Different investments for startups
I dedicate the post of today to all of the startuppers struggling to find funding for their venture. I want to share my experience and what I learnt so far to encourage you to keep going, no matter how many “no” you have received so far.
The first source of funding that comes to every entrepreneur’s mind is, certainly, the equity funding,
where business angels or venture capitalists inject capital in exchange of shares of your company.
The business angels intervene especially during the initial phase of the startup, known as the seed round, where also family and friends can contribute, the average round is around € 500K and 1M, at least in Europe, while the VC use to invest in higher tickets, in the seed round but mostly in series A. The big difference is also that the former ones are easier to reach, they can be your mentors but are not involved in the decisions. The latter ones, instead, will become your business partner, following you during your most important decisions. They, as lead investors, can also help you with the next series of fundraising.
Venture capitals are full of new emails every day, swamped with tons of investor’s pitches and overwhelmed with requests for feedback. It’s completely normal that often they don’t even reply, especially if you send a cold email. According to that, it is easily understandable that a warm introduction by a person that is already in contact with the venture capital is more than welcome, for example a worker that you met during a networking event or maybe a colleague from another VC which is not related to your field of activity, or also a company that the VC already funded but is not your competitor.
Don’t send random emails to any VC, study your target, find the ones that are in your field, interested in your sector and with knowledge, they will help you not only with the money, but especially with their expertise, which is not a secondary benefit.
Once you have identified the VC interested in your segment, study them, understand their values, find other companies that they have funded already, to ask them for suggestions. LinkedIn is an amazing tool for networking. You can’t approach them in general terms, just by copying and pasting tons of similar emails. Each VC is different and each of them is looking for something. You need to personalize your message if you want to make an impression.
These two type of investors can either choose to inject capital and get directly the shares or choose the convertible notes. These ones are used mostly during the seed round and by the business angels, are well known in Silicon Valley but are gaining popularity all across Europe. It is a form of short-term debt that will convert into equity in the future, mostly in conjunction with a financing round. In fact, the investor will receive equity in the company instead of the reimbursement of the debt. The primary advantage of the convertible notes is that the issuer and the investor are not forced to determine the value of the company, when, in fact, there is not much to base the valuation on, for example, if the startup is still just an idea. There are key terms of a CN that need to be kept in mind when considering it as a form of financing, even if these terms can vary and can be decided by the investor and the startup. First of all the discount rate, which is the valuation discount given to the investor to be compensated for the higher risk assumed by investing earlier. For example, when the lead investor closes the round at a given valuation, the CN converts at the discounted rate. The valuation cap is an additional reward for the earliest investors, giving them the cap at which their notes will be converted. For example, if the company reaches a high value, the early investors will convert at the lower cap value determined at the beginning (lower valuation means more share for them). The interest rate is the rate that accrues to the capital invested, but instead of being paid in cash, it increases the number of shares that the early investor will receive upon conversion. The maturity date is the time limit at which the company has to repay the notes.
A third important source of funding comes from the corporates.
They eventually have money to innovate and create new products. However, they are also well known for the long decision process and low flexibility. That’s why they prefer to invest in startups. The investments from a corporate mean a real partnership, you help the corporate with your technology and they help you with the market and the growth. On the other side, they don’t help you in the next rounds.
If you can’t access business angels, VC and corporates, there is another tool that is gaining popularity: the equity crowdfunding.
A large number of platforms are born to make the equity crowdfunding possible, where a large number of individuals contribute with a small amount of capital to finance an idea or a project or a new business venture. The investors can invest as little as $10, based on the terms of the website and receive shares of the company, while the entrepreneurs have the possibility to benefit from a vast number of investors easy to access. The biggest risk is that a large number of individuals are now part of the cap table of the venture, making it difficult to manage. The best way to make the equity crowdfunding works would be to have a representative of the group that manages the portfolio.
Non-equity funding
If you think that you still don’t need a business angel or VC, maybe because you don’t want to give away a big part of your shares and start with the dilution process and you also think that your valuation is still low, you can opt for a loan. Nowadays, almost all banks have a program to provide a
loan for startups, which doesn’t have high entry barriers, as, sometimes, the government assumes part of the risk to incentivize the startups.
The loan helps you to grow your business and the value of your startup without dilution of the cap. But still, it is a debt, so every month you have to repay a part of it and eventually the interests.
Sometimes it could happen that your business is attractive for an investor but either he doesn’t want to risk much or you don’t want to dilute your table.
In this case, the revenue share model is a good solution, where the two partners share the risks as well as the rewards.
On the one side, it can be considered as a sort of protection for the investor that doesn’t pay more than the revenue that the startup can generate. On the other side, it is an incentive for the startup to work hard and generate more revenue. Each part that participates is compensated for his effort. However, this model is not famous to finance a startup, in fact, it is used more within corporate governance to promote partnerships, to increase sales and share the costs.
The revenue sharing should not be confused with the profit sharing. The former one, in fact, is about the operating profits or losses, while the latter one concerns the revenue left over after all the costs have been removed and it is for the equity owners.
Nowadays, the increasing number of startups is the reason for the birth of more and more startup competitions.
Some of them are incubator programs, where a certain number of startups are selected to participate without giving away their shares, they are asked to be part of the program till the end and compete for the final prize. Some of these programs are issued by private investors, some others by the government to incentivize the innovation, and some others by corporates to find new potential partners. Other competitions for startups last just a few days, the startups are asked to pitch on stage to, again, compete for a final prize. I would advise being selective with these competitions, some of them are really useful and can open an important door for you, not only in terms of money but also a good network. Some other events are a waste of time for your business. It is important to understand and make an estimation of what will be the output of each event. Try to ask previous participants, check the guests and the investors invited, so you can see if they are a good fit for you.
Each of these forms of investment can work, it depends on the stage of the startup and on the ability of the team to study the best option. If you are seeking for investment spend some time to make a plan, define a goal and evaluate all the options in deep details. It might seem that you’re wasting your time, but you’re not.
