Startup Capital
What are the ways to find funding for your start-up?
How do you finance your startup business when you are thinking of a tech start-up? Even today there are several ways to find a capital investment for your tech startup. Inspite of all the problems with banks worldwide and all the bad messages about problems with business funding there are still several options available. Since you are (or will be) the owner of a high risk tech startup the bank will probably not be interested in lending you money for your plans. Far too risky for them! At the most, the bank allows you to maintain a small debt in your bank account but only up to a certain amount. So let's take a look at venture capital. But before stepping into detail about a venture capital investment you should realise that there are in fact a few important sources of a capital investment. These are introduced below.
Startup Business Financing with money from a Business Angel
Business Angels are people with a business background as well as (much) money at their disposal and they are willing to invest in projects they find interesting. These projects often have no turnover. Business Angels are also called informal investors. This is especially for the entrepreneur with new technology but no money a very interesting target group. It is very important to have good agreements with a Business Angel and also to capture them in a good contract
Startup Business Financing with Venture Capital
Venture Capitalists (VC) are professional investors who attract money from large parties (such as insurance companies) and they invest the capital in interesting (technology) companies. Of course they try to make a good returns for the money that the investing parties have made available. Usually they do not invest in projects or companies that are still in a very early stage of their development. Most VC's specialize in a particular sector, region or phase of the companies they invest. The money from the VC (the Fund) is managed by an investment manager who often is an experienced entrepreneur with a large and relevant business network.
Startup Business Financing with grants and loans from the government
Perhaps public financing may be a better option? Some governments have billions of dollars available for innovative developments in the form of grants and loans. This is particularly true for the development of new technology. Each of these programs have their own target audience, duration, amount of grant available per project, special conditions, etc.. Writing a good application is crucial for getting the grant.
Startup Business Financing with money from Family, Fools and Friends
Family and friends is a very obvious group of potential investors that it often is overlooked. Family can be your parents, brother and sister but also a distant cousin. With family and friends (even more than usual) it is very important to talk over the risks and the chances of success. This can prevent many problems when things go wrong.
How to find finance is one of the most frequently asked questions by individuals with an invention in a startup. Unless you have already enough money of course, but here we presume that you will have to find finance to be able to realise your ideas. Remember, any party interested in financing your project will have the idea that more money can be earned by investing in your business idea than when their money earns interest in a regular savings account of a bank. In this latter situation the risk is limited but the interest earned will also be limited. It is very important to realize that there are different types of money providers out there and their main distinctive feature is that they work with different risk profiles of the businesses they invest in. So, when you ask yourself "how to find finance", it is the trick to find an investor that fits your risk profile. Otherwise, you may put a lot of time in conversations of which you could know in advance that they would lead you to nothing. So, to begin with, we take a look at the supply side of money. What are the main type of money providers which can help you with the funding of your brilliant ideas? But before we do so there is one more important condition to take care of in the first place: the fouding of a startup company!
How to find finance for my startup?
In the financial world high risk means high return and low risk means low return. So investors who want to earn a lot of return on their investment are willing to be exposed to quite a lot of risk that they loose their money. Of course, also in these cases the investor seeks for ways to minimieze the risks. Therefore, a party which provides funding, whether it is a bank, an venture capital company, or a wealthy individual (a socalled business angel) always wants to know as precisely as possible where his money is spend on and how this fits into the complete picture of the project. Therefore, in order to succeed in finding finance for your project, business idea or invention it is crucial that you have a small business. This is a company with the sole purpose to further develop your ideas. So, it does not has the goal to employ thousands of people. On the contrary, very often such a small business even does not employ any staff at all, even not yourself as the owner. The main purpose of this small business is to shape your project into a manageable entity. So, when you ask yourself "how to find finance" your will have to ask yourself instead "how to find finance for my small startup company?
What if your tech startup is a high risk investment? Risk and Return are the number one keywords in the financial world. A high risk means a high return and low risk means a low return. This guiding principle of "High Risk, High Return" predominantly determines your chances of raising capital for your brilliant business idea. Someone will be interested in financing your startup business if he or she believes to get back more money than he puts in compared to what the expected return is when he puts his money in a regular bank account. Trust is the derivative of risk, i.e. trust that everything will work out in the end and the investor makes a nice profit. In this case even a high risk investment in your startup should be possible.
High risk investment as a sum of business risk and technological risk
If you - let's say - start a shoe store you will be exposed to certain business risk. It could be that your store is opened in the wrong neighbourhood or suddenly walking barefoot in public is cool and the market for shoes completely collapses. These are considered as "normal" business risks and a bank can deal with that. A bank knows how these risks should be estimated (based on your personal situation and your business plan) and will come up with a loan offer which is based on a certain interest rate. The interest rate depends mainly on the level of risk in the investment (other factors are e.g. the inflationary expectations). In other words: what are the chances that the bank will not get his money back (together, of course, with interest and profit)? As a rule, banks are always very selective when considering loans to a startup company.
However, when a startup company is based on an innovative technological product which is still to be developed it is a total different story. At first, it is far from certain that the company succeeds in developing the brilliant innovative idea into a product (the innovative concept was very attractive but the newly developed device just does not work .........). Secondly, the newly developed product has to prove that it can attract enough customers who want to pay money for it (there are numerous examples of amazing new devices that nobody wanted to buy). In other words, the investor has, in addition to the technological risks, also to deal with a totally different level of business risk. This accumulation of risks levels creates a risk and return game that is usually not acceptable for a bank. It is for this reason that in most cases the owners of innovative business ideas are dependant on other types of investors
Investors want to earn as money as possible with the lowest possible risk. This in itself is ok, because it is the same you want. Capital investment and risk reduction is the big game played and banks, business angels and investment companies are very good at it. So you will have to understand what risk and return means for you in this respect. In this way you can give your idea and, at the end, your personal earnings a fair chance.
Professional investors are the hardest test for an idea or project. Therefore focus on the investor and think as an investor. How do investors who are interested in financing your startup business want to reduce the risk of your tech startup? Even if you are convinced that you have enough funding to introduce your idea as a product on the market it is good to look at your project with they eyes of an investor. It is the best guarantee your can get that your start up company does still exist after five years.
Startup risk: How do investors want to reduce the risk of your startup?
An investor is not satisfied with a simple description of your business idea. He wants to know exactly how much money you will need each month of the investment period, how it will be spent and when you are going to make profit with your idea. Furthermore, he wants to know how much he will earn when he leaves the company or when the company is sold to another party (this is called the exit moment). Making profit on his investment is the main reason why any investor is interested in your idea. An investor will therefore make every effort to guarantee that the invested capital is fully repaid together with a good profit. Otherwise, he better takes another project to invest in. To be sure that the startup risk is reduced as much as possible an investor often demands that:
- One person in particular feels responsible for the project (the Director or CEO). He will earn a bonus (e.g. additional shares) when a predetermined milestone or a certain deal is achieved. Often a Director or some other Manager is delivered to the company together with the invested money. Take it or leave it. This experienced entrepreneur / manager will be sitting in your chair and decide what happens. The question is: will you accept this and if you do so, make sure that you can get along with this person if you want to survive in your own company.
- All key project team members have invested (some) personal money in the project and not only their spare time. This creates serious involvement because there are no free rides allowed.
- The invested money is really spent on the project. The money will be released in installments and only paid when a certain milestone has been achieved.
- The knowledge used in the project is solely owned by the company (or transferred to the company based on an exclusive license).
- Etc. What kind of conditions would You come up with before you would give one million of your hard-earned money to a nice guy that you do not really know with a very good good idea...???...., therefore,
- .......
- .......
In short, investors want to earn as much as possible with the lowest possible risk. There is nothing wrong with that because that is exactly what you want.... Therefore, the trick is to find an arrangment which makes you both feel comfortable.
In the financial annex of your business model or business plan you indicate how much capital you need to fund your startup. This is they easy part. But how do you raise this capital? Most likely, the bank will not be interested to invest in a risky technostarter business with some indistinct invention. This is due to your risk profile which is based on the sum of the business risk and the technological risk. In this case it is assumed that the inventor and owner of the startup has no capital available. So you have to approach the capital market. What do you mean by capital market? And where should you start? There is always hope. It is sometimes stated that on the capital market there is twice the money you need for every good businness idea.
The capital market: remarks on investers and banks
The required initial capital to start your startup with an invention comes from investors or from a bank. There is a fundamental difference between these two categories. An investor provides capital which will be owned by the company. He buys shares and thus he will be co-owner of the company. Therefore, being an investor means also being at risk. If all goes well and the company makes a lot of profit then he can earn a lot of money in return but if the adventure goes wrong not only your money but also the money of your investor is gone.
Banks, on the contrary, provide capital which is not converted to shares and therefore, the bank will not be a formal co-owner of your company. Banks do not like risk and they will always want their money back. For this reason they will always ask for a pledge to cover the risk. "Do you have a nice house, Sir?".
What do you mean by capital market?
Remember that the capital market, just like any other market, is ruled by the normal laws of supply and demand. To be successful in financing your business idea it is very important to analyze thoroughly the capital market Who are the players and what are they looking for? It is clear that you will only be able to raise enough money if you approach the right party with a convincing approach of your business idea. Furthermore, be aware that the process of searching and finding capital for your business idea can take many months.
Where to start? There are a number of factors to consider when you start your search for capital. These are:
- The type of your project or company. There are capital providers that invest only in certain types of projects and enterprises. For example in the IT sector or in the Life Sciences.
- The stage. Each project or company can be characterized by a certain stage of life. These are from the start: (a) the seed stage in which you only have the brilliant business idea, (b) the start-up stage, (c) the growth stage, and finally (d) the established stage. These stages are closely related to the risk profile. Investing in an early stage is much riskier for an investor that investing in a later stage.
- The amount of money you need.
In the early stages of your startup company you will probably not make any money because you do not sell anything. This development stage may extend to several years which is characteristic for many of these small startups. In this stage there is a lot of hard work going on to develop the technology, building prototypes and transfererring the idea to a product which is ready to enter the market. A good example of this kind of startup is a small pharmaceutical company that develops a new drug. It usually lasts more than ten years before a new drug enters the market. In most cases these companies do not plan to introduce the new drug on the market themselves but they are aiming at reaching a certain milestone (e.g. the new drug can cure mice) and then sell it to a big pharmaceutical company. To be continued
Many times people with an idea ask themselves: “How to find investors for my idea?” Just keep in mind that an investor will be interested in your idea if he thinks that there is a lot of money to be earned by investing in a startup company which is build around your idea. And that the risk for losing his money is not too high. For an investor risk is the top number one crucial thing! Therefore, if you seriously want to atract capital for the development of your idea you have to start thinking about risk and how to reduce the risk as much as possible. And that is exactly the purpose of a tech startup venture. Any investor who is interested in financing your startup business, whether he is a business angel or a representative of a venture capital firm, wants to know where he puts his money in and how it will be spent. He always wants to keep track of his money. This is why the development of a technology, to pursue market introduction, is mostly shaped into a startup venture. The purpose of this tech startup is not employing thousands of people. At the end it may lead to a huge technology company if you are very successful but for the time being the purpose of the tech startup is to shape your invention into a manageable entity in which you can attract enough venture capital to be able to give the development of your technology a boost.
How to find investors for an idea? Begin a tech startup with your idea
Why should you start a tech startup? A new idea shaped as a startup gives overview. A company is represented by someone who is responsible (a Director or CEO). It has an address and a bank account. The team members working on the technology are not unbound individuals anymore, but they are usually formally linked to the company as a shareholder. Giving them an an interest and an obligation ensures that they will not be able to withdraw from the project easily or spend the invested money on a nice car. Furthermore, if the technology company has done well and the value has increased tremendously it can be sold by the various shareholders a whole. In this case it is not necessary to work out separate deals with all persons involved in the project. Moreover, in practice the latter will never happen because this is not doable for an investor and in such a case he just will not be interested. Remember, that in most cases professional investors can choose from dozens of projects to invest in.
A patent in your tech startup
If there is a patent to protect the idea or the invention, the owner of the patent (many times this is the employer of one of the founding shareholders) has to transfer the patent to the tech startup. This is crucial. If the startup venture does not (or will not) own the exlusive right over the exploitation of the technnology and therefore is not free to use and commercialize the invention, investors will not be interested.
What is the definition of Seed Money? And what is Seed Capital? Seed money is an expression related to startup business financing. This is money that supports the development of your invention in the early stage of your startup. That may even be the project phase when there is, at that moment, no question of a startup. Seed capital is used to cover all research & development expenses associated with the project. In this stage it is of utmost importance to use the seed capital for improvement of your invention only. That is the only way to add value to your startup. In this R&D phase there is no cash earned but value will be created in the form of knowledge.
This first research and development phase of your startup is also called the seed stage. It is obvious that the person or persons who provided the seed capital are at high risk. Normally, this high risk will be expressed in the conditions that are associated with the capital provided. And in most cases the high risk will be translated in a high interest rate.
Seed money and Seed Capital
Seed financing is a common approach when people want to start a startup. Often, a single investor does not provide the total amount of seed capital that is needed for the startup. Instead, in most cases the seed capital is generated by a few individuals each providing a part of the seed capital. In this way the risk is reduced for every investing individual. This approach helps to minimize the risk for each investor and furthermore, the startup may buy some more time before the investors are beginning to grumble that it all takes so long before the company becomes established and begins to generate some revenues.
How is the seed capital repaid to the investors? This may be a simple arrangement in which the company repays the investor over time by an annual sum including an agreed portion of interest. It is also possible that, in return to the investment, the company offers a part of the shares. And of course combinations are also possible. The investors may be paid partly by cash and partly by shares.
Invest in your own startup!
In all these arrangements it is very important that you are willing to invest in your own startup. This is the most convincing way to show that you also believe in the project. When it is not obvious that you are prepared to put your money in your own project it will be much more difficult to attract money from investors. Therefore, make sure your own money is (or will be soon) in the project before you approach potential investors. Why is this? Well, try to imagine yourself in the position of the potential investor. Would you be eager to put your money at risk by giving it to a person with a great story but no money at risk? Putting own money in a project with a fair chance that it will be lost is far more convincing than many hours of lost sweat. I have experienced this myself one day when an interested investor said: so you have spent more a thousand hours in this project to get it going and it is amazing technology, but you are still alive so it did not hurt you.... Eeuuuh??..........Ouch........(!!)
What is Debt and Equity? More general terms as financing, finance, funding and investing are often used in the context of startup business financing. However, debt and equity indicate what are in fact two basic and different types of business financing. It is very important to be aware of the fundamental differences between these two types of financing: debt financing and equity financing.
Equity Financing
An investor, whether he is a business angel or a venture capitalist, provides money to invest in your startup company in exchange for ownership of a part of the company. This means he will become, as you are, a shareholder. The investor takes the risk that, if the company fails, he never sees his money back. But if the company is a huge success, he makes much greater return on the investment than the interest rates linked to a regular bank account. On another page of this website you can find more information about raising equity to finance a startup.
Debt Financing
In case of debt finance you borrow the money from the debt finance party, which is typically a bank, but there are other possibilities, and you agree that your will pay back the money in a specified amount of time and with an agreed interest rate. Be aware of the fact that your will have to pay back the money whether your startup company is a success or not. Debt financers do not like risk. It is their money and it will be their money and they want it back. Always! Therefore, a typical provider of debt finance, like a bank, always looks for a security: "do you have a nice house, Sir?". Eeeeuh, what do you mean? You can find more information about borrowing money to fund your new business venture on another page of this website.
