How to fund your startup? We compare different options | Industry
It’s undeniable that cash flow is absolutely crucial to getting a startup off the ground and ensuring the sustained survival of the business. It’s a task, however, that many struggle with – given two-thirds of startups have less than a year’s worth of money available, according to Anand Sawal of investment analysts CB Insights.
There are a vast range of options facing founders today. You can go to an angel investor, a venture capitalist, bootstrap the business with your own money, crowdfund, ask for a bank loan, partner with a bigger firm, or even run an Initial Coin Offering (ICO) to raise funds.
Unfortunately, selecting the most suitable source of funding for your new business is a tricky one. “This is the decision most founders get wrong, often hindering or causing irreparable damage to the startup’s longer-term prospects,” warns Ofri Ben Porat, co-founder of AI and computer vision firm, Pixoneye.
“Focus on the type and scale of the problem your product is aiming to solve, and then consider how and when specific investors can help you achieve those goals,” advises Damian Kimmelman, co-founder of DueDil.
We spoke to a range of founders and investors on the pros and cons of different funding options for startups. Here is what they had to say.
‘Bootstrapping’ refers to the funding a company using either personal finances or ploughing its operating revenues back into the business. Some founders swear by it, like Colette Ballou, who set up Ballou PR. She told Techworld: “Bootstrap if you can. I always have.”
What are the advantages of this route? Simply put, it keeps you in full control of your company and spending – in many ways an ideal state for a founder.
“The main benefit of starting and growing the business from personal investment is that we don’t have to justify any spend to a board or worry about outstanding debts,” says Jake Madders, co-founder of Hyve Managed Hosting.
However, there are downsides. The main issue is that there are restrictions on growth because the business can’t grow more quickly than their credit permits, whereas external funding lets you to grow as quickly as you need or want to. It’s also a much riskier approach, as if the business fails, it is your own savings that are lost.
Having said that, if you are certain about a business idea then you should be willing to take a financial risk. It’s something that can appear in a favourable light before venture capitalists and other potential investors too.
However, at the earlier stages of a startup’s lifecycle, personal investment may be the only option. This means money for hiring will be tight, and founders will have to take on the vast majority of the legwork.
“It has meant a lot of long hours. It has required a lot of work on the part of Jon and I [the cofounder],” Madders admits. But even this he says, has allowed him to have, “such a personal pride in seeing the success of the company, having been involved in every step of the journey”.
You can also try to raise funds from people close to you, such as friends and family. This provides an easier and less bureaucratic way of accessing funding but could create problems in your close relationships if difficulties related to the business arise.
There is a lot to be said for choosing to go to an angel (or ‘seed’) investor – especially an individual within your startup’s sector that you have a good existing relationship with. It’s a popular route for early-stage startups that need a bit of extra cash to help get them off the ground.
Potential angel investors can be found through your personal network, for example using tools such as LinkedIn, or by researching the area of your startup to try to find investors who have supported other, similar businesses.
“One of the best ideas is to get angel investors who are a few stages ahead of you in their business journey. Angels who have already made massive successes might be too removed from the problem you are trying to solve,” says Kimmelman.
But more than just funding, angel investors are invaluable sources of business expertise, who will help to guide you on your entrepreneurial project.
Angel investors will choose to invest in your startup because they share your vision and excitement, and have faith in your team and the viability of your idea, Porat says. They will be committed and a supportive, realistic mentor of your business.
Where are the disadvantages? You will have to cede some control over your business, given that the angel investor will expect a cash return or equity in the business.
Angel investment may also be less appropriate if you are running a later-stage startup or require access to large sums of cash.
Bank loans or grants
An obvious way of gaining seed money is obtaining a business loan. These can be solicited from banks, local authorities, government organisations and small business associations. You can access a comprehensive list of all loan options for small businesses in the UK here.
To access these loans, you’ll need a clearly formulated business plan as well as meeting some other requirements. On the plus side, the terms and conditions are clearly defined, as well as the interest rate. However, you may be tied into some tedious practices such as creating detailed lists of expenditure and possibly restrictions such as what you are permitted to invest money into.
Grants are loans that you don’t have to pay back. They are given on the basis of what your business idea is and may be particularly applicable if your idea is for a good cause.
If your business involves innovative technology, you may be able to get support from InnovateUK or Horizon2020.
You can also enter competitions for funding, such as the monthly Small Business Grants competition for £5,000.
Venture capital investors
Venture capitalists get a lot of attention in the tech press yet they are inappropriate for the vast majority of startups. So it’s really important to think through whether it’s the right route for you before you plough time and effort into trying to get VC funding.
To access VC funding, you will most likely need to demonstrate a track record of growth and revenue, as well as plans to scale up quickly.
One of the biggest advantages of VCs is they have access to vast sums of money, so it’s a good option if you need to expand at a rate beyond that viable via angel investors or bank loans. They also have great connections and experience, so will be able to help make introductions and give advice, as well as support on tax, law and personnel.
However, tread very carefully. You will have to cede even more control over your business than with angel investors. VCs will take a sizeable stake in your business and will expect a say over its future direction. It also sets a clock ticking to the sale of your company, when VCs expect to ‘exit’ with a sizeable return.
“Don’t rush towards VC funding. If you’re in the early stages particularly,” Porat warns.
It is absolutely crucial to bear in mind that “angels manage their own money, while VCs manage other people’s funds,” he says.
There are different forms of venture capital funding, with some early round investors willing to pitch in at the prototyping stage, and late-stage investors willing to commit millions to more fully fledged businesses.
Many startups are naturally wary of partnering with a big corporation. They are very different beasts culturally, financially and in many other ways, so caution is warranted.
However, it isn’t a route to instinctively jettison.
“As long as the founders retain control over the daily business operations and enough freedom, the ‘corp-up’ approach provides a number of benefits that a VC could never replicate,” says Boris Bogaert, cofounder of Xpenditure.
In particular, these benefits include access to the resources, customers and products of a multinational company and a trusted ‘brand’ from day one, he says.
Corporate venture capital, where startups take money from a big corporate’s fund, is also an option. For example fintech startups have received investment from CVCs like Santander ‘InnoVentures‘, Citigroup’s ‘Citi Ventures’ and Goldman Sachs, says Ali Ramadan, VC specialist at law firm Bird & Bird.
These corporations can help with providing expertise, supplier and customer networks and navigating regulations, he adds.
However, there are massive risks, as referred to earlier. Partnering with a large corporation can be playing with fire, and startups should be aware of their relative size and strength.
The same issues around loss of control crop up, but to compound that there is also the fear that a corporation could steal your intellectual property, try and buy your startup (though this may be desirable in some cases), overload you with bureaucracy or force you to lose flexibility or identity, for example adopting their branding.
You also need to have a lot of trust in that corporation. If you’re putting all your eggs in one basket, you’d better ensure it’s a reliable one.
Although not always the first route startups consider, there are plenty of upsides to running a crowdfunding campaign. It’s a popular route for B2C startups in particular, as these hold most appeal to members of the public – who crowdfunding campaigns aim to target.
“Crowdfunding platforms can offer young businesses the opportunity to not only raise funds but also test the concepts of their new idea directly with interested consumers, helping them develop their products in the meantime,” says Ramadan.
The advantage of crowdfunding is that it combines raising money with a marketing campaign, says Joel Hughes, UK head of technology and hardware at Indiegogo. This worked well for Monzo bank for example, which raised £2.5 million in under 24 hours.
However, this means that if you’re going down this route, it’s beneficial to have some serious social media flair on your team, to package up your business idea in the most appealing way and promote it effectively online.
“Now the regulations have been put in place to allow equity crowdfunding, anyone can invest in the companies they believe in. This helps the business get help from a broader pool of investors and, in exchange, these investors benefit financially if the company is successful, and more than ever can feel like part of the team,” Ramadan adds.
It’s also a good route to consider for certain businesses because it does not involve offering equity or voting rights to investors (this is actually banned on almost all crowdfunding sites).
However there is one obvious risk. Many of these crowdfunding sites such as Kickstarter have a clause whereby if you do not meet your target, you have to return all of the money invested. This scenario would involve (very publicly) failing to raise enough money, which could lead to both financial and reputation damage.
There is also the fear that others may copy your idea, and it can be a very time-consuming way to raise cash.
For those interested, however, read our pick of the best crowdfunding sites, to decide which one might suit your startup idea.
Initial coin offerings (ICOs) have taken off over the past year, as the market for cryptocurrencies matures. This has become an increasingly viable option for startups looking for funding and some VCs, such as Jamie Burke, CEO of Outlier Ventures, have even suggested this could be the future of investment.
In 2017, startups raised a combined $5.6 billion through ICOs, but how do they work? In essence, an ICO involves raising capital for your company by launching a new form of cryptocurrency, which interested investors can purchase in exchange for more established cryptocurrencies such as bitcoin or ethereum, or fiat money. Naturally, this is an approach most suited to companies in the tech or specifically the blockchain or crypto sphere.
But before you decide on an ICO, it’s important to consider whether the token can be effectively integrated into your ongoing business in a meaningful way or whether you see it as solely a means to raise fast cash. If it’s the latter, the value of your token will likely crash after the initial launch phase.
Investors buying tokens in an ICO are acting in a similar way to IPO investors, in the hopes that the value of the token will increase in future if the company becomes successful.
The benefits, according to Blockpool’s cofounder David Blundell, are that ICOs are open to all investors, allow startups to dictate their own terms, have lower fees than the alternatives, lead to more community interaction and keep control with the startup founders to crowdfund as they choose. It also lets them accept any currencies, thus widening the potential pool of investors.
The boom in ICOs has created much opportunity, but means that potential investors today are becoming more discerning and that companies must increasingly approach them in the same way as they would an IPO.
It means that companies will need to employ more awareness raising tactics than previously, orchestrating sophisticated social media campaigns and getting active on forums such as Bitcointalk and Reddit for example.
Another good start is to develop a thriving Telegram community – the tool of choice for most companies in this space – and to invest in a polished web presence. You will also need a whitepaper to illustrate projections for the company, how many tokens will be kept by the founders and how long the ICO campaign will run for, among other things. Ideally, this will be clear, concise and not too jargon-heavy.
There are downsides. ICOs are not without risk, given only 48% of those launched in 2017 were successful. Although some VCs are hailing them as the future, some investors can be wary about putting their money into ICOs because of their lack of regulation giving rise to plenty of fraudulent cases. However, expect ICOs to continue becoming more commonplace as cryptocurrencies become increasingly mainstream.