Funding 101: A Quick Guide to Start-up Funding
25 July 2019. 5 mins read.
A crucial part of any startup is funding. Businesses can only thrive when there is an adequate amount of money to keep it going, and securing start-up funding can be one of the biggest hurdles for founders to be able to get their business off the ground. Below we will examine a few different ways to secure funding for your start-up business. Between a friends and family round, angel investing, and seed funding from venture capitalists, these are all important parts of the financial process of bringing your business to life sustainably.
Crowdfunding from Friends, Family, and Extended Network
For most founders of start-ups, the first influx of financing for their projects actually comes from the people around them. Leaning on your network of contacts can be a great way to secure financing early on and help established your business in the community. This is referred to as a “friends and family” round of funding. While most founders definitely invest their own hard-earned money into cash flowing their business, their friends and family can be an incredibly crucial first step in growing the business. Start-up founders rely on their relatives, friends, and professional network to fund the business by either crowdsourcing, exchanging equity, or taking loans from people close to them. Popular crowdsourcing platforms allow startup founders to launch a campaign where they are able to either take donations or promise a future product in exchange for a donation. Exchanging equity is also a popular practice at this point of the business; many business owners take on silent partners who will gain a portion of equity in the business in exchange for partially funding the project. Another way to financially sustain a business in a beginning is to take loans from friends and family members during this round, with a promise of paying the lenders back once the business has become profitable or by a certain length of time. At this stage of development and financial need, a start-up founder’s network is the key to getting to the next stage of business development and expansion.
Another early stage form of financing for start-ups is receiving funding from what are called angel investors. These early stage investors are deemed angel investors due to their more lenient lending practices in terms of repayment, and higher amounts of funding given. Angel investors can be groups of people or individuals. Typically, angel investors are looking to make handsome returns on their investments, however they are comfortable taking a risk with their investments in the instance the company doesn’t succeed, or they have a certain set of morals that dictate the way they invest their money into companies. Angel investments are great for start-up founders mostly due to their leniency in lending terms compared to traditional venture capitalists. Start-up founders may be able to take a longer time in generating a return for the angel investor’s investment, the terms of the deal may be less stringent, and start-up founder’s have a chance of finding a group of people who will not only want to invest in their business but will also utilize their own network of contacts when it comes time for the start-up founders to pursue traditional funding from venture capital firms. With angel investors, some may take a portion of equity in exchange for their investment instead of just a deal with terms for an exponential repayment. In the case of an equity exchange between the company and angel investors, the angel investors are also subject to dilution of their equity along with the founders. This means that not only are they helping to fund your business to get to the next level, they are also subject to some of the same financial dilution that the start-up founder will face, and they are okay with that.
Typically, the next step of start-up funding will come from a venture capital firm, or VC for short. Venture capitalists are firms or individuals that take a portion of equity from the company in exchange for larger sized checks for financing the business. In a successful start-up, the bulk
of your financing dollars may typically come from VC’s. These are going to be the people who have the ability to help the business with their financial needs for longer periods of time due to the larger amounts of money they can provide. With these deals, however, come more stringent and iron-clad agreements. Agreements are typically drawn out to include time-frames, financial projections to be met, and can even influence the future of the business by requiring representatives from the venture capitalist group to become board member’s of the company.
The first round of financing from a VC is referred to as a Seed Round of funding, and rounds thereafter are referred to alphabetically (Series A, Series B, etc). With each round of funding, equity is given in exchange for more money as the company’s growth expands and the company becomes valued higher. Parameters of what constitutes each series of funding is shifting, but a common value associated with a Seed Round of funding is between $500,000 and $2 million. Each round thereafter is associated with obtaining a larger amount of funding.
As you can see, there are a variety of ways to fund a start-up company. Not every company follows this trajectory we have outlined, but this is the most common way start-ups grow from phase to phase in their business expansion. Different industries are also conducive to different types of fundraising — consumer packaged goods and technology are two examples that find varied success in following these steps of funding chronologically. Whatever type of fundraising works best for your start-up company is what you should pursue, and there are a variety of options for you to achieve funding. Whether that is by looking to the people right by your side and your community for financial support, or pursuing traditional funding from venture capitalists, the financing is out there to take your business from start-up to established.