Startup Funding: Choosing Your Best Option
What do you need to consider when you’re on the road to startup funding? How do you make the best choice among the array of available funding options?
Our How to Successfully Fund Your Startup webinar with R. Branden Harper Director, of Lighter Capital and Sirk Roh, Early Growth Financial Services’ COO, covered the full range of startup funding options and what you should keep in mind as you prepare to raise.
Startup Funding Options
There are two broad categories of startup funding: traditional financing and alternatives. Traditional funding vehicles include equity and convertible debt funding via angels, VCs, and incubators. Alternative encompass loan and venture debt as well as revenue-based financing. Factors like your startup’s stage and the nature of your business will help you narrow down the options to the one that is most suitable for you at a given time.
The best way to approach your funding search is to come up with a game plan before you start, including answering these questions:
- Why are you raising funding now
- Why do you need the funds?
- What’s your cost of capital?
- How will you access startup capital sources?
Your decision around which path to pursue should be framed by taking into account your company culture, understanding the factors that will drive your company valuation, and thinking through how much equity you’re willing to part with. Of course, this also ties into control and how much of it you want to retain over key decisions.
Questions to answer before raising a round of funding
- Do you have product/market fit? Are you ready to scale?
2. Is your revenue model set (do you understand your pipeline and sales flow?) or still in flux?
3. How robust is your sales pipeline? How long is your selling cycle?
4. Do you have the right team in place in terms of domain expertise and complementary backgrounds? What are your additional hiring needs/skill gaps that need to be addressed?
5. What’s your risk tolerance? Are you willing to pledge personal assets to get funding?
6. What is your exit strategy?
In addition to knowing the answers, you also need to have a good understanding of your startup stage and growth rate and the size of your addressable market.
Startup Funding Paths
VCs can deliver high value-added including access to their networks for introductions to startup talent and key accounts. The tradeoffs are high dilution of ownership with some loss of control since VCs will want to take an active role, holding board seats and exercising voting rights.
To attract VCs, you need to be targeting a large addressable market (greater than $1 billion), with a product or service that is disruptive in nature and can scale quickly.
Non-VC and pre-VC options are good choices when you’re in the early stages of building traction and your funding needs are less than $1 million. Options include bootstrapping, tapping friends and family, working with angel investors, participating in business incubators/accelerators (typically in exchange for 7-12% of equity), and crowdfunding. Customer and vendor financing, if you can get it, also work well at this point.
3) Blended options rely on alternatives such as revenue-based financing or venture debt as a bridge to VC funding.
Bank funding comes with no dilution but also offers no value-added beyond money. Know what you’re getting into; the underwriting process is paper-intensive and could stretch to four to eight months. And you may have to pledge personal assets as collateral.
With revenue-based financing, deals are usually structured as five-year term notes with a cash success fee in lieu of warrants in the event the startup gets acquired within 2 years. There is usually no set interest rate; instead monthly payments are tied to a percentage of revenue (typically ranging from 2-8%). Some lenders do require personal guarantees as with bank loans.
4) When you get to Series A rounds ($5 million plus in funding) tech banks and corporate venture arms also become part of the mix.
Prepping for Startup Financing
Now that you’re at the point where you’re ready to take your funding ask on the road, don’t forget to prep for your raise. Come up with a strategy for approaching potential funders. Use your existing network for warm introductions and keep expanding it by attending relevant events.
If you haven’t done this already, write an executive summary of your business plan and create a pitch deck. Product demos are a great way to make your value proposition tangible and to create buzz and excitement in potential investors.
Know your numbers as they relate to your historical performance, future projections, and your capital requirements. Expect to be quizzed on your growth assumptions especially any shortfalls in performance or changes in strategic direction. Know your key metrics such as the average lifetime value of your customers and your customer acquisition costs (CAC) cold. And be prepared to explain how you are maximizing value per customer.
In case you’re thinking that raising funding is something you can complete quickly, know that it can take 3-6 months. Be realistic and build in a cash cushion so that you don’t run out of funds before you complete your raise. The more on top you are of your key business documentation, the more you can help accelerate the process. That includes:
- Detailing your capital structure
- Putting your legal and accounting (whether in-house or outsourced) teams in place before you meet with investors. You’ll look more professional and be ready to move quickly during due diligence.
- Lining up key customers and vendors as references
Keeping the momentum going will be really helpful in managing the timing of your raise. Keep things moving by creating a sense of urgency. Set target dates for lining up funding, follow up with potential funders, and communicate your timeline for closing a round.
Deborah Adeyanju is Content Strategist & Social Media Manager at Early Growth Financial Services (EGFS), an outsourced financial services firm that provides small to mid-sized companies with day-to-day accounting, strategic finance, CFO, tax, and valuation services and support. Prior to joining EGFS, Deborah spent more than a decade as an investment analyst and portfolio manager with leading financial institutions in New York, London, and Paris. Deborah is also a Chartered Financial Analyst (CFA) charterholder.