Startup funding is vitally important. “4 out of every 10 startups today are in the ‘red zone,’ up 29 percent since December 2019,” according to a study by StartupGenome.com. The “red zone” is defined as having three months or fewer of capital runway. Capital is the lifeblood of your company and how you fund your business is one of the first and most critical choices you will make. Your choice of funding can have a ripple effect and could even affect how you structure and run your business.
There are countless types of funding for your startup. In this article, we’ll cover the pros, the cons and key considerations for the three effective methods of funding early-stage startups — outside of conventional small business startup loans.
Pros of Funding Option #1: Angel Investors (Equity)
Angel investors specialize in funding early-stage companies in exchange for a piece of your venture. They have higher investment risk tolerances hoping to get “home run” type returns as in the case of more famous angel investments of Uber, WhatsApp, Facebook, etc. Angel investors are generally well-suited to helping your startup because many of them have successful entrepreneurial exit experience. These high-net-worth individuals oftentimes offer mentorship and veteran guidance along with their capital. This specialized and real-world guidance can sometimes be more valuable than the funding itself.
The typical angel investment size is $25,000 to $100,000. It can go much higher depending on your ability to show how effective your company will be at capturing your share of the TAM (Total Addressable Market). Angels can be great precursor funding to raising larger sums as your company grows.
Cons of Angel Investor Funding
It’s not all wine and roses with angel investors, unfortunately. Their built-in advantage of flexibility versus standard banks can also make them unpredictable. Not only do you have to find the investors very well-suited to your startup, but you will likely have to go through a series of formal and informal meetings, due-diligence formal investigations and negotiations as a baseline. Therefore, it’s very likely it will take you more time to raise angel financing than you first anticipate. Additionally, an even bigger risk is if your company is still in the idea stage and doesn’t have a working prototype or are pre-revenue, the angels may end up with controlling interest in your company.
6 key questions to be ready for with angel investors:
- What relevant industry experience does the team have?
- Who are the founders, key team members and/or advisors?
- Why is your team uniquely and extremely capable of executing your company’s business plan?
- What strategic partnerships do you have (demonstrating future successes)?
- What positive early traction do you have (creation of a beta or “MVP” minimum viable product)
- How do you plan to scale your company in the next 12 months?
Pros of Funding Option #2: Venture Capital (Equity)
Venture capital has experienced a boom over the last decade. The explosion of Silicon Valley startups and massive raises from SoftBank’s $100 Billion Vision Fund, annual capital invested worldwide increased 13 times from 2010 to 2019 to reach over $160 billion. Meanwhile, mega-rounds (investments of $100 million or more) nearly tripled from 2016 to 2018. Venture capitalists, also known as “VCs,” can provide capital, strategic guidance, introductions to potential customers, partners, employees and more. VCs typically focus on certain investment criteria, such as:
- Focus on industry sector: technology, artificial intelligence, space, robotics, biotech, green energy, etc.
- Focus on company lifecycle-stage: seed, proof-of-concept, pre-revenue, Series A or advanced stage rounds with meaningful revenues.
- Focus on geography: Silicon Valley, West Coast, New York, Boston, Austin, etc.
Cons of Venture Capital Funding
Venture capitalists are quite elusive, despite the sometimes impressive amounts of capital we raise. VCs get inundated with investment opportunities, many of those via unsolicited calls, emails and in-persons. The majority of these attempts are actively ignored. If you can reach a VC firm aligned with your company’s vision, it can be a very time-consuming process. Think weeks or months of meetings and conversations depending on the situation.
And, even if that goes well, there will be negotiations by lawyers on both sides of numerous documents to evidence the investment. Not necessarily the most ideal method if you’re looking for faster forms of funding. Further, dependent on the VC group, their involvement may be active, meaning you will no longer be the sole decision-maker.
6 key questions to be ready for with venture capitalists:
- What is the valuation of your company? How did you arrive at that number?
- What is your TAM (Total Addressable Market)? How much of it will you capture in the next 24 months?
- Why is your company best-of-breed among your competitors?
- What will you do to scale your company responsibly fast?
- What time, cost and effort does it take to reach a critical mass of customers?
- What is your exit plan?
Pros of Funding Option #3: Revenue-Based Financing (Debt)
Revenue-based financing is an innovative hybrid of debt and equity funding. It is similar to equity investments because the capital you receive comes from investors or a financing firm. However, the major distinction is the financing group providing you with revenue-based financing has no ownership in your business. A percentage of daily sales is used to pay off principal and any interest generated. Qualified brands can access between $5,000 and $2,000,000+. Consider revenue-based funders with simple (versus complex) one-off fixed fees for each advance. These innovative funders can also be very quick with offers in days versus weeks with a bank.
Cons of Revenue-Based Financing
Revenue-based financing isn’t yet structured for all startups. Revenue-based funders will tend to focus on certain industries such as: e-commerce, technology, etc. And, your startup will need 6 to 24 months of sales data depending on the funder, with a minimum monthly average revenue. So, while revenue-based funding can be quite helpful to those that qualify, you’ll need to have robust or growing revenue and growth projections.
6 key questions to be ready for with revenue-based funders:
- How is your business doing?
- What’s your D2C eCommerce revenue?
- What’s your current marketing spend?
- In what areas?
- How much web traffic do your sites get?
- What are your growth projections over the next 24 months?
Startup funding is oftentimes a fundamental part of the startup lifecycle. Take a good look at your team’s vision, operating style and needs. Your choice of funding will either enhance or serve as an anchor to your company. Whether you’re interested in keeping ownership while you grow or seeking venture capital to raise multiple-comma amounts, remember that affinity partnerships matter. Consider partnering with organizations that offer more than just funding.
Marty Aquino has been a passionate writer on venture capital, technology, forecasting, risk mitigation, wealth and entrepreneurial topics since 2009. He is the founder of Carbonwolf Energy, a venture-capital firm specializing in world-changing and status-quo-defying technologies and people.
Startup Genome - State of the Global Startup Economy
The Wall Street Journal - Uber Jackpot: Inside One of the Greatest Startup Investments of All Time
LeanStartup.co - [Day 3/30] What is an MVP?
Forbes - What Are Angel Investors?
AmeriFactors - Accounts Receivable Financing