Startup Funding: How to Get Money For An Early-Stage Startup
The recipe for a successful business: one brilliant idea, strong enthusiasm and initial capital. If the last ingredient is all you need, I’ll tell you where to get startup funding.
Before you start raising funds in the project, the main thing is to understand the various stages of its life cycle. This will help determine what way (or combination of methods) you take to obtain startup financing.
First, we’ll look financing during the early startup phase — when the idea is, and what to do next, is still somewhat unclear. The methods presented below can be used in other stages, but I recommend that you begin with them as they’re efficient and time-proven.
So, where do you start?
Idea phase. Is it worth it?
Before you rush into the investment process, stop for a second and think whether it’s worth the implementation. Yes, your business idea might have seemed perfect as soon as it came to your mind, and while at first glance it might appear flawless, that’s incredibly far from the truth.
Simple truth is that you’re so excited by your idea, but the emotions of that excitement have a good way of taking an objective perspective on it. You have to stop yourself, adequately assess it, and do intensive market research.
In the course of the research, you will understand whether your idea will change something and become valuable to the world. Is it worth it? Excellent! Then take a business plan and go for the initial capital.
The next step is to understand that the idea is not everything. This is difficult, but this is how an entrepreneurial approach is formed.
To attract the first investment, you first need to calculate all the necessary investments, risks and potential profit — otherwise how will you explain to the investor how worth it this idea actually is?
You must create a business plan in which your path to success is accurately documented, and create a solid foundation for your business from a legal standpoint.
Once again: analyze all anticipated income and expenses. Is profit expected here? Have you considered the cost of your own time? Have bottlenecks been taken into account?
Once again, thoroughly check all your calculations, then again, and after that ask someone to count again. If the numbers remain unchanged, you can confidently move on and start looking for investors.
We are close to what will become an MVP — that is what you need capital for.
But if you can’t start with it, you can start with a prototype. This is the part of the product that you will be able to demonstrate to investors so that they understand what your product will look like. The development of the prototype will require time and money, provided you do not have the technical skills to develop the product on your own.
You can always find a technical co-founder from the first day, or find them when the time comes to MVP development. It is, however, important to understand that you are partnering with them and you will have to divide the equity.
Alternatively, you can also hire an agency that will develop your an MVP. Everything is much simpler here, so the product remains 100% yours, and the agency will charge you only for development.
Depending on where your startup is, you can choose your development path and choose a convenient method of financing (or maybe several at a time). Everything depends on you.
Let’s find out how to get funding for a startup and explore the various startup funding stages you could go through.
Initial capital. Self-investment
When you start a business, you must understand that this is fundamentally risky. If you managed to save enough money to start, it’s better to start with that. By investing your own money, you will not only protect yourself from outside influence, but in case of failure, you will not be in debt to someone else.
This gives you a fixed scale at the beginning, and will allow you to create a project the way you see it. You can always attract investments at other stages, so the main thing is to start right and get the first results.
Credit cards or bank loans
There are certain pros and cons when financing a business with a credit card. For starters, it does not take long to get approval for a business credit card, and minimum payments are generally pretty low. If you want to setup your business quickly and you do not have enough money, credit cards can be an attractive option.
On the other hand, the use of “plastic” can be risky if you run behind on payment. Even the absence of one payment can seriously damage your loan. And let’s not even talk about these interest rates! If you make only a minimum payment, you may need to carry this debt for years.
Regarding the bank loan, here is a slightly different situation. In order to get approval for a loan, you need a good credit rating (usually above 650), assets, and taxed taxes. Banks, such as Wells Fargo, the National Bank of Huntington, J.P. Morgan Chase and the National Association of the United States Bank are the most active when it comes to issuing loans for small businesses.
If you still decide to take this method, then I advise you to use the instructions on Inc.com. It will help you fill out an application for a loan, if you have not filled it out before.
401(k) Pension Plan
Your 401(k) is your money.
It is very tempting to use your savings or 401(k) for investing in your business, but do not rush. Instead of withdrawing money from your 401(k), you can borrow from it. This is a great way to replenish your down payment for a startup.
Money for a loan taken from your 401(k), you will pay to yourself — not to the bank. Prices are usually well matched with mortgage rates. You do not need a good credit history, and the interest is much lower than in the bank. Plus, since you borrow from yourself, you will have many options for repayment, from monthly payments to partial payment (the payment is usually automatically withdrawn from your salary).
But despite all the advantages, drawing from an existing 401(k) has its drawbacks. You can get taxes and penalties if you do not pay the loan on time. This is perhaps the most significant risk of obtaining such a loan. Be careful, and make sure that you can pay the loan even if you quit your job. In most cases, any outstanding loan balance that you do not pay within 60 days is considered a withdrawal and is taxed and, possibly, a 10% fine if you are younger than 59½.
This method should be used only if you are well versed in finance, you have calculated all the risks, and there is a clear business plan. Whatever option you choose, carefully consider the pros and cons and make a settlement that does not jeopardize your future retirement plans.
Co-founders. How to find investors for your startup?
A business plan has been formed, the domain for the site has been bought, and now it’s up to the small business to start the project (the most difficult part). At this stage, the project should show its efficiency and prospects for development in the market. Here, by the way, we will use the MVP strategy, which is based on creating a working prototype of the product and can be tested on the target audience.
MVP (minimum viable product) is a product that can catch investors, but for its development, you still need financial help.
Not many investors invest in a project that is only at the stage of an idea, but there are such options. The main thing is to be patient and not to give up. Have confidence in the project and a clear business plan, and issues with the investor will be resolved.
An angel investor is a private investor with a high level of income, investing their own funds in the development of the company in exchange for a share in it.
As a rule, these are accredited investors with a net asset value of more than $1 million, or their annual income for the previous two years was $200,000 with the same forecast for the current year, or the combined family income of $300,000.
Business angels usually invest in startups at an early stage of development, when the idea has not yet been tested; they are ready to take on high risks associated with the implementation of such projects. In addition, at this stage, the company may not even have a product as such, and if there are already real customers, then the income is still very small.
One of the most popular Crowdfunding sites, which combines startups with business angels, is AngelList. In addition, you could find angel investors for your startup with the help of friends and relatives, in social networks or with the help of consultants.
Business angels can act independently or on behalf of the organization, united in a syndicate or having created a fund. At the head of the syndicate is an authoritative investor; participants pay him a fixed share of remuneration depending on the volume of transactions. The US Securities and Exchange Commission (SEC) limits the total number of accredited investors who can participate in syndicated transactions to 99.
Collective investments of this kind are sometimes referred to as “crowdfunding”, but for greater clarity, we should add that in this article we share these concepts. Regardless of whether the investor is working independently or as part of the association, check it in advance.
Surely you would like, in addition to capital, the investor to connect their connections and share his commercial experience. When taking on a business angel, make sure that you have made the right choice. It’s kind of like getting married without it being quite as easy to get a divorce. Like it or not, they are now your business partner.
Angel funding will suit companies that have already taken the first steps without fully thinking over all aspects of building a business need quick investments. The attraction of angel financing takes much less time compared to traditional venture funds (especially if it’s someone from your family).
Such investors can bring the young company their invaluable experience. Before entering into a partnership with them, you need to clearly understand what percentage of the shares you are willing to outsource, and whether you can be flexible enough to satisfy the desires of your investors. Do not forget about the risks of these fast investments.
The emergence and further growth of such crowdfunding platforms, such as Kickstarter and Indiegogo, not only served as a significant proliferation of non-profit and other organizations, but also provided the founders of startups a unique opportunity to implement their ideas and deliver them directly to consumers.
If crowd-money is seen as an expression of public support, then for founders of startups, this is an excellent way to test the market by pre-selling their goods or services. Such a startup fundraising option will be most useful for those entrepreneurs whose business is connected with technical devices or a creative innovative approach.
One of the advantages of crowdfunding is that none of the “investors” is a shareholder of the startup, so you simultaneously attract the capital to “promote” your project and keep the integrity of your company’s assets.
The only thing is that to get money, you need to provide investors with something specific, while investments of business angels and venture funds are carried out in advance.
Crowdfunding is rather limited in relation to the final amount of fees. Of course, we have already heard about millionaire campaigns, but it should be well understood that the average amount of funds raised is about $10,000 (this figure may be higher for design and technology projects).
With crowdfunding platforms, you have the opportunity to sell your products, even after the money for the project is collected. For example, Indiegogo InDemand allows creators to continue selling their products on this platform, and the MoMA store sells designer products successfully funded by Kickstarter.
Crowdfunding is a great way to support the first stage of your startup launch,empower you to make your MVP, and the perfect proof for investors that people are interested in what you are doing. The main thing is to correctly present your product on the chosen platform and enlist the support of 3F to spread the information about the project.
But we must understand that this financial instrument is still in its infancy, so it is difficult to predict how it will prove itself in the long term.
Startup Accelerators and Incubators
For startups at an early stage, accelerators and incubators offer excellent ways to develop businesses both financially and strategically. Here are some of the key differences between starting up in an accelerator and starting in an incubator.
Usually, accelerator programs have an established timeframe in which individual companies spend anywhere from several weeks to several months working with a group of mentors to build their business and avoid problems along the way. Y Combinator, TechStars and Brandery are some of the most famous accelerators.
Usually the work of the accelerator begins with the application process, but the best programs are usually very selective. Y Combinator takes about 2% of the applications that it receives, and TechStars takes 10 out of about 1,000 applications.
Companies receive small investments and get access to a large amount of money. A network of mentors, usually consisting of executives of startups and external investors, is often the greatest value for potential companies.
At the end of this program, you will probably see all the startups from a certain level of cohort. At that time the business, we hope, has been finalized and tested.
The goal of the accelerator is to help start the business in a few months. If you pass, you will find out in the end what your starting team is and where your project is now.
Startup incubators start with companies that are at an early stage, and they do not work on the set schedule. If the accelerator is a greenhouse for young plants where they are getting optimal growth conditions, the incubator selects the best seeds and gives them better soil for germination and growth.
Although there are some independent incubators that are sponsored by VC companies, others are run by government agencies and large corporations. Some incubators have an application process, but others work only with companies and ideas with which they contact with the help of trusted partners. A good example of an incubator is Idealab.
Depending on the sponsoring party, the incubator can be oriented to a specific market or vertical. For example, an incubator sponsored by a hospital can only look for startups in health technology.
In most cases, startups adopted in the incubator programs move to a specific geographic area to work with other companies in the incubator. Be ready to embrace the fact that you will likely be placed in a joint space in a coworking environment on monthly leases with access to a broader entrepreneurial community.
An incubator can be a problem for a large team. This approach is great for a few people, but at some point it ends up being cheaper to have your own office.
The first stage is the most difficult — one idea is not enough. The more you can show (beyond your idea) to the investor, the more likely that you will obtain funding for your startup.
Think about the future of your project and strive to develop MVP, which will be the starting point for growing your business and attracting more investors (VC funding, IPO, ICO etc.).
Remember: whatever type of financing you choose for yourself at the start, make sure that you have a return on investment plan. And now you understand more on who, what, and how to get angel investors as well other investment opportunities you could take for startup funding. Choose what is most suitable for your company and most suited to your strengths. If this is too much for you, you can always find a business partner who can take on this “dirty” job.
Originally published on EzeTech Blog
P.s. It’s just the first part of my Funding Series. Stay tuned!