What exactly is a startup? For a business enterprise to achieve startup status, it must meet the following criteria:
- At least one principal person of the company is pursuing the project on a full-time basis
- The prototype is being developed or the service is being discussed with potential users
- The business plan is being refined
- A management team is being identified
- Market analysis is underway
- Beta tests are being set up or initial customers are identified
What is Startup Funding?
Startup funding comes in many forms, but generally requires one to give up equity in a company in exchange for early stage financing. Often, this type of financing involves venture capitalists or angel investors. But, as today’s financial landscape continues to evolve, startups are accessing capital in less conventional manners that can provide them the funding they need when big banks will not.
Below you’ll find videos, case studies, links and experts that can help you understand some basics of startup funding.
The Basics of Startup Funding
Startups seem to be all the rage these days – from Silicon Valley to Tel Aviv, it’s hard to escape the concept. But why is entrepreneurship so attractive to so many people? For some, the idea of being one’s own boss is too good a prospect to pass up. Others are attracted by the potential for profit. And certain entrepreneurs could not conceive of working in another field, and are driven by their passion. Regardless of one’s intent, entrepreneurs seeking funding for their startup can follow some simple rules:
For the Love of the Game
Often those who take on entrepreneurship do it due to their love for an idea, rather than a sole desire to find success. In the video below, Jeff Stibel, Vice Chairman of Dun & Bradstreet, states that passion is the one trait that matters most when seeking startup funding. He believes enthusiastic entrepreneurs who are unwilling to say “no” in the face of adversity set themselves up for success, and that the team that best conveys its passion for its idea can expand its options. From investments to contracts to partnerships, Stibel believes infatuation with one’s own idea can catalyze many different business opportunities.
There Is No “I” In Team
Markets and products can change – the quality of character on your team cannot. That is why it is important for entrepreneurs to choose their team wisely. But be aware that you may be hard pressed to find individuals who are as enthusiastic about your idea as you are. With this in mind, Tony Westfall, co-founder of invino, recommends in the video below that you hire slowly and fire quickly when attempting to find partners who are as dedicated as you are.
Ideally, a company is run by 2-5 people whose skills complement each other nicely, as a balanced team is important. If you run a startup with a socially reserved operations guru, you should be comfortable handling investor relations, among other areas. This ability to recognize and capitalize on each member’s strengths and weaknesses is what can make a team great, especially if you surround yourself with people who challenge you to innovate and whom you can learn from.
And great teams can help attract investors. In the seed round of funding, when an idea is merely a concept, investors invest in you and your partners, so pick carefully.
More Than Money
Just as investors invest in your team, you should invest in your investor. In other words, you should view your investors not just as sources of money, but as partners. It is important to understand that investor relations are intricate, and just as you judiciously select your team, you should carefully choose your investors. You may be tempted to take the first offer you’re given and run – don’t.
Initial investors can be your biggest asset to raising future rounds of funding. Therefore, you should seek an investor that you can trust, respect, and learn from. It can be entirely possible that your initial investor will sit on your board of directors for years to come and help with future investments.
If At First You Don’t Succeed, Try Again
Ashish Soni, Executive Director of Digital Innovation at USC, mentions in the video below that merely 0.6% of companies that pitch to venture capitalists or angel investors get funded. 0.6%! That means you could reasonably expect to be in nearly 200 investor meetings. So, if at first you do not succeed, do not be discouraged.
To learn more about the ongoing process of raising capital and other entrepreneurial strategies, and to hear more from Stibel, Westfall, and Soni, check out the video below.
Types of Startup Funding
With so many different funding options available, it can be difficult to know which type of investment is appropriate for your startup. Luckily, most forms of capital can be applicable to almost any particular stage of your startup.
Below is an image that highlights when you can use which type of capital for your startup, as well as detailed outlines of each of the investment opportunities.
For most entrepreneurs, it can be difficult to raise capital from an idea alone; intelligent investors look for more than just a concept before investing. That is why a large majority of entrepreneurs initially opt to self finance or ask friends and family for help – it’s easier, practical, and sometimes the only option.
Like all forms of funding, self financing/asking family for money can be both beneficial and potentially detrimental. Self financing is pretty straightforward – use whatever available funds you have to follow your dream, hopefully without going broke. Using family and friends for funding can also be straightforward, but there is more at stake than just money. For example, it can be extremely difficult to manage your family’s expectations and could put a strain on your relationships, and anything other than success could result in personal risk, if you’ve wagered your lifesavings. On the other hand, there may be low legal risk if the money is lost – you’d like to think your family would not sue you if your business doesn’t get off the ground.
Crowdfunding is a relatively recent funding phenomenon that involves crowdsourcing small investments from individuals. It can be a particularly effective method for funding your startup if you have a defined target market and know which site is the appropriate platform to promote your idea. While crowdfunding can be an effective way to raise capital, its main advantage for entrepreneurs is its ability to grow a community of backers who are engaged and committed to your idea.
Small businesses and startups alike can utilize crowdfunding, but executing a successful campaign can be an art. Our crowdfunding guide can help you learn more about how you can utilize crowdfunding to help you grow your business and turn your backers into long-term customers.
Once you have developed a business plan, created a prototype, identified a target market, and recruited a team, it can be time to seek funding from experienced entrepreneurs. These entrepreneurs, known as angel investors, are usually wealthy individuals who have successfully scaled a startup of their own. They are motivated to fund other entrepreneurs for a variety of reasons: they can gain profit from an exit, they find joy in helping other entrepreneurs, or they enjoy being involved in a growing business.
Whatever their incentives may be, angel investors can be a tremendous source of capital, and more importantly, guidance. Luckily, there are plenty of angel investors to go around, and numerous means to connect with them. First consider reaching out to a friend or networking to find someone who can help. If you do not know anyone, have no fear – there are multiple formal angel organizations that can help. Keiretsu Forum, Bay Angels, and Angel List are some of the many regional and global angel networks that connect entrepreneurs with angel investors.
Venture Capital (VC)
Once you have secured an Angel Investor, and are on track to release the first iteration of your product, it is time to consider the help of venture capitalists (if that is your goal, of course). Venture Capital or VC firms are formal financial intermediaries and are trusted with investing for a group of people or entities, and they can mean business.
All VC firms have a similar structure. They generally consist of Limited Partners, or investors, and General Partners, or the firm itself. General and Limited partners collectively own a Venture Capital fund, which is managed by the VC firm. The fund, in turn, owns a portfolio of investments and profits from initial public offerings or mergers and acquisitions.
Securing a meeting with a VC firm can be far more formal, and far more difficult, than securing a meeting with an Angel Investor. Venture Capital meetings almost always require a personal introduction to a partner, making networking essential – hopefully your Angel Investor can help, if you have one already. We have more information below in the “Stages of VC Investment” and “Meeting With VCs” sections on how VCs invest money and about how the VC presentation process works.
Venture Capital firms are also responsible for funding accelerators, which are becoming more and more popular in today’s entrepreneurial landscape. Accelerators, also known as incubators, are essentially bootcamps for startups where entrepreneurs can receive support and education to help grow their businesses. Hundreds of aspiring entrepreneurs apply to accelerators annually, and for elite programs like Y Combinator and Techstars, the application process can be highly competitive. Learn more about accelerators and to see if they are appropriate for your startup.
Traditional funding, or bank loans, can be hard for startups to obtain – banks are most likely not going to risk lending to an unestablished business that may default on a loan. That is why traditional funding is appropriate for businesses that have a history of sales, strong business credit, and are growing rapidly.
Like all forms of funding, obtaining a bank loan can have its pros and cons. On the plus side, bank loans allow for complete ownership (as opposed to Venture Capital), low interest rates, and some tax benefits. On the downside, business loans are not given usually given in amounts under $250,000, which means you will be paying off any loan for many years. If bank loans are out of the question, or if your business is not in good position to apply for one, there are plenty of alternative lending options.
Stages of VC Investment
Before we examine some strategies that have helped startups secure funding, it is important to understand the different stages of VC investment and how they can pertain to your startup.
The seed stage is the “wide-eyed, new-kid-on-the-block” stage – there’s an idea or concept, no management team or prototype, and patentability is unclear. Furthermore, there is no business plan, time table, or market research – merely a concept. At this stage, venture capitalists have very little interest in providing funding. In order to appeal to VCs, entrepreneurs should develop a prototype, assemble key management, develop a business plan and assess market potential.
After the concept stage comes the startup stage. Startups, which are defined above, can be more attractive to venture capitalists, but still present plenty of risk. A developing business plan and initial market research are not enough to attract investment, but a stellar management team is. If your startup is to obtain funding at this stage, a top-rated management team must be assembled. At this point, a VC would invest in you more so than your idea.
The first stage is considered the preferred investment stage for VCs. At this point, a startup is becoming more of a company – it has proven manufacturing (or its service) and has some initial sales, the initial management team is in place, and the business plan is being refined based on customer feedback. Companies are working toward market penetration and initial sales goals while aiming to break even. Productivity is increasing, unit costs are decreasing, and the sales organization and distribution system are developing.
By the time your startup is ready for second stage funding, it should have developed significant sales and occasionally broken even. You should be in the process of identifying and hiring second level management while exploring exporting opportunities, if applicable. Moving forward, your company should seek to become consistently profitable as it adds significant sales. Funding at this stage can be more sophisticated, and any additional capital should expand marketing, accounts receivable, and inventory. At this point, those investing in your company are most likely anticipating the final stage: harvest and are usually forming plans to reap profits that can include either selling the company or going public.
The next level of financing, called the “bridge” or “mezzanine” stage, is generally sought after by companies who need to carry increased accounts receivable and inventory before the harvest stage. Companies seeking financing at this stage are working out kinks in design, marketing, and distribution in an effort to become a major success. Immediate goals include increasing market reliability, beginning export marketing, and preparing the company for the harvest stage.
The Harvest Stage
Technically there is a fourth stage of VC investment. But, at this point, the end may be near for entrepreneurial companies. At this stage, the company is sorting out its options, which include going public, being acquired, selling out, or merging.
Meeting With VCs
You have probably heard about or even seen examples of entrepreneurs pitching to venture capitalists. And, thanks to shows like Shark Tank, there is a good chance that you picture venture capitalists as shrewd individuals itching to pick apart whatever venture is brave enough to seek funding. Luckily, that is not actually the case.
Most often, venture capitalists are reserved and respectful during investment pitches. They often keep what they are thinking to themselves and they tend to be hard to read. If your pitch goes “too well” – investors don’t pick you apart, don’t ask many questions, and promise to follow up – you may have struck out. On the other hand, some investors will ask pressing questions and point out flaws in your strategy or product, if you’ve caught their attention. Pressuring entrepreneurs during a presentation can be a great way for venture capitalists to assess your understanding, integrity, and potential.
Preparation for your investor presentation is key, especially in the event you are grilled by investors. Luckily, pitching to venture capitalists can be systematic: for the most part, there is a right way and a wrong way to do it.
Here’s what you should know prior to a meeting with venture capitalists:
You have about ten minutes to pitch your idea in a VC meeting. That’s not a lot of time to present an idea you’ve been refining for thousands of hours. To make a good impression, you should present the key elements of your business:
- How will your business make money?
- Focus on your business, not the technology behind it.
- Get to the point quickly!
- You have ten minutes, regardless of how long your appointment is.
- You are the expert – be ready to answer tough questions.
In those ten minutes, you can be evaluated on:
- The logic of your plan
- The four risks (see below)
- How you communicate
- Your level of expertise
- Can you become a CEO?
- Are you tough? Do you have integrity?
- Does the business fit the VC’s portfolio plan?
The Four Risks
Venture capitalists take calculated risks. There is a certain level of uncertainty innate in entrepreneurship, but VCs do their research to give themselves an understanding of how to best mitigate potential risks. In particular, VCs can examine four different kinds of risk when evaluating a company: technical, market, managerial, and financial. Let’s take a closer look at each.
While you should not extensively highlight the technology involved in you venture, you should briefly discuss it. VCs will want to gain an understanding of your stage of development, which can range from a new-tech concept to a finished, purchased technology. They will also want to assess any intellectual property and know if you have applied for any patents.
Venture capitalists will definitely be concerned with your target market. As you present, they will examine if the target market is credible, sufficiently sizable, growing and/or developing. VCs will also look to see if your target market will have a desirably competitive market.
As previously mentioned, venture capitalists are not just investing in your idea – they are also investing in your team. To assess you and your partners, VCs will ask a handful of questions which may include:
Does your team have a sufficient technical background in its field of business? Does your team have a record of achievement in the business? Does the leader? Is the team fully committed? Does the team have integrity?
Since venture capitalists are in the business of making money, they will want to know the current and future financial situation of your company. You should highlight variabilities of cash flow and what financial stage your startup is in. Is your company pre revenue, post revenue with a negative cash flow, or cash flow positive? And they’ll want to know why you want money – is cash for capital or to fund losses? Hopefully it’s not the latter.
You should have a presentation to accompany your pitch. Before you construct the slides for your presentation, though, you should start outlining everything you want to say. Group your outline into two sections: reasons to invest and reasons to not invest (or risks). Then narrow each group of information to 3-5 key takeaways to be incorporated throughout your presentation.
You’ll want to budget your presentation to about 20-25 slides. Note that these slides should highlight the important information and messages you want to convey. You should also have a set of unbudgeted backup slides to answer any question you might encounter. Doing so demonstrates preparation and can impress your investors.
Here are some general presentation rules and tips you can follow:
- Don’t clutter slides. Make sure investors’ eyes are drawn to the important information.
- Avoid information on the edges; don’t clutter or mix messages.
- Examine every word, bullet, or sentence – does it fit / is it necessary?
- How will each slide be perceived? Initial reactions?
- “Show” don’t “tell” – superlatives are superfluous.
- Be consistent – make sure numbers, verbal descriptions, and details match.
- Start with an agenda and circle back to it frequently.
Additionally, you should follow investors’ thought processes at all times, and be cognizant of how they will perceive your message. With that in mind, highlight the following in your presentation:
- Mission – what pain does the company alleviate?
- Reasons to invest
- Risk and mitigation strategies
- Team – what are the strong points?
- Financials with cash flow – risk?
- Appendix – answers to all important questions
Remember: the message you intend to send is not the same as the message received, so review your presentation with a mentor or trusted colleague before putting it in front of potential investors.
Vinok Khosla’s Top Powerpoint Rules
Vinod Khosla, billionaire venture capitalist and founder of Khosla Ventures, is well versed in the area of VC presentations. Here are his top powerpoint rules:
- State the problem. Emphasize emotion over detail.
- Titles should be messages, not a topic (i.e.: “big target market” vs “market).
- What is the viewer’s takeaway from a slide in five seconds?
- There should be one focus point per slide. If there are more, the slide is too complex.
- Each slide should have no more than 4-5 lines and one picture/graphic.
- Aim for 5-6 words per line and about 25 words per slide. Try and fit all messages / headings on one line.
- Minimum font size for big headings should be 22 or 24 pt, 18 or 20 pt for subheadings, and 12 pt for picture “picture” view.
- White space on each slide is a good thing. Use light fonts to reduce complexity of slides.
- A visceral story is more important than a complete story.
- Make sure you highlight all risks and your plans to mitigate them. If you don’t know, say so.
- Clearly state your ask.
- Engineer the takeaways – investors should be able to easily construct an email that highlights the opportunities, technology, competitive advantages, and risks your company presents.
All in all, you should use your powerpoint presentation to guide you through your pitch. A powerpoint allows you to pitch with emotion and clearly highlight the main takeaways of your business. And, don’t forget, less is more.
Challenges of Startup Funding
By now, it should be apparent that startup funding does not come without its challenges. Regardless of how you opt to fund your business, you are likely to run into some difficulties. Below are some common challenges entrepreneurs face when seeking startup funding.
Time – From developing a business plan to searching for an investor, startup funding is a time-consuming process. You can expect to devote a fair amount of time to the process if you want to succeed.
Finding and Selecting an Investor – Like the entire funding process itself, finding an initial investor can be labor intensive. You should not settle for the first offer of financing that comes your way and instead seek out an investor who can be your partner for years to come.
Creating a Business Plan – Completing a comprehensive business plan can be more difficult than you think. Doing so takes time, effort, and forward-thinking. Compiling a business plan that answers investors’ questions, however, can pay off.
Talent Acquisition – Compiling a top-tier management team is no easy task. The process itself is rigorous, but creating chemistry between the team is even more challenging. Remember, building a strong team makes raising capital easier, so don’t cut corners.
These entrepreneurs wrangled capital from many different sources. Where and how? That’s what they’re here to share.