Just imagine: You have an amazing business idea and a group of people who believe in that idea. You guys pool out money from your savings and work on building the product around the idea. Your start-up starts to gain traction with an ever-increasing customer base. This forces you to expand your operations and your team. Before you know it, your start-up has captured a major chunk of the market and is now looking for an initial public offering (IPO).
Now, you would say, this is just an imagination. However, when it comes to face reality, the situation can become scary, unpredictable, and full of surprises. There are lots of amazing entrepreneurs who have achieved it. For example, look at the history of Dhirubhai Ambani. However, these people belong to a rather small elite minority.
More often than not, startups are dependent on financial help from outsiders to get their business on track. The primary reason for that being the journey of commencing a startup has thorns in it. Hence, there is a great chance that you might need external help in the form of money (in most cases).
What is the Problem?
It has everything to do with the startup ecosystem wherein raising money is seen more of a victory than making money. This kind of thinking has made the process of raising money more complicated, though, and only worthy of an elite few. This factor itself has demotivated and intimidated a lot of promising entrepreneurs.
In the forthcoming sections of this write-up, we have tried to demystify the notion that raising money is not complicated. We will also provide you with different options you can choose as an entrepreneur to raise money, the exact procedure to follow, and the things that are appropriate for you and your business.
So, without much ado, let’s get started.
Definition of Funding or Raising Money
It is well-known that every business would have to undergo expenses and someone has to pay for them. This is where the capital of the business comes into the picture. However, at some point in time, while running the business, you will spend more money than you make.
Without proper financing for your business, your startup is at risk of imploding or going nowhere. To resolve this problem and restrict risks, business owners take help from outside sources. This is known as funding or raising money. Now, this can be in the form of debt or by sharing the partial ownership of the business.
How Does Startup Funding Work?
A startup can raise funds either through debt or equity. Now, debt is a form of a loan which is borrowed from an individual or bank at an agreed rate of interest. The borrowed money needs to be paid back along with interest within a stipulated period.
However, there is a big problem with this one. The 100% risk is yours and you are under the obligation to pay back the borrowed money. Also, the process to get the loan is quite tedious. It is also restricted to businesses with a decent cash flow already.
To reduce the risk, certain business owners raise money by giving away partial ownership of their company, in the form of equity (shares). The people who invest the money get a share in the company depending on the money they lent. However, the good news is, you are under no obligation to pay back the money.
The investors, normally, prefer to wait it out and cash out their investment, i.e., the investor gets to sell their shares of the company. It is also known as an exit. Now, this exit ordinarily happens when the value of the share is exponentially higher than what it is bought for.
This is a simple explanation of how startup funding works. In the next section, we will look at the different options entrepreneurs have to raise capital.
Different Ways to Raise Funds
This option is readily available to every entrepreneur. In simple words, Bootstrapping means building your startup from scratch with your own money and funding the day-to-day operations and sales of your offering.
Most of the time, entrepreneurs raise their funds by taking help from their friends and family. This way, it not only diversifies risk but also ensures that you get certain leeway while repaying the debts to your friends and relatives.
This is the most preferred way for entrepreneurs to raise funds. However, if you think bootstrapping is easy then you are wrong!
The entire risk of the business is entirely on the entrepreneur and his team. This can be a double blow as most entrepreneurs dip into their savings. It even has a drastic effect on how much they grow. There are lots of sacrifices and compromises to be made while bootstrapping.
Whereas, since you, as an entrepreneur get the entire pie, i.e., total control of the company, you are likely to concentrate on developing the products and financing it through sales instead of external financing. Now, since you are not inclined to borrow money from outsiders, the cost in the form of interests or equity go considerably down. This can help you move towards positive cash flow.
All of these factors encourage service companies to be bootstrapped. There are lots of startups globally that were bootstrapped and have reached the pinnacle of success.
With the advent of the internet, the gap between the business and its customer has been closed, thanks to the elimination of the middlemen. Now, due to this, there was an issue of trust which has also been solved to an extent by different services.
Today, people are buying online even before the product is released! This is known as crowdfunding. It is the opposite of the traditional business route. In an ideal situation, you would first develop a product, get some traction, raise some money, get more customers, and grow from there.
However, with crowdfunding, people pre-order the product before it has started being developed. This way, you can utilize the money from the “sales” to create the product and ship it to the customers.
From crowdfunding, you can raise a small amount of money from a lot of people instead of a lot of money from limited people. It is even possible to select whether you wish to have a part in the equity or purely base it on pre-order. Crowdfunding has been quite successful in raising donations for different causes.
To get your project crowdfunded, it is important to have a comprehensive business plan. Then you need to set goals, milestones, timelines, and the way you are going to execute and deliver it. You also need to tell how you are going to deploy the funds. A prototype, even in the design form, can be of great assistance in describing your product to the audience.
Once you are ready with these things, go to crowdfunding platforms like Indiegogo, Ketto, Wishberry, etc.
3. Government Funding
The government can help if your Startup needs capital. This type of government funding comes in the form of a grant which is not required to be repaid. Alternatively, you get tax incentives, which are a deduction to encourage spending and investment.
If you are residing in the U.S.A., for your startup apply for the Small Business Innovation Research (SBIR) program. It supports technological innovation and R&D. You can also get other funding options as a part of White House’s “Startup America” initiative, which is typically for high-growth startups.
4. Equity Crowdfunding
We have already discussed crowdfunding in an earlier point. Crowdfunding is a way for startups to raise a small amount of money from a large number of people. With equity crowdfunding, the investors get a stake in the company. Their reward is the profit they expect in return for giving you the money.
Equity crowdfunding is slowly but gradually filling the gap that startups and investors have complained to be existing for early-stage companies.
5. Venture Capital
In case you are looking for venture capital for your start-up, then venture capitalists can make it happen for you. VCs are deep-pocketed investors who put money in startups if they see the potential of growth in it.
Investment criteria from the investors’ point of view that drives an investment
Here are some of the criteria that investors evaluate before they drive into investing in a start-up.
The Crux of Your Idea and Its Potential
The investors would look into your idea and it’s potential. Your idea needs to be practical, exclusive, scalable, innovative and promising in the market
Type of Business
The investors would also look at the type of business you are in, including the credibility and credentials of every core team member. Along with business model, pricing & cost structures.
Investors keep a close eye on the future potential of your business. This can be showcased with the help of a well-drafted business plan, like business strategies, the usage of funds, value proposition, and the exit strategy.
Investors also look at the return on investment. They need to feel confident about your investment proposition and be convinced that you will return their investments.
Things to Keep Handy While Approaching Investors for Funding
- Include an all-inclusive business plan with a projection of 5 years and investment offerings & estimated valuations.
- Prepare a Powerpoint presentation covering 15 to 25 slides summarizing your business plan. This will come in handy while presenting in front of the investors.
- Include a well-crafted executive summary having a two-page document covering the overall business plan. It would act as an ice-breaker to initiate formal communication with the investors.
- Prepare an elevator pitch, containing a 5-minute verbal summary of your business idea and plan. This comes in handy especially when you are meeting the investors during events or conferences.
- Spend adequate time and effort in researching, drafting, and preparing the components of the pitch before approaching the investors.
The Best Way to Approach the Investors
Once you have the pitch ready, it is time to approach the investors. Organize a meeting at start-up events or competitions. You can even proactively approach the investors by sending them emails with teaser documents and follow up meetings. You can use investment forums or referrals to reach investors.
Always keep this in mind: The fund-seeking process is time-consuming, difficult, and challenging. Most of the time, you will be faced with rejection but do not lose your hope and be relentless. Also, balance out your time between seeking the funds and running your business. After all, without running the business, no one will give you the funds.
At first, it might be difficult for you to know the real intent of the person you are approaching for the start-up funds. But, through discussions and meetings, it is possible to know what the investors have in their minds. Understand their objective and way of working etc.
From the write-up, you might have understood that there are lots of factors that go into starting a business and especially when you are looking for start-up funding. However, it is one of the best ways to get startups off the ground and hopefully on the right track.
Thanks to the start-up funding option, you have the chance to have a strong foundation without contemplating hard about the team salaries, office or retail space, product development costs, and other hurdles during the initial period of the business.
We hope this piece of content helps you as a budding entrepreneur to take the wise decision of opting for a start-up funding option from a reputed source so that your business reaches new heights of success.