At some stage, most entrepreneurs will need to finance their startup. This means raising money to fund the continued growth and development of their business.
Financing a startup can be one of the biggest challenges an entrepreneur will face.
Roughly 90% of startups fail, and a large part of this is due to the inability to raise enough money.
Investors and financial institutions specialize in funding different stages of the startup lifecycle.
Each stage has two unique factors
- RISK and
Early stage businesses have higher risk but also higher potential for reward, while later stage businesses have less risk but also less opportunity for reward.
While there are no rules or set formulas for startup financing, it is important to understand the risks and opportunities at each stage.
Where to raise money
There are numerous ways to raise funds depending on the stage and funding needs of a company.
Early stage companies
- Friends and Family
- Crowdfunding campaigns (Kickstarter)
- Grants from the government or small business loans.
- Angel Investors
More mature companies
- Venture Capitalists
- Private Equity
- IPO (Initial Public Offering – when a company goes public to sell shares of its stock.)
Calculator: Who wants to be a millionaire?
So, you’re building the “next big thing” and ready to raise money.
In the beginning, it’s a catch-22 (a lose-lose situation). You need financing to build the product or service, but very rarely will an investor give you money without a beta (prototype version) already built or customers already using the product.
- support in making difficult decisions
How to raise money
The first step is often bootstrapping- starting a business using personal means and finances to get it off the ground.
Ways to bootstrap can include:
- Maxing out credit cards
- Borrowing against property
- Cashing in savings
- Pulling money out of retirement accounts
Did you know that there are no taxes or penalties for using a 401(k) or IRA to fund your business?
From there, most startups need to move on to outside investments. Aside from the money, there are other benefits that come from bringing on investors.
Benefits from bringing on outside investors:
- support in making difficult decisions
If investors have experience in the same industry, they can make it much easier to recruit talent and grow the business with their expertise and network.
|Funding Option||Round of Involvement||Description||Pros||Cons|
|Bootstrapping||idea phase||you self-finance and build the product yourself with no outside help||you have complete control of your idea and business||money can run out quickly; the market tends to grow faster than personal cash flow, so it's hard to keep up|
|Crowdfunding||early build stages||taking financial contributions from people without giving up equity||a great way to determine the demand for your product; can potentially generate more money than anticipated||doesn't work for all types of companies|
|Friends and Family||early build stages||asking friends and family to lend you money, but being careful to keep it a business transaction||friends and family know and trust you and want to help you succeed||mixing business and personal can strain relationships; they may want involvement in your company|
|Traditional Lenders||early build stages||credit cards/banks/small business loans||these are all debt financing options, meaning that they need to be paid back by a certain time and with interest||too much debt can be debilitating; traditional lenders can be conservative and have strict requirements|
|Angel Investors||established product, but ready for expansion||wealthy individuals who are usually experienced entrepreneurs||provide money and mentorship; will potentially come in at an earlier stage where they see potential for growth||might have different views on how to run your company; may do whatever is necessary to ensure a return on their investment|
|Venture Capitalist||business is already an established entity with a proven business model||a firm that invests large amounts of money with the hope of expansion and big returns||credibility from a reputable VC opens doors to further investments; enable growth because of cash flow||tend to only get involved in later stages; can force changes on the company/whatever it takes to make money|
With the backing of multiple investors at different stages, a company should aim to have customers and sales in place to generate cash flow. The transition is made into a growth-stage company, which comes with a whole new set of challenges: growing the business, adding staff to support the expansion, and implementing a team to continue upsizing the company.
How to find investors
There are multiple ways to secure funding. Networking and utilizing personal connections are often the most effective approaches.
Raising money does not necessarily guarantee success. Here are a few examples of companies that raised millions of dollars and crashed soon after:
- Pets.com raised $82.5 million in an initial public offering (IPO), but closed after operating for a little more than two years.
- Webvan raised $375 million in an IPO but closed after two years.
- eToys raised $164 million in an IPO but also closed after two years.
- Kozmo.com raised about $250 million but closed after three years.
Here are some examples of companies that did not raise money and have grown to become incredibly profitable and lucrative businesses:
- MailChimp, the email marketing and subscription company, recorded over $400 million in revenue last year and has never raised any outside funding.
- Nasty Gal initially started on eBay, and Sophia Amoruso, the founder and owner, bootstrapped this startup for five years before raising outside capital. Nasty Gal then raised over $50 million. Eventually, Nasty Gal filed for bankruptcy in 2017.
- FedEx initially didn’t take off. When it was on the verge of bankruptcy, Frederick W. Smith, the founder of FedEx, took the company’s last $5000 and flew to Las Vegas to play blackjack. He made $24,000 which he used to keep the company afloat
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