- When it comes to fundraising, there are a whole host of sources of funding beyond Angel Investors and VCs. You should consider raising capital from all of these before turning to Angels and/or institutional investment.
The startup boom has been accompanied by a venture capital boom and the options available to Founders looking to raise capital are now multiple.
Combined with the fall in capital requirements to build a business, more and more investors have appeared to help Founders start and grow their companies. Long gone are the days where venture capital was dominated by a few large firms and startups had little choice but to turn to savings, family and/or friends.
Here are the various ways in which you can raise capital for your startup depending on what stage you are at or what space you operate in.
Self-funding is an effective way of financing your startup, particularly in its very initial stages.
If you have ample personal savings, then bootstrapping your startup can be advantageous as such funding has little formality attached to it with compliance/due-diligence needs non-existent. Bootstrapping your startup also has the added value of showing your tangible commitment to the company which may be looked on favourably by investors in the future.
Family & Friends
The bread and butter of very early stage fundraising.
Family & friends are the main source of financial (and emotional) support for many startups in their very early stages.
Because of the stage at which they invest, family and friends take on the most risk when providing capital.
As a result, you should be very transparent about your company, strategy and plans with the money provided and focus your fundraising efforts on those who can afford to lose the money they give you.
Using the capital of a large number of people, crowdfunding has gained popularity over the last several years and is a novel way founders are funding their startups.
Crowdfunding can be a quick and cost-effective way of raising capital and has other advantages including publicity, customer feedback and garnered interest from ‘bigger’ investors such as VCs.
Numerous platforms now exist where Founders can describe and showcase their product or idea, highlighting their goals, strategy and capital needs in an attempt to receive capital from hundreds and thousands of consumers.
You can find out more about raising capital via crowdfunding here.
Angel investment is one of the most common sources of capital for startups, particularly when fundraising at the Pre-Seed and Seed stage.
Angel investors are high-net worth individuals who use their own money to invest in startups and small businesses in return for an equity stake. Angels are also likely to contribute their knowledge and non-financial resources to help the company.
Whilst similar to venture capital firms (VCs) there are important distinctions:
- Angel investors are individuals whilst VCs are companies or institutions. Angels can, however, group together to form an Angel syndicate. There are also angel investment networks that specialise in different business types and industries.
- Angels are more likely to invest in startups that have not demonstrated the growth a VC would look for to invest.
- The average ticket size (capital invested) of an Angel is typically much smaller than that of a VC, being anywhere between 5k-100k.
- A venture capital firm primarily focuses on maximising their returns, whilst an Angel is more likely to have alternative motives such as personal interest in the Founder(s), product or problem the startup is solving.
Venture capital firms
Venture capital firms (VCs) are organisations that take equity in a company in return for the provision of capital, known as equity financing.
This is for the primary purpose of maximising the return on their investment. A crucial thing that a VC looks for in a company before investing is that company’s potential to return the fund. This essentially means the VC’s investment in your business alone must have the potential to give them the desired exit proceeds for their entire fund.
Compared to Angels, the average ticket size (amount invested) of VCs is much higher, often reaching into the millions and, unlike Angels, VCs do not use their own money but that of investors. However, like Angels, VCs will also provide their expertise and network to support the startup.
VCs tend to invest in more established startups, where there is proven product opportunity, market opportunity, management and existing investment.
The process of gaining investment from a VC is typically more formal and systematic than that of other sources of capital, requiring extensive outreach on the behalf of the startup, detailed discussions between the startup and VC and comprehensive due diligence processes, amongst other things.
Broadly speaking, VCs can be split into three groups;
- Early stage/Pre-seed/Seed,
- Series A/B/C and
Across these groups, some VCs will also specialise in investing in startups operating in particular spaces, e.g. SaaS, Biotech, E-commerce etc.
Due to this variety, it is important startups find the right VC for them when fundraising, both in terms of the stage at which they are looking to raise and the space within which they operate.
Accelerators are cohort-based, fixed-term programmes that aim to create and/or ‘accelerate’ the growth of existing companies.
As part of their programmes, accelerators provide resources such as capital (unlike most incubators), education, working space, networking opportunities and mentorship in return for equity.
Not all funding has to be equity-based. Debt-financing is one alternative, the most common form of which is a bank loan.
Obtaining a bank loan as a startup is, however, hard and most banks do not finance startups.
Find out more about debt financing your startup here.
Banks are not the only source of debt financing.
Peer-to-peer lending (P2P) is a business loan where a large number of private investors come together, usually through an online platform, to lend capital to a business. The idea is that the lenders and borrowers get a better rate than obtaining the loan from a bank.
Whilst the startup applies for the loan directly through the online platform (the P2P provider), they will borrow money from a group of individuals rather than one institution. This aside, loans obtained through P2P lending platforms are much the same as traditional bank loans.
Read more about P2P lending and how it works here.
If your startup operates in a certain industry, is of a specific size, engages in research & development or its Founders are of a certain demographic, it may qualify for governmental grants.
Grants come in different shapes or sizes. For example, some provide reduced or subsidised costs, training, free equipment or direct capital.
Most governmental grants are awarded to early stage startups or startups that have yet to launch. Fewer grants are available to more established startups.
Grants that provide direct capital will have different conditions attached to them. Some will be provided as a loan and will need to be paid back with or without interest, some won’t have to be paid back at all and some will be offered on the basis that you will match the amount provided.
Obtaining a grant can be difficult as many are complex, specialist and have certain requirements attached to their provision.
You can find out more about government grants for UK, EU & USA companies here.
Alternative financing options
The explosion of startups has been accompanied by an explosion of different financing options, both in terms of the numbers of providers and types of providers. Innovation in the finance space over the last few years has seen new financing options for both investors and founders.
Revenue-based investing (RBI), also known as revenue-based financing, is one of the more prominent new investment models and financing instruments appearing in the startup fundraising ecosystem.
It allows businesses to raise capital from investors by giving them a percentage of the company’s ongoing gross revenues in return for the money they invest.
Investors receive a consistent share of the company’s income until a predetermined amount is reached. This portion of revenue is paid at a pre-established percentage until a certain amount is reached. This is usually a multiple of the original investment, ranging anywhere from three to five times.
You can read more about RBI, it’s advantages and disadvantages and the different companies that offer it here.
Shared Earnings Agreement (SEAL)
A Shared Earnings Agreement (SEAL) is a financing instrument developed by Earnest Capital typically used instead of equity-based financing instruments. A SEAL is not debt, does not have a fixed repayment schedule and does not require a personal guarantee.
The investor instead earns a percentage of ‘Founder Earnings’, in other words, the money that encompasses founder(s) salaries, dividends and retained earnings once outgoing expenses and costs have been accounted for. The sum the investor earns is called ‘Shared Earnings’.
The investor only starts receiving their Shared Earnings once a predetermined Founder Earnings Threshold has been exceeded. This ensures Founder’s are earning a sufficient amount from their Founder earnings before investors start seeing a return.
This Founder Earnings threshold distinguishes a SEAL from Revenue-based investing (RBI) which are repaid monthly no matter how much revenue the company generates.
A SEAL is also capped using a Shared Earnings Cap that is agreed upon prior to investment and which is a multiple of the initial investment. This can be anywhere between 2-5x the original investment. Once this cap is reached, Shared Earnings payments to the investor stops.
Convertible debt is when a business raises capital by borrowing money from an investor, or group of investors, and it is agreed to convert the debt into equity in the future. You can read more about Convertible Debt Loans (CLNs) here.
If you’ve spotted any inaccuracies in this post, please let us know. We want to make sure we are offering the most update to date and accurate information. Feedback is always welcome.