How to Finance Your Startup

Categories: Business |

How to Finance Your Startup

This is not a guide on how to get rich, but rather an outline of the multiple options of getting financial support for somebody who has an innovative idea and wants to commercialize it. There are several startups that have transformed into “unicorns”, the private tech firms valued at more than US$1 billion without being listed on the stock market, like Uber, Dropbox, Instagram, Pinterest, MongoDB, and Airbnb. So why can’t your idea grow just as impressively?

To finance your innovative idea you’ll probably first use your own savings or even your credit card – in other words, you’ll “bootstrap” your business. Bootstrapping has for many years been the only financing for many companies, like MailChimp, Airbnb or Bullhorn (and Belatrix as well). Building your company with existing resources and earned revenue is a controlled and low-risk form of growth, but at the same time you might lose market opportunities and face challenges in achieving faster growth. For this, external funding is often needed.

First of all, you have to be really passionate about your idea and convinced that it will be profitable, because you’ll have to convince a skeptical investor to put money in your project and show them a return on investment. Once you receive the money, you will be under pressure to deliver your product/service to the market quickly. Of course, this involves risk and failure is possible. That’s why an investor expects special compensation. Additionally, in many cases in exchange for backing you, you’ll have to share ownership of your company.

At a high level the principal sources of primary funding for an entrepreneur are:

  1. Family and friends – who are emotionally related and may be easy to convince, but there is of course a risk of breaking a good relationship when something goes wrong and you might not be able to return the money.
  2. Bank loan – usually not accessible for an entrepreneur and, even if it is, it’s typically costly and tough to secure.
  3. Incentive programs – offered by governmental organizations, but usually these financial supports are full of requirements that are difficult to fulfil. But in any case, make sure to check out the incentive programs in your country or region.
  4. Seed accelerators or incubators (aka startup hubs) in this category we can find both: private companies or mixed entities related to universities or governmental organizations. Initially they only offered a physical environment for startups (offices) or professional services (mentoring, legal, accounting) at a low cost as they were being shared. But now, they offer seed funding as well. Y Combinator is the best example of the new model of backing an early stage startup. Entrepreneurs can apply with their idea and twice a year the company selects a large number of the best projects and invests a small sum to support those teams during a 3 month stay in the Bay Area. Here they polish their proposals with the help of experts, before the final presentation to investors at the Demo Day. This successful model of incubator has been followed by other seed accelerators, such as: TechStars, Excelerate, 500 Startups, and Capital Factory. This backing looks similar to financial aid in college, but the incubators take in exchange a small amount of equity of the new company.
  5. Crowdfunding – this is a new way of backing creative ideas at a relatively low cost, which relies on leveraging the global community from the Internet. There are some sites that connect an idea generator with many small private investors. The most well-known is Kickstarter.com that has funded tens of thousands of projects, from rock albums to documentary films, with a reasonable failure rate at 9%. Kickstarter’s backers usually support a single idea project with a limited time period, so it’s not an option for long term investing. There is a type of crowdfunding, called the reward-based one, which consists of pre-selling a final product or service, as a reward for the investment. Some other crowdfunding sites are: GoFundMe, Crowdfunder, RocketHub, appbackr.
  6. Angel Investors – these are in general private investors who offer their capital for early stage, small investments, also called seed funding. In return they receive a percentage of equities. It’s important to say that angel investors are usually veteran entrepreneurs or successful professionals, who apart from financial support, offer knowledge and experience by mentoring and helping you succeed.
  7. Venture Capital –these are firms that specialize in financing new ventures. They invest funds on a professional basis; it means they support established startups with a certain revenue level. VC firms, by receiving ownership in exchange for funding, strictly monitor the venture and its management team. As they are typically focused on specific industries, VC firms can provide useful expertise in areas such as legal or marketing, areas often overlooked by startups. Given the high risk of failure, venture capitalists are mostly interested in startups with high growth potential, that will give them higher than average returns to compensate for the risk.

This is a very brief overview of some of the most important sources of financing available to an entrepreneur. However, access to different forms of finance is not the same in every country, particularly with regard to angel investors and VC firms. For example, in Argentina – which has one of the strongest entrepreneurial communities in Latin America, the VC market is still at an early stage of maturity. There are only a few VC firms (like Quasar Ventures, Kaszek Ventures, AxVentures), so for Argentine entrepreneurs it can be harder to access capital than it is in other regions.

Finally, I’d like to mention support from institutions like Endeavor, which through a global network of mentors and business leaders, provide entrepreneurs with guidance, resources, and mentorship (but not funding). Such a network provides entrepreneurs with a strong environment to increase their chances of success. After all, money is not the only thing that will lead to your success.

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