Funding your startup is one of the most important and challenging tasks you will face as a founder. If you are creative, there are many options to fund your startup. None of the options is perfect and each one brings certain pros and cons to you and your startup.
I cannot definitively tell you which option is the right option for you. You should consider a variety of options and weigh the pros and cons of each and then decide which ones are practical for you. In this article, I will discuss a range of options you should consider.
Dig into your own pockets
The most common way to fund your startup is through your own means. After all, if you are not willing to invest in your startup, why should any other investor invest in your company? If you expect to use “other people’s money,” your startup may not get off the ground or putter along. I believe founder investment is essential, whether or not the founder investment is significant. Every founder should have some skin in the game. Here is how you might tap your own resources.
You can also invest earnings from part-time employment or consulting activities. In my view, it is better to take a flexible consulting role than full-time employment. It is very hard to start and grow a startup while holding a full-time job, and I believe a startup must have at least one full-time founder for the startup to be successful. One nonobvious con of a part-time job is that any source of income will take some pressure off you to succeed with your startup because any income provides a fallback option. I know most founders think they will work just as hard whether or not they have a second job, but that is not always the case in practice. A founder who is concerned about being able to pay rent, eat or fund payroll is a very motivated founder. Even though living on the edge may not be the safe path, it is an effective motivator.
You may be able to borrow cash on your credit cards. Founders, who borrow cash on their credit cards and then make the minimum credit card payments until they can pay down the balance, have funded many successful startups.
You may be able to borrow against the equity in your home if you are a homeowner. Home equity loans carry lower interest rates than many other borrowings. The downside (and a significant one) is you could lose your home to foreclosure if you default on the loan. Therefore, before taking a home equity loan, make sure you can repay the loan by securing employment in the worst-case scenario.
If you have a Michael Jordan sneaker collection, a boat, a restored classic Mustang or other non-cash assets, you could sell those assets for cash and then invest in your startup. Will you receive full value? Not likely, assuming you sell your assets in quick sale.
Regardless of how you get personal investment funds, you will need to decide what you will receive in exchange for your investment. You could choose to buy Common Stock or a simple Preferred Stock, such as Series FF, in exchange for your cash investment. You could also choose to make a loan, whether a simple demand note or as the first investor in a convertible debt financing. The terms of these securities are beyond this article, but check back a more detailed article about different types of securities in the near future.
Reach out to people who know you best
Other than funding your startup through your own means, friends and family are your next best source of funding because individuals who know you and believe in you are more likely to support your startup’s business plan even if all the kinks have not been worked out.
One advantage of raising money from friends and family is that they’re easy to find. There are, of course, some risks raising capital from this group as well. Failed businesses often destroy personal relationships. I have seen many family relationships and friendships ruined when startups fail and friends and family lose money. It is advisable to discuss the risk and the likelihood of failure with your friends and family before accepting their investments.
There are other disadvantages of this type of financing. For example, friends and family usually do not have connections to help startups raise more funding and often want to be unnecessarily involved in the startup. That is, you may find you have more Chiefs than Indians if you take family money. Traditional angel investors generally are passive investors and they permit the founders to manage the startup and may connect the startup to its next funding source through their connections. Angels are motivated to help raise more funding to protect their investments.
Connect to angel investors through your personal network
You should plan to tap your personal network, and their networks, to locate angel investors. Think about the six degrees of Kevin Bacon and try to develop your own six degrees. Don’t be afraid to ask for connections.
Networking takes time and often you will need to develop a personal relationship with an angel investor before they invest in your startup. Very few investors invest after the first pitch. With angels, you have to pitch and pitch again. No may not actually mean ‘no’. This is why it is important for you to tap your personal networks early and often.
Individual angel investors typically invest between $10,000 and $500,000 and the aggregate average angel investment for a startup is $500,000 to $600,000. Most angel investors do not seek board representation or many contractual investment rights.
Attend seminars and events for networking
If you live in a tech hub, there are multiple startup and entrepreneurial events every day of the week. In my neck of the woods in Silicon Valley, there are literally hundreds of events a week and probably at least 10 good startup events in that mix. These events are publicized in Meetup, Eventbrite, StartupDigest, Zvents or online editions of news media. Law firms also publish events they host. Not all of the events have investors in attendance, but a number of startup events have speakers who are investors and are willing to speak a few minutes after the events.
Other events have investors in the audience seeking deal flow. Investors usually do not raise their hands and announce their identities to avoid attention, which means you need to be clever to find the investors in attendance. Look for individuals on the periphery of the room who do not appear hungry for connections (display no signs of founder desperation) and are not particularly interested in networking. After you learn how to spot investors in the audience, find a way to spark up a conversation.
Borrow against your startup’s assets
If you have customers, you can ask them to pre-fund their purchases. I represent two startups that have received their initial funding from their customers or joint venture partners, in one case more than $6 million. It is not a common way to finance a startup, but a cheap way if you have willing customers.
Corporations fund startups because startups are more nimble and are better able to develop technologies than larger companies. Big companies have spent billions in failed research and development expenditures and are sometimes willing to provide seed funding to startups that are developing interesting technology in exchange for future investment rights, future acquisition rights, or board positions. This type of funding happens more often for technology startups.
If your startup needs to purchase inventory for sales (online or brick and mortar), certain vendors will defer payments until the startup sells its inventory. This is not a direct source of funding, but does save precious cash for other purposes.
Another option is to factor accounts receivable if your startup has revenue. Factoring means accepting less than the full amount of accounts receivable, which means profitability is negatively affected in the short term. Survival is more important than profitability for a startup, and a short-term hit to profits may be a good trade-off.
Borrow from your peers
Borrowing from your peers has never been easier and not as crazy as it might sound. This is not a new innovation. There have always been lending groups based on occupation, ethnicity, gender or other common characteristics. More recently, a number of online peer lending groups, such as Lending Club, have changed the peer lending game with new models. Many startups now raise $25,000 to $100,000 through peer lending to start their companies.
There is power in the crowd
You might want to consider crowdfunding. Crowdfunding is a new way to raise capital and some of the most prominent crowdfunding sites are Kickstarter and Indiegogo, but there are many niche sites focused on industry verticals. These sites are different from equity crowdfunding under The Jumpstart Our Business Startups Act (better known as the JOBS Act), which is still not permitted until the SEC has published the final rules regarding equity crowdfunding.
Crowdfunding in the Kickstarter mode is not selling equity or debt in your startup. Instead, it is raising funds through pre-sale of products or services or for rewards. Many crowdfunding sites require a minimum amount to be raised before any backers are required to fund. As such, your fundraising goals should be realistic if you decide to post a project on one or more of these sites. Successful project promoters often front money to produce a video, promote their project and possibly become backers to show momentum. The difference between a promoted project and a non-promoted project could be the difference between success and failure of a project. There are many examples of projects that have initially failed and then been wildly successful the second time after the promoters rebrand the projects and hire PR agencies to promote their projects. A recent example is the Coolest Cooler, which originally missed it $125,000 goal before raising $13 million its second attempt. Even if you like beer, ice and hotdogs, $13 million for a portable ice box is unbelievable.
Crowdfunding is a mini-business in itself and the projects that raise the most money are often not the best projects. If you decide to crowdfund, research the market, evaluate why certain projects have been successful, develop a plan for your project, and then execute.
Connect through online platforms
You can try free investor match services. These services allow startups and investors to connect through their marketplaces. Of course, many people know about these services, which means you need to determine how to stand out from the clutter on the platforms (not an easy task). Your startup will be a needle in a haystack on one of these sites.
Try these sites, among others.
AngelList is one of the more popular and effective online platforms for startups that are seeking funding, co-founders, or employees. Through the platform, startups are able to post a profile that describes the startup, the founders, the board, the advisors and its service providers (including lawyers, the most important service provider).
FundersClub enables startups to receive small investments from numerous investors by aggregating individual investments into investment funds under which FundersClub will be the general partner and only receive incentive-based compensation on the gains.
Gust provides a platform for startups to connect with investors. Startups and investors create profiles with a brief description of their businesses, founders, and management teams.
Angels groups open the door to dozens of individual angel investors
If you don’t know any angels, one way to find angel investors is through angel groups. Angel groups or angel networks are groups of angel investors who band together to share and evaluate deals and make individual investments in conjunction with other members. The groups are intended to help source deals and also syndicate risks among many investors. Some angel groups charge startups to pitch. If the fee is more than nominal, I would pass on that group.
The Angel Capital Association is a good source of contact information for angel groups. This organization lists its members’ contact information and summarizes information about investment objectives of its members. After you have the contact information for an angel, you can check on LinkedIn whether someone you know can connect you with the angel. If not, try a cold call or an unsolicited email.
Accelerators are a new source of funding
You should consider an accelerator program if your startup is tech oriented. Accelerators help startups at their seed stage (pre-Series A) by providing guidance and mentorship in three to six month accelerator programs. The credible accelerators offer investment of $15,000 to $150,000 as part of their programs. Of course, admission to the best-known accelerators, such as YCombinator and TechStars, is very competitive and it’s often easier for a startup to raise capital from angel investors. If you are accepted into a lesser-known accelerator, proceed with caution. Their investment will cost you three to 10 percent of your equity and you may not get any value in return.
Venture capital firms fund tech startups with traction
If your startup is focused on technology and has traction, you should consider venture capital firms as potential investors. A venture capital firm, or VC for short, is an entity that manages capital for other investors, called limited partners. Venture capital firms usually do not invest in angel transactions and, as a general rule, they expect more progress from startups they invest in than angel investors. If you are a startup without any meaningful traction, do not waste time reaching out to VCs.
Venture capital firms invest in startups where they perceive potential exit values higher than $50 million (and often a few hundred million for capital intensive startups). You should evaluate whether your startup meets these metrics before seeking VC funding.
Venture capital firms seek to own at least 15% to 20% of the equity of a startup on a fully diluted basis, receive Preferred Stock for their investment, have a right to designate a board member of the startup and vote on a number of negative covenants called protective provisions.
You do not need to know an investor to make a connection. Many of the venture capital firms list their investment professionals’ contact information on the firm websites, including premier firms like Sequoia Capital. Not all venture investors respond to unsolicited inquiries, but a surprising number of them respond if an email piques their interest. Many startups claim to have as much success cold calling venture capital firms as they do through a semi-warm introduction. Don’t be scared to act without an introduction.
The National Venture Capital Association is a good source of contact information for VC firms.
Your law firm may have access to premium online content
There are a number of premium subscription services, such as PitchBook and VentureSource, which have collected investment firm information (angel groups and venture capital firms), including contact information and types of investments made. Both of these services are relatively expensive, but they do have great investor profiles, targeted industries and contact information for investors.
Not many startups have budgets for premium content. Many law firms and accounting firms have subscriptions to these services and startups that work with such firms might be able to get access without charge (or at least without incremental charge above the normal high law firm rates). This is one reason to choose a good law firm.
Venture lenders are not a viable source of funding for most startups
Venture lenders are specialized bank and non-bank lenders that provide debt to venture-backed startups for working capital or specific assets purchases, such as computer equipment. Unlike traditional banks, venture lenders will lend to startups without profits, positive cash flow or material tangible physical assets. Venture lenders receive warrants from the startup to compensate for the higher risk of default than traditional bank loans.
Venture lenders sound like a great source of startup funding, but are not generally for most startups. Why? Venture lending occurs only if a startup has raised venture capital investment and the prominence of the venture capital investor matters to the venture lender. If your startup does not have a prominent venture capital backing, it won’t be able to raise venture debt. Venture lenders are not lenders in angel financing rounds.
Summary
I hope you learned a few new ways to fund your startup. The first two options are probably the realistic options if you are just starting up. Nonetheless, be creative and remember it takes persistence to find outside capital.
One of my clients shared a story with me about his seed backers, two guys who sold their oil and gas startup about 15 years ago. As the story was told, the oil and gas tandem struggled to raise capital and struck out more often than they succeeded in fundraising. They believed in themselves and never gave up no matter how many times the door slammed in their faces. Finally one investor agreed to invest in the tandem’s oil and gas startup. With the funding and years of hard work, the tandem eventually sold their business for $400 million.
Fundraising was not easy for them and they had to endure a lot of rejection in the process. In fact, they met with 139 investors who rejected their fundraising pleas before the 140th investor prospect said “Yes.”
I hope none of you get 139 rejections before you get your success, but don’t be discouraged by some rejection. Rejection is the rule, not the exception.
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