How to Raise Capital for Your Startup
Building a startup is a task that requires a lot of thought and energy.
Refining an idea, finding a team, and creating a proof of concept are all difficult undertakings a startup needs to undergo. To allow a startup to tackle these issues head-on, a startup will seek out funding to get the capital needs satisfied.
Raising capital is something all startups face and is a process that can be achieved through many different avenues. Startups take the saying it takes money to make money literally, and knowing how to raise capital is very important.
Raising capital for a startup is one of the very first obstacles a startup will face.
There are many different methodologies to gaining capital for a funding round. The funding requirements and the needs of a startup will dictate the appropriate funding option. Each method carries benefits and disadvantages.
By being familiar with all the ways a startup can obtain capital, a founder can determine the methodology that is best suited for their startup.
Some ways to raise capital include crowdfunding, venture firms, angel investors, bootstrapping, and networking. Venture firms and angel investors typically utilize equity financing, while crowdfunding, bootstrapping, and networking typically does not utilize equity.
Equity is a great tool that can be utilized to incentivize investors to have more interest in the business’s success.
Below is a discussion of the different ways a startup can raise capital for their startup. Each section will go into detail about how the funding option works.
The term crowdfunding refers to a funding system that utilizes a mass number of individuals that donate in small increments to meet capital requirements.
The first crowdfunding platform was created in 2003 and was called ArtistShare. The platform was utilized to get musicians the funding necessary to get their music digitally recorded. The artist seeking funding gave the backers a digital copy of the music when it was released. This set the stage for today's crowdfunding landscape.
Today there are a number of crowdfunding resources and many of them work on a rewards-based system. Essentially, a startup using one of the crowdfunding platforms would create a promotional video describing the product they want to create. At the end of the video, there is typically a tiered list that describes the different amounts an individual can pledge, along with the reward for that specific tier. One common setup is that the more an individual pledges, the more of a discount they would receive on the product being promised.
While crowdfunding sounds like a fantastic way to gain capital, it does come with some drawbacks.
The first of which is that these crowdfunding sites tend to take a percentage of the money made during the funding phase. This may not seem like a big deal but this percentage needs to be taken into account when creating a funding goal. For example, let's say it will take $100,000 for a business to get to a point where they can produce their product. When choosing to go through crowdfunding to gain funding, a startup would need to add an additional 5 percent to the asking amount of the funding round to ensure they will have the required $100,000, i.e. an extra $5,000.
Crowdfunding is not just limited to reward-based systems, as there is equity-based crowdsourcing available as well. While it is nice that a startup can gain capital through the masses buying equity, it is unable to instill motivation in the investor to want the startup to succeed.
VCs and angel investors both work hard to ensure a startup is on the right track and has everything they need to succeed. The motivation underlying this helpful attitude is that these investors have enough stake in the startup to be motivated to help. Having a very large distribution of shares makes it less likely that investors will go out of their way to help a startup out.
Venture capital is an investing institution that offers funding to startups in return for equity in the startup. Gaining venture capital investments can be a great way to raise capital for a startup. Additionally, gaining an understanding of how the firm works can help a startup have a better understanding of the needs a VC has when selecting a startup to invest in.
A venture capital firm is essentially an investment firm that regulates and utilizes a fund composed of financial contributions from a number of limited partners. Each limited partner pitches into the VC fund, and after the contribution, the VC fund can become quite large.
The venture capital firm can be thought of as the manager of the fund that gets to select what investments to take on and which ones to decline. Venture capital firms tend to have a large fund at their disposal and can be a huge help when looking to raise capital for your startup.
Venture firms grant capital to startups in return for equity stake in the business. As a startup, the utilization of equity to finance a startup is a smart move because equity keeps investors engaged which can greatly impact the amount of value an investment firm can have.
While a venture firm can often provide funding, a bonus of some VCs is that they offer non-monetary aids to startups. Venture firms like M13 take pride in the contributions they make to enable entrepreneurs and startups to be successful businesses. M13’s approach is to enable founders to succeed by giving them the tools and guidance they need to navigate the startup process. Running a startup without guidance from a more knowledgeable mentor can be extremely difficult. Gaining the backing of a venture firm like M13 can have large impacts on the future of a startup and its launch.
Venture capitals tend to be utilized for series A funding rounds because this round is significantly less risky when compared to seed rounds of funding. Series A is also typically when a startup needs the most assistance in transitioning from a small startup to one that is capable of delivering a product.
Finding a VC that provides seed to series A funding is uncommon. M13 provides early-stage investing and utilizes this opportunity to help shape a startup into a business that can deliver sustainable growth and scalability.
Investing early allows an investor to have a larger positive impact on a startup because they can help guide a startup through its establishment, hirings, and more.
An angel investor is an entrepreneur or successful individual that is looking to invest part of their own personal finances into a promising startup.
Angel investors are a great way to raise capital during the early stages of a startup.
Angel investors provide a form of equity financing like venture capital does, but are able to provide funding much earlier on. The reason for this is that angel investors have fewer parties involved in the process. A VC needs to consider the needs of the shareholders, employees, and more. Meanwhile, an angel investor can make riskier decisions when it comes to early startups in need of funding.
Angel investors are mostly utilized during seed rounds of funding because of their ability to fund early. Seed stage startups typically do not have many assets, and as such, their valuations tend to be low. Early startup investing is a high risk but high reward game for angel investors.
Since valuations of young startups tend to be low, an angel investor can get the most amount of equity per dollar.
For startups, angel investors are a great way to get the first need for capital without having to go into debt. Angel investors place an extra significance on the founding team.
Since seed startups typically do not have a long financial history to determine the likelihood of success, angel investors are restricted to selecting investment startups based on the founding teams and their drive and talent.
Bootstrap funding was at one point the standard way of getting funding for a startup. The term bootstrap funding is utilized to describe how a startup achieves funding.
Bootstrapping is a methodology where a founder or founding team self-finance the startup. To accomplish this, founders would take out money from their personal finances or utilize personal debt to fund the idea.
The main advantage of the bootstrap method is that a startup can retain complete control over the business without having to dip into the equity of the startup. For those looking to have complete ownership of a startup this may be the right choice, however, bootstrapping is one of the riskiest methodologies to utilize.
When personal finances are on the line, a lot of pressure is placed on the startup to succeed. If a startup fails and personal finances were used, the founder is still responsible for the associated debts and is unable to effectively recoup and money invested.
Another negative aspect of bootstrapping is that it typically takes a much longer time to bootstrap than it does going out and trying to get investors. Bootstrapping typically occurs in small increments over time, and while it is able to save a business equity, it does not save time by any means, which can cost startup potential.
Increasing costs of entry for startups has also greatly reduced the rate at which bootstrapping methodologies are used. In today's startup landscape, a seed funding round averages around $2.2 million dollars. This amount is not a large ask for venture capitals or other investors, but when the money is coming out of the pockets of founders, this amount is often too high for a startup to consider utilizing bootstrap methods.
An individual should never invest more than they are willing to lose, and with an average seed funding of $2.2 million, many founders have determined that the risk to their personal finances is not worth it.
Networking is an important professional skill that many develop while searching for employment. Because networking is typically associated with finding employment, it is often overlooked as a way to get capital for a startup but it is an incredibly useful tool in getting a startup funded.
Networking also provides an effective means for individuals to find people to help their startup in ways other than funding. Having connections in the business world is never a bad thing, as you never know who could be the next person in your network to give you the funding or resources you need to get your startup going.
The goal of utilizing networking to raise capital is to find an individual within your social circle that can either assist by providing funding or by getting you into contact with someone that can provide capital.
One such scenario that happens quite often is that a network connection can give you an in at a venture capital firm or angel investor’s office. Having the network connection vouch for you can be huge in getting a sit down meeting with investors.
In today's crowded startup landscape, it is getting increasingly difficult to even get a meeting with investment firms. By having a wide-cast net of connections, a founder can greatly increase their chances of getting a meeting and getting funded.
Overall, raising capital for your startup can be accomplished in many different ways, and each way offers strengths and weaknesses. Each methodology can be used in conjunction with other methodologies, or a founder could alternate between funding methods based on the stage of the startup. The possibilities are truly limitless with the combination of funding methodologies.
Determining the method that best suits your situation is important in ensuring you get the capital you need when you need it. The factors to consider when selecting a method of raising capital should include whether or not you want to utilize equity, what stage funding you are trying to achieve, how fast you need the funding and the amount of funding.
For those with a large funding requirement and don’t mind utilizing equity, a venture firm is worth considering for funding. For smaller funding amounts that don’t utilize equity, a founder may want to look into crowdsourcing or bootstrapping.