A rundown of startup funding and what might work for you.
“If I just had $x, my company could really grow.”
At a certain point, your tech startup likely will need an influx of cash. From a round of key hires to technology investments to taking advantage of a huge sales opportunity, at a certain point, your business will need capital in order to scale up.
While there are stories of bootstrapped startups who ride their profits or their founders’ personal wealth to success, the vast majority of high-tech startups — especially those in entrenched industries like healthcare – will take on loans or investments to accelerate growth.
Here’s what you need to know about startup financing options, whether it’s your first (or fourth) time ‘round.
Credit vs. Investment
There are four primary types of financing for startups, as outlined here. They include: Equity, Venture Debt, Convertible Debt, and Convertible equity. Each type deals with either financing (credit) or funding (investment). Here’s what you should know about each type of startup financing:
Equity = ownership. Investors will become partial owners which does minimize a founder’s own rights as an existing owner.
Venture debt is higher-risk than traditional loans and therefore comes with increased interest rates (and sometimes a founder must sign as personal guarantor of the loan).
Convertible debt can become equity if the loan is not paid back under predefined terms. “Many start-up owners like convertible debt because it’s predictable,” writes BizJournals.
With convertible equity, investors can transfer debt into ownership contingent on predetermined events (like if a startup is purchased or becomes publicly traded). This flexible financing option is popular for startups.
However you decide to move forward, fundraising is necessary for most tech startups (even if, as we said above, you bootstrap at first). As you weigh your options on the type of financing, it helps to understand the way startup funding works: in rounds.
Funding in “Rounds”
You are probably familiar with the idea that startup capital is raised in rounds, sometimes identified by letters. The seed round consists of raising startup capital, while subsequent rounds pursue additional funds that are often used to grow the company. The idea of funding in rounds can be daunting as you start out but developing relationships with investors is key.
“Advice abounds on the best way to value your startup. But one thing’s for sure, whether you are attempting to raise money for the first time or requesting a second round of funding, your investment group will need to see that you are confident,” we wrote in an earlier blog post. Confidence is really key during funding rounds, because potential investors will look to you as an indicator of your ability to achieve goals. Additionally, a complete understanding of funding and what investors expect is essential.
Understanding how much you need to raise is important, especially in the age of the “mega-round,” which is as the New York Times so aptly summarized: “$100 Million was once big money for a start-up. Now, it’s common.” Raising such a large amount of money has become more routine in a startup friendly culture marked by eager investors. “For the start-ups, the pots of money are changing the normal way of building a tech company. They must move even faster, expand their ambitions and collect more investment money than ever — even if they might not be ready.”
“Fundraising can be a numbers game so you really need to do research and have a long list of potential VCs in case the earliest ones don’t bite.”
– Mark Suster, Managing Partner for Upfront Ventures
Startup Funding Choices and Pitfalls
“Is there such a thing as slow and successful in startup-land?” asks Crunchbase writer Joanna Glasner. It seems as though most startup stories you hear speak of overnight high-valuation or sudden crashes. Some founders may like the rollercoaster ride (raising money quickly sounds good), but plenty of startup owners wonder if business really has to be so polarized.
Studies suggest that boom-or-bust isn’t the only way that startups can find success. But the real answer may lie in the business itself: startup founders have choices when it comes to funding, and there’s no answer that works for each and every business. “Capital doesn’t make funded founders any more insightful than their bootstrapped brethren,” says Hackernoon.com. So what can startup founders look to when making financing choices?
“Cash flow issues are the second most common reason startups fail, accounting for 29% of failures. In many cases, access to capital would make a big difference. Yet the loan application process is notoriously opaque for small business owners.”
Data. Looking into investors to see if they are a good “fit” for your startup is a more effective long-term strategy for startups, as is getting a good read on metrics like product-market fit and how many dollars you need (tip: it’s often more than you think). It’s also important to be cognizant of the data behind what leads a startup to fail or succeed. CBInsights found that the “odds of becoming a unicorn” hover around 1%, and only 12 startups have reached that status. For most, a pragmatic and well-advised business plan is needed in order to succeed.