As an entrepreneur, founder or business owner there is a multitude of challenges you will encounter, to the point that you have to be a bit crazy to think you are going to succeed. It is well-known that most businesses fail and few businesses grow to 10, 50 or 100+ million dollars in annual revenue. Even if you think you have the savvy and uniqueness it takes to grow a business 100x, you will need to raise some serious dough along the way to help you get there.
There are many approaches to raising money for your startup; some that many people are unaware of. Fundraising may be one the most challenging things you do. I have met with thousands of start-ups in the past few years, and the following list highlights seven of the most effective ways I have seen them raise money. The following list is not meant to be a comprehensive, but simply a modern overview of common ways founders, entrepreneurs and startups build their runways.
1. Friends & Family Round aka “FFR”
Most successful tech startups raise their first capital from friends and family investors. Raising money from friends and family is usually takes the least amount of work and it can feel great when things go well and everyone is positioned for a big payday. It is also great from a founder’s perspective because of the minimal equity stakes. However, and this is a BIG however, raising a FFR round can ultimately be a poor choice because involving friends or family in business can strain, or in the worst cases, ruin relationships, especially when things do not go well. Perhaps Christopher Wallace, aka Biggie Smalls, said it best when he stated, “this rule is so underrated- keep your family and business completely separated.”
Further pitfalls of FFR
Since Friends and Family financings are usually the easiest to complete - often taking less than two months from start to finish and usually raising $25,000 to $150,000 in total. The only problem is that most people who invest in Friends and Family financings are usually well-meaning, but inexperienced entrepreneurs often treat their friends and family investors unfairly and cause considerable damage to their startup and future funding opportunities.
There are many mistakes a founder can make during the FFR. One of the most common ways entrepreneurs get into trouble and end up screwing up this critical round is over valuation. There are many problems this can cause further down the business lifeline, but if these are not addressed immediately they can severely hurt a company’s chance at future fundraising of any kind. Research your company’s competitors- including their annual revenues and talk to a professional business valuation expert if possible. As always, remember EVERY detail matters.
Another common area for missteps during FFR is with legal requirements. All financing and share sales are governed by securities legislation. Entrepreneurs must know the legal requirements before accepting that first dollar of investment, even if it is from a family member. You can find a ton of information on startup funding legal requirements from our friends over at Angel Blog.
One important last note; your slide decks and pitch need to be flawless. Treat a FFR round as professionally as you would any other investor. It is critical to refine your pitch and messaging. Your slides should be easy to understand- EVEN BY YOUR FAMILY. This will make your future pitches and chance encounters much more effective.
2. Crowd Funding
Kick starter, Fundable, RocketHub, SeedUps, Indiegogo and custom solutions like CrowdEngine are changing the way many startups raise money, test markets and prove concepts. Crowd funding is efficient because it connects you with potential brand advocates right away and usually requires little travel. It also gives you another tremendous benefit; crowd funding allows you to test your potential market right away and gather valuable data ahead of time. This is why some professional VC firms will advise founders to run these campaigns AFTER they have raised VC money. Generally, no equity is at stake. This can be an effective way to “pre” sell your product and build a runway.
The downside of a well-designed kick-starter is that it can cost A LOT of $$$$. Everything needs to be perfect; your video, brand work, messaging, etc... Whatever you plan to show people must be executable. Kickstarter is littered with the corpses of startups/projects that failed to deliver, and thus encountered serious social/public/legal ramifications. There are also many new custom crowd sourced fundraising options to be aware of. Tilt, CrowdEngine, Launcht, Crowds Unite, InvestedIn etc. are innovative crowd funding platforms that allow you to control and customize the crowd funding experience. These custom solutions can be expensive to implement, but they can be awesome solutions for start-ups that have raised some money via more traditional methods because they allow for greater control and provide more campaign options. For example, custom solutions can allow giving up very small amounts of equity, loans or run exactly like a kick-starter without you having to pay out a percentage of what is raised.
Read an excellent guide on crowd funding by Fundable (these peeps know their stuff)
Angels are professional individual investors. They can be a good choice to raise money right away with no high monthly fees. Angels are often active in their communities and invest locally. They can also be great because they not only provide capital, but also advice based on deep experience. No wonder they are called angels! There can, however, be a dark side to these investors.
There are a few things you need to be aware of before striking any deals with an Angel investor. Angel investors rarely follow up on investments - which most companies that plan to grow large need. It is worth noting that you are likely going to be giving up something substantial to be working with an Angel. Angels are mainly in business to see a return on their investment and be involved in company activity (note that over-involvement can often be an issue).
Professional venture capital firms offer a wealth of connections, expertise and talent. They often include access to coveted spots in hard to access accelerator programs. Start-ups that have strong VCs often share that the highlight of these investors is that the leaders inside these firms provide a unique mentorship, which greatly contributes to the start-up’s success. The challenging aspect of the traditional VC is getting a foot in the door. You need to have an excellent product or service and your team needs to be top notch. Branding, product and PR work is usually required before top VCs will even take a phone call. You will also give up significant equity to a VC, but the fact that any VC company is willing to invest means that they believe your business holds tremendous opportunity- usually for them to make A LOT of money. Note that offers can include complex sets of distributions and costly checks and balances. As in all cases, details matter. It is wise to pay attention to your offer sheet details, talk with other founders (preferably those who have worked with the VC in question) and remember to speak with your team. Triple check everything and have a trusted outside advisor give their opinion.
5. Crowd sourced VC aka “Syndicate”
Crowd sourced venture capital, also known as an “Angel Syndicates”, are the latest and greatest innovations in the VC community. Syndicates are groups of Angel investors that have combined forces like Voltron to form what are essentially large VC funds – but without the regulatory oversight that is often attached to many traditional VC firms. These deals can have very favorable term sheets. However, there are some downsides.
These funds lack the traditional hand holding of large VC funds and access to top accelerators may be more difficult. There also tends to be one person in charge of running the syndicate, which usually ups the micromanagement.
This is the most common and difficult way to build a business. Recently however, bootstrapping a business has become less common as seed capital is so easy to come by these days. There are many considerations you need to take into account before attempting this route and information on the subject is plentiful. Before you begin research though, perhaps the first question you should ask is: does the business, with limited investment from founders, plan to generate enough sales to sustain- and grow- operations? Keep in mind this often involves starting up using founder(s) personal life savings (which are often in limited supply- you are a broke founder after all), scrap metal, blood donations- literally anything you have to get going. From there all profit must generally be invested back into the business in order to grow it. It’s critical to understand that when bootstrapping your profits are your ONLY means to grow. There is no outside help to purchase the latest and greatest- you have fund it yourselves.
The companies that I have seen bootstrap most successfully (Companies like Storm8 for instance) have a mantra that can be distilled to a basic premise. These companies empower employees to not just spend company resources, but to invest company resources. A great article by one of the founders of Storm8 (founded by ex-FB engineers) can be found on Tech Crunch.
There are many great books on start-ups and building businesses. If you plan to go this route I recommend you read a few (read: many) that jump out at you. Here are two I recommend.
7. Loans, Credit Cards and Peer-to-Peer aka “P2P”
If none of the above options are available, or just seem to be a poor fit for you (every situation is different), then maybe borrowing aka self-funding your business is the best option. Self-funding a new business involves doing everything you can to build your business: personal assets, trades, favors, cash, loans- basically anything an entrepreneur can bring to the table. If you choose to go this route and bootstrap your new business into existence, there is one common trait I have noticed amidst the successful entrepreneurs; they pour every cent that they possibly can back into the business time and time again, even when times are bad. When things are good, I see the best entrepreneurs continually reinvest and build entirely new revenue lines.
Although self funding a startup into existence is common, it is usually also a dangerous practice for many reasons. For the sake of brevity, I will provide two: First, because a new business does not have credit on its own standing. Loans, credit lines, equipment purchases, office leases or anything that requires credit will usually require a personal guarantee. Second, the runway (or amount of time you will need to make a profit) is usually longer than anticipated. Make sure you have the resources to cover everything you need, and even extra if you want to go this route. Also, remember to get there you need good credit, a home equity loan, a SBA loan, or the like.
Loans and credit cards are a time-tested method for funding a proof of concept, bridging a cash gap and for expensive equipment purchases. For larger cash needs, collateralized bank loans and traditional business or SBA loans are great options to consider. Recently there is a new player in the small and medium sized business (“SMB”) market that you should consider. “P2P” or “peer to peer” lending is an increasingly popular form of borrowing that circumvents traditional banking. Companies like Lending Club, Upstart and Prosper have changed the way people can connect and lend money.
These simple platforms connect those willing to lend with those needing loans. The end result is bigger, better loan terms for entrepreneurs and sizable, stable returns for investors. If a loan is all you think your company needs now, P2P could be the way to go.
As I mentioned in my intro, this list is not meant to be a comprehensive list of all the ways you can raise money for your business or startup. Hopefully, in reading you were able to learn a few things that you did not already know regarding the trends in raising capital. Most importantly, be aware of the risks. The vast majority of startups and businesses fail; it’s a well-known fact. If you do decide that you are crazy enough to go this route perhaps your own mantra should be: stock the war chest for war.