Even the best business ideas need funding and often find it challenging to raise them. Without finance, the business cannot exist. Although many startups are funded through owner savings and investment from friends and family, that option is not always sufficient or even available. So what we will do here is look at the most critical sources of startup financing in the world today.
#1 Angel Financing
An angel investor provides capital to startups, often in exchange for ownership equity or convertible debt. They back startups at the early stage in their lifecycle when the risks are such that no other category of the investor will back them. There is some fluidity in our options here. Many angel investors operate through equity crowdfunding platforms or angel networks where investment capital is pooled. They often also offer their advice and experience in addition to their investment capital. Companies such as Facebook, Uber, and WhatsApp were built through angel investing. Angel investors are motivated by the prospect of making outsized returns in exchange for the high risk that they assume in investing in a startup’s early stages. Investments are usually between $25,000 and $100,000.
At this stage in a startup’s life, the essential thing that angel investors are looking for is product-market fit. In other words, an angel investor wants to know how well your product meets an existing and hopefully growing consumer or enterprise need.
You can look for angel investors through crowdfunding platforms, other founders, accountants, lawyers; AngelList; venture capitalists; angel investor networks; and investment bankers.
The best angel investors often have already had very successful liquidity events, not just because they have cash, but because they have experience of what it takes to succeed and the right networks to see your startup through.
Crowdfunding is a way of raising funds through a platform in which many people contribute relatively small amounts to businesses in need of fresh capital. It comes with the advantage that while raising funds for a business, it can also lead to greater awareness of a startup’s products.
You start by creating a profile on a crowdfunding platform such as Kickstarter and Indiegogo, where you describe your company, its products, prospects, goals, and market. Next, you outline how much money you are looking to raise and what that money will be used for. If your campaign gets any traction, investors will contribute to your campaign. They are given owner equity or a claim on profits, a free product or service, or a contribution-based discount on your products and services in exchange.
A successful crowdfunding campaign rests on the following elements:
- First, explain every feature and the product’s usability in detail. You can do this through graphics, breaking up each feature to make it more exciting and memorable.
- Have a video to draw mass appeal. The video should focus on your product and add a human face to it all by introducing you and your team to your audience. Products are great, but people love to back people. So it means a lot when a product can be tied to other people.
- If you already have an established brand, make sure you use your normal brand and tag lines. This will ensure there is no brand dilution and credibility is maintained.
- The written word will always be necessary, but the visual is more instinctual and memorable. So use fantastic imagery and graphics to grab attention and stay in people’s minds.
- Communication is so important. Your backers need to have their queries responded to quickly and clearly. They should be regularly updated, and communication is done in the simplest, most effective, and most transparent way possible.
#3 Venture Capital
Many startups raise investment capital through venture capital (VC) firms. VC firms provide private equity financing to startups with high growth potential or demonstrable high growth (in terms of annual revenue, operational scale, and other metrics). As with angel investors, venture capitalists take on the risk of investment in the hope of earning outsized returns. Unfortunately, startups have a high rate of failure. The typical VC portfolio will have many firms that end up going bust. They gamble that one or more of the businesses in their portfolio will become such a success that it makes up for their losses elsewhere. VC firms typically like to work with innovative technology or business models startups.
VC financing is tough to get. Understanding how VC firms make their decisions will help you get that little bit closer to getting funding from them. VC firms love companies with massive market opportunities with room for explosive growth. Ideally, your business should have some operational history to show the viability of your value proposition. So you should have seen early customer adoption, or have a product prototype, or something tangible.
Understand what kinds of businesses the VC firm you are approaching typically invests in. For instance, some focus on specific industries, others only invest at a particular stage in startup life, and others have a geography focus. In addition, a rising VC firm group focuses on helping marginalized groups such as African-Americans, women, and other such groups.
VC firms get approached by so many founders. You want to keep your “elevator pitch” short and make it powerful so it’s memorable. Your best shot will come if someone in your network has a relationship with the VC firm and can make an introduction on your behalf.
# 4 Small Business Loans
The most traditional route for startups is the small business loan. You can get this from a bank or an alternative lender.
You can approach a bank or alternative lender for a line of credit that will allow you to access funds as and when you need them. There will be a limit to this line of credit, for example, $100,000, but it will allow you to manage your cash flow and any unexpected expenses that arise. Interest is only charged on credit used.
Another option is accounts receivable financing. This is another form of credit based on your business’s accounts receivable. The interest rate is typically variable. The credit line is paid down as your customers pay off accounts receivable.
Your startup can also explore working capital loans, small business term loans, Small Business Administration (SBA) loans, and other loan facilities.