How The Next Million Start-Ups Will Be Funded
On the breakthrough in funding for business growth
Let’s say you’re an entrepreneur. You run a Start-up that has just finalized on its Minimum Viable Product (MVP) or a Scale-up with existing customers. In both cases, chances are that you need financial capital to continue to grow and expand your business.
Allegedly, there should be multiple funding options for you in both stages.
One option is selling your soul to a Venture Capitalist (VC) firm.
Another option might be persuading thousands of people to contribute +/- $10 in a crowdfunding round.
Both not too favorable if you ask me.
Raising Funds Is Always a Struggle (even if you deserve it)
I have been active in the European and African startup space long enough to see that raising capital for business growth is where most entrepreneurs struggle. In certain geographical areas or business fields, entrepreneurs struggle more than others, but the fight for funding remains a difficult one to win. Even though, your business case is super solid and you deserve funding based on your numbers and expected growth.
Assessing Your Funding Options
In this post, I will propose an objective framework to assess the various funding options that private companies and small businesses generally have access to.
TL;DR Scroll all the way down to see the comparison-matrix.
I have used this framework myself to compare a Digital Security Offering (DSO) (also referred to as Security Token Offering) as a funding option, with other funding options.
First, I have defined four criteria on which to rate the potential of each respective funding option:
- Network effects
Each criterium is composed out of one or more sub-elements as follows:
- Feasibility *Effort *Time *Applicability *Capability
- Control *Decision power
- Costs *Commercial *Fees *Discounts needed *Legal *Tech
- Network effects *Inclusion of investors *Value for investors *Ethical incentives *Financial incentives
Subsequently, I have made a selection of possible Funding options in the Netherlands.
It is worth noting that this work was initially done for a Dutch scale-up in need of growth-capital, as a part of my new venture: FundMeUp.
Based on the assumption that these are the most favorable and accessible options, with regard to raising capital in this geographical region, I have selected the following options:
- Governmental funds/subsidies
- Business loan from a bank
- VC firms
- Equity Crowdfunding
- Digital Security Offering (DSO)
Each funding option is rated per criteria at five different scores: 0, 25, 50, 75, 100.
For explanatory purposes, I will briefly share the scores and some critical takeaways per funding option.
The feasibility of raising growth capital through governmental funds and/or subsidies varies strongly per country and/or region. Generally, this option requires a lot of effort for a relatively low output (in the NL) and is very time extensive, because one must wait for tender and funding rounds to close. It is impossible to exercise any influence on these processes because they are governed by the institutions that coordinate the funds and subsidies.
For instance, many subsidies are subject to a lot of regulations and restrictions that exclude companies, because they are in the post-development phase. However, the majority gross of the funds are also gifts that only require monthly reporting. Therefore, loss of decision power varies per fund. But, on average, companies must obey a lot of rules and restrictions created by the fund providers.
Raising funds via this route is not very costly, at least not in the Netherlands, which is excellent. But, there are no strong network effects involved in this funding method. This option is scored as follows:
Feasibility — 0
Control — 50
Low costs — 100
Network effects — 25
Business loan from a bank
Banks do not commonly lend money to start/scale-ups for several reasons. Firstly, starting businesses do not have a lot of assets and collateral which can be turned into cash to repay the business loan. Additionally, a company in the growth stage might not have the track record and capacity to prove it can generate enough revenue to repay the loan.
In most cases, banks that fund private companies via a business loan do not require to exercise any decision power. However, the governance structure is strongly correlated to the costs of financing. Whereby governance structures that do not fit the bank’s “preferred model” pay a higher interest rate over their loan.
Banks are financially involved because they do not want any company to default on their business loan. However, these incremental benefits do not compound — in the form of more investments — when one bank commits capital to a loan. Generally, banks are more involved with financial services and less ethically engaged. Although, this trend is changing with more ethical banks making their entrance in finance. Individual forces rather than collective forces drive these ethical motivations. Put more simply: The occurrence of a bank persuading another bank or financial institution to commit financial capital based on (only) the “better world” argument still seems very unlikely today.
Feasibility — 25
Control — 75
Low costs- 50
Network effects — 25
VC firms are, in comparison to banks and governments, more used to investing high amounts in start or scale-ups at different stages. In general, persuasion of VC firms requires low efforts and high yields. According to experienced Venture Capitalists, one (investing) VC can act as a catalyst for more VC investments to come.
VC’s tend to claim and exercise a lot of decision power which is not beneficial to sustainable company growth. VC’s force private companies towards an exit and demand to have boardroom influence in a lot of cases. VC firms do this not because they are evil, but because it is the only way for them to be profitable and keep their limited partners happy. This does not apply when the VC fund is tokenized, but that is a different essay.
Because VC’s and High Net Worth individuals are the only ones able/willing to lock up their capital for a significant period, they can ask high discounts on private company funding (up to 70%). This compensation is also referred to as the liquidity premium.
As stated earlier, one VC-investment can act as a catalyst for many more to come. Additionally, the VC’s can bring specific skills and abilities to their portfolio companies and thus add value by influencing key operations.
Feasibility — 100
Control — 25
Low costs — 50
Network effects — 75
Successful crowdfunding is a bit of an art. A lot of crowdfunding campaigns (especially on the smaller platforms) end up unsuccessful in the time-frame appointed for it. The effort to execute a successful crowdfunding campaign is enormous. Additionally, the amounts raised via crowdfunding are relatively small — 1% of international crowdfunding campaigns raise more than 100,000 USD and 75% less than 10,000 USD.
In nearly all cases, the company raising funds via crowdfunding preserves complete control over the companies' governance, pre- and post-funding.
The low costs of crowdfunding are what attracts a lot of businesses to this funding option: Businesses pay a fee to the crowdfunding platform (from the funds raised). However, the unforeseen marketing costs married to a successful crowdfunding campaign can be a bit of a shock to some start-ups.
A significant disadvantage of crowdfunding is the absence of financial incentives for investors. All investments made in a crowdfunding campaign are gifts (Although, givers sometimes receive products). There are no individual or collective financial incentives for people to contribute to a campaign. Ethical incentives are strong, as most crowdfunding companies aspire to contribute to a societal cause.
Feasibility — 25
Control — 100
Low costs — 75
Network effects — 50
Also a bit of an art, similar to standard crowdfunding. Except for the fact that investors have more financial incentives which makes reaching the funding target more feasible. Therefore, equity crowdfunding raises higher amounts: a little over 226,000 USD per funding round in the US. In Europe, equity crowdfunding is still in an infant stage and the amounts are considerably lower.
In most cases, start-ups remain in full control, similar to standard crowdfunding. However, costs are higher (due to legal, financial and yearly recurring costs).
The lack of financial incentives which is the downside of standard crowdfunding is successfully solved in equity crowdfunding. Moreover, equity crowdfunding is inclusive. In most jurisdictions, private company investing is limited to a select few (mainly due to high settlement costs). Equity crowdfunding successfully opens private equity investment opportunities to both institutional and retail investors.
Feasibility — 50
Control — 100
Low costs — 50
Network effects — 75
Digital Security Offering (DSO)
A new, emerging industry, which is set to provide all the valuable components of the options mentioned above is the Digital Security (or Security Token) Industry. Digital Securities are essentially real-world assets such as gold, art, real estate or equity with a digital wrapper.
DSO’s relatives— Initial Public Offering (IPO) and Initial Coin Offering (ICO) — have raised an average of $120M and $25.5M, per offering in 2018. The first DSO’s show more or less the same trend with amounts being raised between $100M and $13M.
DSO’s have the unique ability to combine the best of both VC and (equity) crowdfunding: Allowing the issuers to remain in control of their organization while achieving scale in amounts raised.
A company can open the investment opportunity for both institutional, high and low net worth individuals. Additionally, the company can change the rules of the VC-game — by removing the liquidity premium referred to earlier.
The barrier of entry for investors would be lowered drastically, enabling promising community-driven growth with real financial and moral incentives.
Feasibility — 100
Control — 100
Low costs- 75
Network effects — 100
Companies could set up the right legal structure and ‘tokenize’ their shares by capturing all the legal features in the token’s technical architecture. Once everything is legally and technically compliant, the company can offer the tokens to the general public via a Digital Security Offering (DSO).
By doing so, companies can unlock a lot of value for their investors by delivering them: liquid assets (24/7 tradable on Security Token exchanges), individual asset sovereignty, reduction of settlement time and costs, fractionalized assets, and interoperability — which means owners can trade their assets at various secondary markets. The incremental benefits of a DSO for private company funding will be huge.
To wrap up, a nice oversight of all funding options and their overall scores using harvey balls:
⭘ = 0%
◔ = 25%
◑ = 50%
◕ = 75%
⬤ = 100%
In this assessment of different funding options, I have tried to consider the various funding options for start and scale-ups objectively, even though I have written about the potential of Digital Securities (Security Tokens) before.
I hope the framework will help other investment seekers to assess various funding options to grow and explore their full potential.
Feel free to connect with me on Linkedin — and get in touch!