Venture capital financing can be crucial to the success of a startup. By understanding the key issues in venture financings, entrepreneurs can increase the likelihood of a successful outcome. Venture capital comes in a lot of different flavors. Some venture capital is provided by corporations that have separate venture capital investing arms. So you might think about a trade off between raising money from a traditional venture capital investor versus raising money from a corporate venture capital investor.
You have busted your hump to get your product concept fleshed out and gained customer feedback about the importance of your solution. Maybe you even have a prototype and have been engaging with customers in trials. It could even be that you have started to generate initial revenue.
Under any circumstance, you have made the decision that you are ready to seek outside capital for you startup and move beyond the “bootstrapping” and friends and family stage of financing. Should you seek investment from a bank/lender, an angel investor or a firm? What specific angels or VCs should you approach?
There are eight primary things you need to consider before seeking outside for your startup, and that will help you make these decisions. Looking at these eight factors will help you determine the how, what, when, where and why of your financing round.
1. Ultimate goal and milestones
The first thing you need to have is a vision. Where do you ultimately want to take your ? To get excited and willing to invest, it is essential to clearly articulate your vision, exhibit passion and create excitement about your business. Once you have this big picture story, you need to have your vision grounded in an actionable plan.
What are your financial and non-financial goals for your business over the next 12 to 18 months? How much capital do you need to raise to achieve those goals? What will you do with the money? What key milestones can investors expect you to achieve over the next two to three years, and are there some big milestones that you’ll achieve in the next 12 to 18 months that will result in a step function increase in your valuation?
2. Target market size, growth and market share
Most outside investors have a particular investment thesis that they like to pursue. They invest in particular technology areas or certain vertical markets. Being able to clearly articulate your market size, market growth and your forecasted market share is essential to having credibility in your financial model. However, it is also critical to understanding which investors are the best targets to your company. Depending upon the stage of your company, your company might be suitable for angel investors or VCs.
3. Unique value proposition
You need to have a unique value proposition, sometimes called a unique selling proposition, for your product or service. I like to use the word value since it implies that you are looking at things from the customer’s perspective.
How much value does your solution have? It is based 100 percent on the problem you are solving for your customer. The only way to determine this is to intimately understand the customer. It is essential to have customer interaction and feedback before seeking outside financing for your startup. Therefore, it is also implied in a unique value proposition that your target customers have validated this value.
You must have testimonials and that demonstrate this value. At the right stage in the process, some investors may even want to do reference calls with your key customers about this, especially in the B2B world.
4. Product-market focus
Part of your strategy needs to show that you have a specific product market focus, and this will be your beachhead for establishing your business. You can then have a roadmap to attack adjacent markets with your solution. Or you can develop adjacent products that leverage your current product to service a bigger portion of the overall business with your customer.
If you come across as wanting to do everything for everybody out if the gate, then you will raise significant concern with investors. I call this the “boiling the ocean” strategy. It is really hard to do. However, if you just focus on a single product-market segment, unless it is massive, investors will consider your idea as “too niche.”
In many cases, even if you can show that your business idea can be profitable, if the market is not large enough, investors will relegate your idea to a “lifestyle business.” This is a business where you can make a fine living for yourself and have a comfortable lifestyle, but investors can’t make much money.
You resolve the conflict of these two issues by having an initial target that is very interesting, and a roadmap that addresses a spectacular opportunity.
5. Investing your personal resources
Prospective investors will want to know that you are busting your hump in building your business and that you are willing to make massive sacrifices to make your business successful. They will also be even more impressed if you have made significant progress on the business by using your own money. Investors like to see that you have “skin in the game” or “sweat equity” both in terms of your time, and in terms of your money. This is even more significant if you have had a big exit in a former startup.
6. Desire for control
When you make a decision to raise outside capital for your company, you are making a decision to relinquish sole control of your business. This is true even if you maintain a majority interest in the company. You may also be faced, at some point, with whether to bring an outside CEO into the company.
I like what a corporate attorney friend of mine who focuses on startups and VCs says about this: “Do you want to have a CEO title or do you want to be rich and have a successful company?”
It is not always true that you need an outside CEO, but there are many more circumstances like this. See , , , , and . Two notable examples of amazing companies that hired outside CEOs while they were still startups are Google and .
7. Ability to service debt
If your business generates a lot of cash and you can service debt, then a small-business loan may be a better alternative than raising outside equity capital. In that case, you will be able to maintain control. It is something that some companies should consider.
8. Leverage in negotiations
The final point is knowing what leverage you have in negotiating a deal and the importance of negotiating a “fair” valuation vs. a “optimum” valuation. Each financing round in a private company is an intermediate step to an ultimate exit for your company, whether you ultimately sell your company or take it public. It is way more important to get the right investors into your deal at a fair valuation vs. the wrong investors that add no value at an optimum valuation. It is also important that you consider corporate governance and deal terms as key factors in negotiating a financing for your company. In some cases, this is even more important than valuation.
A good mentor or coach can help you if you’re looking for further advice on which funding options are right for you and your company.
Startup Law ResourcesVenture Capital, FinancingFiguring out the best way to fund your startup is difficult. Here we outline 12 of the best sources of funding that you can leverage to launch your startup.6 min read
1. Self-Funding / Bootstrapping2. Friends and Family Investors
3. Crowdfunding
4. Incubators / Accelerators
5. Angel Investors
6. Venture Capitalists
7. Loans / Credit Cards / Debt
8. Small Business Grants
9. Barter
10. Partnership / Licensing
11. Commitment to A Major Customer
12. Ask a Lawyer
Updated June 25, 2020:
It takes money to turn a great idea into a great product, but “money doesn’t grow on trees” and you may not have thousands of dollars just waiting to be spent. So how do you turn your dream into a reality? Here are some of the best options.
Self-Funding / Bootstrapping
Many entrepreneurs start with some level of self-funding (also known as bootstrapping) and, in fact, future investors likely will want to see that you have some “skin in the game”. Even if you can only put in a little money, it is worth considering the benefits. For example, you don't have to worry about keeping investors happy. You also can keep more profits to yourself. Many founders also hold off on taking a salary, consider tapping into the 401(k) retirement account, and/or have a side job to help make ends meet while they get their business up and running.
You also can use your initial profits to bootstrap future growth instead of relying on future funding rounds.
Friends and Family Investors
First, make sure you read our guide on raising money from friends and family investors and the dangers that your startup faces. Your friends and family may be willing to help you grow, and they probably wouldn't make you jump through the many hoops. These investments generally are some type of loans or stock purchases and are something later investors will likely find to be a positive (i.e., if your family and friends don’t believe in you, why should the investor).
However, to protect yourself and your relationships, make sure you have a clear written agreement that outlines how the money will be repaid. Also, remember that even if the arrangement is informal, you should confirm if any securities restrictions apply to the arrangement.
Crowdfunding
Crowdfunding is quickly becoming a popular way to help fund a startup.
However, before seeking crowdfunding, make sure you look at our guide on the various crowdfunding legal issues and tips on how to avoid legal mistakes.
In the traditional approach to crowdfunding, you offer a first-run product or some other incentive in exchange for a monetary contribution. Contributors receive no equity and are not entitled to be repaid.
In many cases, the process is essentially a pre-sale of your product and not an investment -- and not regulated by the federal Securities and Exchange Commission.
Equity crowdfunding is a newer option made possible under the Jumpstart Our Business Startups (JOBS) Act -- which allows you to seek small investments from a large number of investors. You use a crowdfunding platform to post a listing similar to a traditional crowdfunding campaign, but your investors become shareholders. This includes voting and dividend rights as outlined in the shareholder agreement.
If you're interested in equity crowdfunding, carefully review the requirements of the Jumpstart Our Business Startups Act because it is a regulated securities offering.
Incubators / Accelerators
Incubators and accelerators generally provide groups of startups with workspace, business advice and training, and potential funding. They are often sponsored by universities, industry organizations, or individual companies. You can learn more about what you should do to legally prepare for the accelerator program beforehand in our guide here.
Each startup gets support from the sponsor plus networking opportunities with the other startups. In exchange, the incubator or accelerator may take an equity stake especially if they provide funding.
You can find incubators and accelerators geared towards local businesses in most cities. Accelerators and Incubators with national recognition include the following:
Angel Investors
Marcus Lemonis from the TV show 'The Profit.'
Startup Loan Options Outside Of Venture Capital Companies
Before seeking out angel investors, it is highly recommended to make sure that you read the guide on angel investors and the things startups must know and prepare for beforehand.
The upside is often a closer personal relationship that includes heavy mentoring. The downside is that an angel investor will often ask for a large equity stake and possibly even a controlling interest.
Typical investments frequently range from $25,000 to $250,000. Because angel investors operate with a smaller, less formal structure, they can have widely differing expectations of the terms of an investment. While getting a large investment offer is exciting, you need to make sure it's best for you.
Venture Capitalists
Venture capitalists are professional investors who invest in startups and growing companies. This makes them a receptive audience when you're looking for investors to pitch. However, you'll generally need to be past the earliest stages because the typical venture capital investment is $1 million or more. It may also take many months to close the deal.
It is highly recommended to read this guide on how to get venture capital and the most important things startups must do beforehand.
Make sure that your interests are aligned with a prospective venture capitalist. These firms often seek fast returns and push for rapid growth. This may go against your desire to build slowly and steadily.
Venture capitalists also seek, and regularly exercise, substantial control over a company. If you want to follow your own vision, venture capitalists may not be right for you.
It is further important to note that venture capitalists typically want to use their own investor agreement. As with any important contract, you should carefully review it to ensure it promotes your own interests and goals. Don't be afraid to negotiate changes or walk away if it doesn't.
Loans / Credit Cards / Debt
New businesses can find it challenging to get a traditional loan from a bank unless they have business assets for collateral and/or are willing to personally guarantee the loan (e.g., by putting up the equity in their house). However, the federal Small Business Administration (“SBA”) offers several small business loan programs that can help you get approved. Some entrepreneurs also may utilize credit cards, microloans or venture debt to finance their companies.
Once you have steady sales, you may be able to open a credit line against your accounts receivables (what customers owe you) (also referred to as “factoring”) or use your business equipment as collateral for a loan (also known as an asset loan).
Small Business Grants
Grants provided by the government or private organizations can provide free funding. To receive a grant, your company may need to be engaged in some sort of societal good or specialized area, such as education, medicine, or alternative energy. You can search for grants at grants.gov.
If you do receive a grant, there may be limitations on how you can use the money, and this could create an additional accounting burden for you.
Barter
Many businesses understandably prefer to be paid in cash, but there is still room for trade in the modern economy. Look for small businesses that can fulfill one of your needs and have a problem that you can solve. You may be able to trade your services in exchange for something you need (e.g., agreeing to do IT for a company in exchange for using their office).
Even if you don't directly receive cash, the savings will allow you to further stretch your resources.
Partnership / Licensing
Sometimes, growing on your own isn't the answer. Instead, you may want to create a partnership or licensing deal with an established company who can benefit from your product.
Startup Loan Options Outside Of Venture Capital Group
For example, if you invented a cell phone battery that lasted twice as long as existing batteries, you could: (i) go through the expensive and risky process of trying to market your battery independently to consumers, or (ii) strike a licensing deal with an established manufacturer who would love to put your battery in their next model.
In a partnership or licensing arrangement, funding might be limited to an advance on a first order to help you scale up your manufacturing. However, the bigger win is that by reducing the costs of setting up your own supply chain and marketing strategy, you won't need as much funding.
Startup Loan Options Outside Of Venture Capital Services
Commitment to A Major Customer
If you can lock in a major customer, they may be willing to fund your development. In exchange, they may want to adapt your production process to their exact specs, receive exclusive distribution rights, or get dedicated support. This commitment may be tied into an early licensing deal or white-label agreement.
You'll also gain the advantage of reducing the risk of your investment by locking in a guaranteed minimum return.
Ask a Lawyer
The best funding option is ultimately a personal decision based on your unique goals and risk tolerances. Consulting with an experienced business lawyer who has seen many businesses succeed and fail can help you make an informed decision about what's right for you. Post your legal need through a job on UpCounsel to find a highly qualified lawyer in your area.