor may ask for large equity stakes or even a controlling share.
The typical investment ranges from $25,000 to $250,000. Angel investors have a more informal structure than traditional corporate structures, so they may have different expectations about the terms of investments. A common way to handle investment expectation is to standardize with the SAFE terms described above.
It can be difficult for new businesses to obtain a traditional loan from banks unless they have collateral or are willing to personally guarantee the loan (e.g. by contributing equity to their home). The federal Small Business Administration (“SBA”) has several small-business loan programs that may help you get approved. To finance their businesses, some entrepreneurs may also use credit cards, microloans, or venture loan.
After steady sales, you might be able open a credit card against your accounts receivables. This is also known as “factoring” or you could use your business equipment to secure a loan (also known under the name of an asset loan).
Grants for small businesses
Free funding can be provided by grants from the government and private organizations. Your company might need to be involved in a specialized or social good, such as education, medicine or alternative energy, in order to receive a grant. You can search for grants at grant.gov.
There are many sources of startup funding, including grants, loans, and different kinds of investors. Click on the links below for more details.
- Search thousands of federal funding opportunities on Grants.gov
- Find R&D seed funds from the SBA’s SBIR/STTR
- See if you qualify for a SBA loan
While many businesses prefer to receive their cash payments in cash, there are still opportunities for trade in today’s economy. If you are looking for small businesses that can meet your needs or have a solution to a problem, look out for them. In exchange for your services, you may be able to trade them. For example, you might agree to help a company with their IT needs in exchange for marketing services from them. Even if you don’t receive any cash directly, your barter arrangements will help you stretch your resources further.
Sometimes, it’s not possible to grow your business on your own. You might consider partnering or licensing with an established company that can benefit from your product. If you have a battery for your cell phone that lasts twice as long than the existing ones, you can either go through the costly and risky process to market it to consumers or you can strike a licensing agreement with a manufacturer who would love to include your battery in their next model.
A partnership arrangement or licensing agreement might limit funding to a single order. This advance could be used to scale up manufacturing. The bigger benefit is that you will not need as much funding if your supply chain costs and marketing strategy are lower.
Commitment From a Major Customer
You may be able to secure a large customer to finance your development. They may offer to modify your production process according to their specifications, get exclusive distribution rights or support you. This may be tied to an early licensing agreement or white-label contract.
Venture capitalists can be described as professional investors who invest in growing businesses and startups. They are a great audience if you are looking for investors to pitch your idea. You will need to be able to move beyond the initial stages of your venture capital investment. Venture capital investments average $1 million. The deal may take several months to close.
Venture capital is not long-term funding. Venture capital is meant to be used to build a company’s infrastructure and balance sheet until it is large enough to sell to a corporation or go public. The venture capitalist purchases a stake in the idea of the entrepreneur, nurtures it for a brief time, then leaves with the assistance of an investment banker.
The structure and rules of capital markets are what make venture capital unique. A person with an idea or new technology may not have any other options. Usury laws restrict the interest banks may charge on loans. Public equity and investment banks are also constrained by operating procedures and regulations that protect the public investor. A company couldn’t access the public markets if it didn’t have $15 million in sales, $10 million assets, and a good track record of profit. This is because less than 2% have revenues greater than $10 million. Despite the recent reduction in the IPO threshold due to the issuance of stock in development-stage companies, the financing window for companies with less revenue than $10 million is still closed to entrepreneurs.
The risks associated with start-ups often justify higher rates than what is allowed by law. Bankers won’t finance a new company unless there are sufficient assets to pay the debt. Many start-ups today have very few assets in today’s information-based economy.
One advantage of working with VCs is the access to their Rolodex of senior growth partners. If you have to increase sales in a quarter, it is a good idea to ask your growth team members to introduce you to the decision-makers at your target accounts. You can also use your growth team members to make reputable connections when you need to hire a CXO for your team. The VC partners should have experience as startup operators and be able to relate to what it’s like daily in the trenches. You’ll end up taking advice from people who don’t understand your problems and can’t give you the best direction.
You should ensure that your interests align with potential venture capitalists. Venture capitalists often want quick returns and rapid growth. This could be against your desire for slow and steady growth. Venture capitalists are also interested in gaining substantial control over a company and often exercise this power. Venture capitalists might not be the right fit for you if you are looking to pursue your vision.
Importantly, venture capitalists will often want their own investor agreement. You should carefully read any contract you sign to make sure it serves your interests. If it isn’t, don’t hesitate to negotiate and remove the most objectionable clauses. In the end, as a bird in the hand is worth two in the bush, you should accommodate the professional investor as much as reasonably possible.
With VCs, it’s more important than ever to meet people face-to-face and establish connections. Both founders and investors want to reconnect with potential partners. It’s like a marriage when you bring in an investor or founder. Thus, while video conferencing sounds tempting, there is much to be said about meeting investors in person.
It is rare that the original plan presented at the investor stage will ultimately go to market. Investors seek partners and teams that can help them through pivots and changes.