Startup Fundraising – Pluses and Minuses
From bootstrapping to venture funds, there are many different avenues.
Fundraising for a startup company often takes more skill, talent, and innovation than creating the product or service you want to deliver. I deal with IP-centric businesses where patents are a core asset, and that implies that the entrepreneur is creative, innovative, and tries new things.
All of those creative juices should be applied to raising funds for your startup.
Tackling a hard engineering problem and creating a patentable invention uses the same creativity and innovation as it takes for fund raising.
Here are some of the different ways that entrepreneurs have raised funds for their startup:
Bootstrapping a startup is the hardest way to grow a company, but the best in many ways.
Bootstrapping forces a company to focus on delivering value and generating revenue from the beginning. If you can generate revenue quickly, you do not need other people’s capital and you can control your own destiny.
Plus: Bootstrapping allows you 100% control.
Minus: You may not have enough runway to make it to profitability.
Friends and Family
Raising money from friends and family is sometimes called the “friends, family, and fools” round.
Giving money to a friend or family member to start a business might be great when everything works out but can lead to irreparable harm to those relationships. Thanksgiving dinner might be pretty tense when you just lost your parent’s retirement money on a startup.
If you do a friends and family round of funding, it is always best to treat it seriously and have fair terms.
Often, a relative or friend might want a ridiculous share of the company and might demand terms that will make it impossible to raise money from angel or venture investors in the future. A ridiculous term might be that they want their percentage to be non-dilutive, meaning that every time you raise money, their share remains constant. There are plenty of ways a friend or relative can demand terms that make it impossible for other investors to come in.
Plus: family and friends want to help, so it may be easier to get the money.
Minus: done badly, friends and family money can damage your relationships – and kill your ability for future financing rounds.
Angel investors are high net worth people (typically over $1,000,000 in assets) that invest in startup companies. Angel investors can vary all over the map in sophistication, with some writing a check after hearing the pitch, and others doing 40+ hours of due diligence on every deal.
In general, the more due diligence an angel does, the better their returns. So even if an angel investor seems like they are taking their time and looking under the hood, they are doing you a big service.
Sophisticated, experienced angel investors can be a huge advantage to you. Many angel investors have deep experience and can act as mentors or advisors to you.
A typical individual angel investor might be able to write a check of $25-50K.
Remember that an angel investor needs to invest in 20+ deals to see a reasonable return. Even though they have a lot of money, a prudent angel investor will be spreading it across many investments.
Plus: Angel investors can be huge cheerleaders and offer a lot of help
Minus: Individual angels are hard to find
There are 400 or more angel groups around the US and internationally. These are groups of angel investors who invest together. A typical angel group will share the due diligence workload, and they will pool their money together into a larger investment.
A typical angel group might have 100 or more investors.
Many angel groups can invest $250K-$1M, and some angel groups might invest more.
Many angel groups syndicate deals. One angel group might hear the pitch and become a “lead” investor, doing most of the due diligence and negotiating terms. They may talk to other angel groups about joining the round on the same basic terms. By syndicating deals, angel groups join forces and work together to raise larger amounts of money for a company.
Each angel group is different. Some have a large paid staff and may be highly organized, while others are a volunteer organization. Some angel groups require that you pay money, sometimes tens of thousands or more, before you present your company. Other groups, especially the smaller groups, might not charge anything at all.
Angel groups are organized under the Angel Capital Association, which is the national umbrella organization.
Before you pitch to an angel group, do your research. Some angel groups have particular interest or expertise, such as healthcare, software, or agriculture technology. Other groups may have a regional or local interest, or may specialize in “impact investing.”
The best way to do research is find companies who received funding from the group and contact the CEO. Ask them how well the process worked, what requirements were placed on them, and anything they would have done differently.
Expect to undergo an extensive due diligence with angel groups. Many angel groups have members who are lawyers, accountants, marketing experts, operations experts, etc. It is not uncommon for the quiet person in the back of the room at an angel meeting to have spent a career in your field. That person might know far more about your business than you do, so make sure you have researched your business as best you can.
Some angel groups have created their own “funds.” These are pools of money that they are going to invest. Typically, a group might ask their members to see how many people are interested in investing, and if there is enough interest, the fund will invest alongside individual angels.
Plus: Angel groups are designed for funding startup companies, and have a lot to offer, including educational programming.
Minus: Some groups can take a long time to go through there process and you still might not be funded.
Seed Funds and Venture Funds
Funds are different from angel investors in one important way: the fund managers are investing someone else’s money while the angel investors are investing their own money. This creates a different motivation for the investment.
Angel investors often invest because they want to be part of a startup. Often, they like an entrepreneur’s vision and enthusiasm, and they want to help and advise the company. Funds, on the other hand, need to return money to their investors, who are called limited partners.
Fund managers need to make money, first and foremost.
A good fund manager will look at investments as dispassionately as possible. This is one of the differences between angel investors and funds: angel investors might invest with their “hearts” more than their “heads.” Expect more rigorous and thorough due diligence with funds than angel investors.
Some funds can provide introductions to experts in virtually any field. These funds can open a lot of doors for you. They are making sure you have all the elements to succeed, and often they will help you find the pieces that are missing.
The size of the fund will tell you how much money they typically invest. Very large funds cannot spend the time to vet hundreds of small deals. They focus on relatively large investments at later stages of a company’s growth. Smaller funds, conversely, focus on earlier companies.
Even though you might feel desperate to take anyone’s money, finding the right investor can be extraordinarily valuable. The right investor can give you advice, open doors, and help you in ways you cannot imagine. The wrong investor might be aggravating, micromanaging, or not give you any help at all.
Plus: Funds are sophisticated and professional.
Minus: There may be much less flexibility if you do not perform well.