Raising the money needed to fund a startup is one of the most complex processes faced by any entrepreneur. The process varies by industry, investor, and individual company, and securing funding is crucial for any business owner to get right. Without capital, an idea is just an idea.
With extensive experience working with new entrepreneurs and investing in budding companies, the owner of Dubai-based venture capital firm Dale Ventures is in a unique position to provide invaluable advice to anyone looking to turn a dream into a reality. Dale W. Wood, both founder and CEO of Dale Ventures, says there are several different funding sources available to those looking to get their business on the ground.
For early seed funding, for example, it is common for founders to approach friends and family asking for help. Usually, venture capitalists get involved after a business launches its product and gathers traction in the market, but there are always exceptions to the rule.
Here, Dale W. Wood breaks down eight common funding types for startups: bootstrapping, friends and family, incubators, exclusive enterprise customers, business loans, angel investors, crowdfunding, and venture capital firms. As an expert in the venture capital ecosystem, Wood uses his own experience vetting pitches and mentoring business owners to explain how startup founders can target the right type of funding and raise invaluable capital.
Bootstrapping
Bootstrapping is a term used in the tech startup space. It signifies a self-funded startup. The advantage of bootstrapping is that it shows future prospective investors that a founder is confident in their idea, and willing to risk their own wellbeing to ensure the company’s growth. It also means a larger piece of the company’s equity will remain with the founder, even after future funding rounds.
Friends and family
This option is rife with pitfalls and the potential for soured relationships. While entrepreneurs raising money from their network of friends and family is not a new concept, its a trend that is becoming less and less common.
In the United States, investment by close friends and family members funded 22% of startups in 2020, down from 38% in 2013. The average amount of money startups raise from friends and family is between $10,000 and $50,000.
Startup incubators
Most large cities have startup incubators or accelerators that exist solely to boost the growth potential of early-stage startups by providing basic infrastructure like a workspace, internet facilities, and more. Incubators may also equip startups by training employees or offering pre-seed or seed funding. In return, incubators get equity in many startups while promoting the local business ecosystem.
Exclusive enterprise customers
One of the easiest ways for an entrepreneur to fund their startups is to convince a big enterprise player that the software or service their company offers is valuable. Large companies may commit to funding startups in exchange for exclusive rights to the product and customization to match their specific requirements. While locking in an enterprise-level customer is one of the safest forms of funding for entrepreneurs, it is a highly remote prospect.
Business loans
Taking out business loans to fund startups is a risky option for entrepreneurs, and it isn’t easy. Because startups have few assets to provide as collateral, it can be next to impossible for a founder to get a small business loan in the early stages.
On the potential upside, small business loans do allow founders to ensure they retain full ownership and control of their startup. In addition, there may also be government-backed loan guarantee models, like Federal SBA-backed loans in the United States, to help startups get credit quickly despite a lack of assets.
Angel investors
Angel Investors are high-net-worth individuals who have usually been entrepreneurs themselves. They invest in the early stages of a company, in seed or Series A rounds. Angel investors tend to want considerable equity in the company they fund and take a hands-on approach, bringing deep industry expertise. To reduce risk, several angel investors might band together to spread their investment across companies, with an average combined deal size of $200,000 to $400,000.
Crowdfunding
Crowdfunding for startups, a.k.a. regulation crowdfunding, lets entrepreneurs raise capital in exchange for company equity by sourcing funding from many people over the internet.
Buying and selling securities, like equity in a company, is regulated by government entities and these regulations vary by country. This is different from traditional crowdfunding, where the odds of raising enough capital to fund a startup are remote. Regulation crowdfunding is much more effective, even though it is highly regulated.
In the United States, startups raised more than $310 million in 2020 using regulation crowdfunding.
Venture capital
Venture capital is one of the more traditional sources of funding for startups. VCs, or venture capitalists, invest in companies or industries with the potential for rapid growth. In exchange for money, the investors take equity stakes in the company. The VC also often brings expertise and a network of professional connections to the table.
The VC ecosystem works by spreading out risks across several high-potential prospects who do not have access to traditional sources of credit. The VC aims to help the company through the adolescent growth phase until a successful exit. The exit can be either an IPO or an accusation, ensuring the VC turns a profit on the initial investment.
Venture capitalists invest in a company across its lifecycle, with subsequent funding rounds also standard. However, it is common for VCs to invest in companies that have already launched products and generated some market traction.
So, which type of funding is best?
The answer to this question depends on the specific situation that the startup faces. While crowdfunding is undoubtedly an innovative option that seems easier to secure, it might not be the best option for every industry.
And while venture capital funding may be harder to close on, and may come with strings attached, a VC also brings deep business expertise, a vast network of connections, and many more resources to the table.
In the end, it is up to a startups founder to research the best source of funding based on industry type, market conditions, and potential for return. From there, entrepreneurs can pitch their ideas to potential investors with more know-how than your average bear.