It is no secret that startups need funding to grow. While many startups, says Suraj Kumar Rajwani, CEO of DoubleRock, have met their initial funding goals from friends and family, receiving outside investment is now a necessary step for most young companies. With so many options for startup investors, it can be difficult to determine which type of investor or investment instrument is ideal for your company’s needs.
Luckily, there are many different types of funding available for startups these days, each with pros and cons. Knowing which type of startup you are will help determine the best type of funding for your company. The following is a list of some common types:
Bootstrapping
Bootstrapping or seed funding from friends and family is your best bet if starting. Suraj Kumar Rajwani says bootstrapping means that the company founders invest their own time and money into creating the product and growing the business until it becomes self-sustainable. Seed funding is a small investment for initial expenses like legal fees and salaries in exchange for partial business ownership. The investor sees greater potential in your startup than bootstrap investors; however, they usually do not provide enough funds to cover all costs associated with scaling up the business (see SaaS).
Bootstrapped companies spend every spare second of their time freeing resources for development, while investors expect some returns at least within five years. Investors also expect a higher return than bootstrapped companies expect. Moreover, they often try to acquire the entire company after an initial period.
Crowdfunding
Crowdfunding involves cash donations from large numbers of people, typically solicited through the internet or other media. You have probably heard of Kickstarter, which allows new ideas (products or projects) to be advertised on their website and financed by micro-donations. If your project meets its funding goal within a certain amount of time, all those who donated receive some type of thank you gift in return (usually the product they donated toward). Equity crowdfunding sites like Crowdfunder and CircleUp allow startups to sell shares directly to accredited investors.
While these sites are great to get your idea in front of hundreds if not thousands of influencers, says Suraj Rajwani, they are not ideal to gain long-term funding. There are no contractual obligations to keep the investors on board past the initial launch period.
Angel Investing
Angel investors are high net-worth individuals (HNWIs) who invest in startups early on. To become an angel investor, one typically has to have a lot of money and take risks. Serruya Private Equity is the Canadian startup that started by taking over Yogen Fruz locations across Canada with $10 million of their own capital.
They typically invest smaller amounts of money in a large number of ventures, and angel investors’ investments are usually concentrated in one industry. Angels fund ventures that have the potential to scale rapidly or show great promise for future growth.
Venture Capital
Venture capitalists (VCs) are private equity firms that provide startup businesses with high-risk capital in exchange for a percentage ownership stake in the company. Capitalists add value by leveraging their experience
Venture capitalists usually invest larger amounts of money than angel investors invest but expect a large return on their investment. VCs are interested in companies that have proven they show ROI (see Return Of Investment). They also want to influence the company’s decisions and strategy, which is why it’s best not to take VC funding until you’re already well-established (and profitable!).
Seed Investment
Seed investment is an early source of financing used by entrepreneurs to start new businesses or accelerate growth for existing ones. As mentioned earlier, this type of investment helps startups overcome initial costs like legal fees and salaries. After paying off the bills, returns begin returning to the investor (usually after five years). There are many different types of seed investments, but they essentially fall into two categories: convertible debt and equity.
Government Grants
Many governments offer grants to startups looking to scale up or whose products directly benefit society (usually in the form of job creation). This type of funding typically requires matching funds from founders and pays out only after hitting targets. If you are looking for free money, grants might be right for you!
Debt Financing
If your product does not need much investment upfront, debt financing is a great option. Business development corporations (BDCs), banks, and credit unions offer loans at low-interest rates with flexible payment options. However, just remember that legal action can take place if you fail to pay off your loan according to any terms stated in your contract!
Series A, Series B, and Series C Financing (Funding Rounds)
As your startup grows, you might want to switch investors to gain additional capital. Venture capitalists often provide series A financing after a successful seed round; they are looking for 8x returns on their investment within 3-4 years. If the company continues to grow, then it will move on to Series B financing, which larger VC funds typically offer with more experience scaling up companies.
A company only gets one chance at a good pitch during this round of fundraising. Therefore, video with care! Most importantly, make sure everyone in your company knows why Series C funding takes the business to the next level. Relay the milestones pursued along the way.
Final Thoughts
You have most likely heard about people receiving overnight success through funding. However, this usually implies that the investor has enough money to help build an entire business themselves or is simply looking for a short-term investment with quick returns. Every type of startup financing comes with its pros and cons ― be sure you do your research before deciding which one(s) are right for you.
