01 May Startup Financing 101: Finding the Financing Option That Works for You
I find so many aspiring founders getting confused with financing the initial steps of their journey. Mainly because angel and VC funding is so well publicized. Often debt financing, social investment, family loans, crowdfunding and bootstrapping are overlooked without fair consideration.
The best thing to do before considering the array of funding options you have before embarking on your journey is to simply start saving. Commit to save and store away money as you would when buying a car or house. You should do your best to bootstrap the start of your journey. If I left my job today to start a business, I would minimize the capital requirements needed by taking the following steps:
- Save as much as possiblefrom my current job while figuring out what idea I am willing to spend the next 5 on (or rest of your life).
- Figure out how I can live as cheaply as possible(e.g. cut out unnecessary expenses, move back into my parents’ home temporarily, cancel subscription to my cable provider, etc.).
- Calculate my minimum monthly income, thebear minimum to maintain a decent standard of living and cover my bills.
- Survive on savingsor get a flexible job that allows you to dedicate the majority of your time on your winning idea.
Incubators vs. Accelerators
Truth be told, the lines have become increasingly blurred in recent years. At their core, both structures offer co-workspaces, similar to pure-play office rent companies such as WeWork. However, incubators usually focus on the embryonic stage where founders are still figuring out what their goals and direction will be at the pre-seed funding stage.
Accelerators focus on ‘accelerating’ growth at the seed stage, providing short programs (usually 6-12 weeks), where the goal is to achieve product/market fit and introduce founders to additional funding from VCs.
The Difference between Angel Investors, VCs, and PEs
An angel investor is a wealthy individual that invests in your startup and becomes a shareholder (co-owner). They are usually former entrepreneurs who have successfully gone through an exit and can therefore provide advice based on their experience.
Venture capitalists (VC) raise funds from Limited Partners (LPs). These include, but are not limited to angel investors, public and corporate pension funds, and insurance companies. Funds usually have a focus on a geographical region or sector and sometimes both. Funds are managed by general partners (GP) who are the VC themselves. The GPs invest the money from the fund into a series of potentially high-growth, early stage companies. This is a very high-risk investment, so the goal of the fund is to return much more money than was invested by the LPs. VCs aim to make 5-10x returns from investments within a 3-5 year period. Returns are actualized if shares are sold during funding rounds, but mainly from when the startup exists. Exits usually occur in two forms: the startup is sold to an acquirer or the startup issues an IPO (Initial Public Offering), which means shares are made publicly available on a stock exchange and therefore the VC makes a return on those shares as they are purchased by the public.
Private equities (PE) also raise funds from LPs. These include, but are not limited to, endowments, public and corporate pension funds and insurance companies. The funds are usually larger than VC funds, but in the last 10 years the lines have become more blurred. VCs like Andreessen Horowitz raise funds over $1.5 billion, while PEs used to typically focus on mature companies that present an opportunity for cost cutting, efficiency gains and driving business growth. Now they also invest in startups. However, PE funds are often $10 billion or more and look for undervalued assets they can takeover, improve and sell at a profit. PEs buy part or the whole company, using large amounts of debt (leveraged buy-outs). They leverage a loan from an investment bank, inject minimal capital and aim to turnaround a company in 3-7 years and then sell the asset for a profit. At times this could mean taking a company off the public stock exchange to improve performance then putting it up for a public offering again in order to make a return on their investment.
Where Can I Find a List of Investors?
When deciding on how to finance your startup, be sure to consider all options available. While saving is preferential, there are other sources of funding for whatever your business needs are. Evaluate all, then make the choice best for you.