This is the first blog post in a series about the good, bad and ugly of startup fundraising. In this post, we provide an overview of what founders need to know before getting started.
Some of the world’s most successful companies were self-funded, or bootstrapped as it’s known in the startup scene. In the 1970s, Steve Jobs and Steve Wozniak started building computers in Jobs’ garage. To fund their venture, Jobs sold his car and Wozniak sold his calculator. More recently, in 2004 Mark Zuckerberg launched Facebook from his dorm room at Harvard University. Zuckerberg relied on college friends to provide the finance he needed to pay for servers to host the site.
However, both firms eventually sought external funding to grow and fulfil what turned out to be their significant potential. According to Crunchbase, Apple raised $80,000 in 1977, followed by another $150,000 the following year (from renowned venture capital firm Sequoia Capital). Peter Thiel, the Paypal founder, became Facebook’s first investor with an injection of $500,00 in 2004.
Most startups try to follow a similar trajectory. You reach a point when you need to take on external funding to continue growing. This is a major milestone on the startup fundraising journey, so we’ve put together a brief overview of the key decisions faced by founders.
TL;DR (in case you’re in a rush, here are the highlights):
- Most startups eventually need to raise funds to continue growing
- Factors to consider before you raise include the level of customer adoption and the scale of the opportunity
- Equity funding means giving away a share of your company, whereas debt funding works like a loan
- Sources of equity funding include venture capital, angels and crowdfunding, while revenue-based finance is a form of debt funding
- How much you aim to raise depends on your growth plans
When should you raise?
Prospective funders will want to see some evidence of progress, so here are a few questions to help you pick the right time to make your pitch.
- Do you have what’s known as a minimum viable product (MVP)? An MVP shows that you have established a problem that exists and your product or service delivers a solution
- Has your product or service gained traction? Ideally customers are paying for it but providing proof of adoption could be enough for some funders.
- Can you demonstrate the scale of the opportunity? One metric you can use is the total addressable market (TAM). The TAM indicates how much revenue you could generate if you sell to every customer in your target market.
With that said, don’t be put off if you start slowly. After all, a strong offering carves out a niche of its own, and an astute funder will recognise the potential.
What are your startup fundraising options?
Once you’re ready to raise, you can choose between equity funding, where you give away a stake in your company to an investor, or debt which is effectively a loan.
Here’s a quick breakdown on your options:
- Venture Capital (VC): VCs pool capital from institutional investors such as pension funds and wealthy individuals and then conduct rigorous research before investing in a startup. That means you hand over a share of your business, but as well as injecting finance, VCs also offer valuable expertise which can accelerate your startup’s growth.
- Angels: Like VCs, angels invest and receive equity in return, but they’re typically high net worth individuals managing their own wealth.
- Crowdfunding: Crowdfunding is a relatively new source of finance, but it has become popular thanks to sites like Kickstarter. Crowdfunding involves raising capital from a large number of investors in return for equity, debt or a reward such as early access. Some founders use it to launch a product or service.
- Revenue-based finance (RBF): RBF offers a way of securing funding without giving away equity. It works like a loan, with the repayments linked to your net revenue. Unlike a traditional lender, you don’t have to provide collateral and your repayments fall if you have a slow month, but the total amount you owe doesn’t change.
How much should you raise?
Your target depends on how you’ll use the money to help your startup grow.
One way of coming up with a figure is to work out the number of months of operations you’d like to fund. You can base that calculation on the salaries of your current team and any new hires you might add. As well as your operational costs, development budget and marketing spend. It makes sense to have several versions of the plan in case you end up raising less capital than anticipated.
If you’re considering taking on equity funding, think about how much of your startup you’re willing to sacrifice. Less is better from your perspective as a founder, but the investor’s valuation, not to mention your negotiation skills, will also influence the percentage.
When it comes to debt funding, the amount you can borrow will depend on your startup’s creditworthiness. Lenders rely on a broad range of criteria to make a decision, from your bank balance to metrics from recent marketing campaigns.
Remember to consider your runway – how long the capital raised will last before you need to consider funding again.
Check out the other blog posts in this series about startup fundraising.