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Opinion

Stone & Chalk’s ultimate guide to funding startups: Part 1

- June 30, 2020 3 MIN READ
Not a preferred fundraising method for founders. Image: Breaking Bad
The last few months have demonstrated the kind of volatility we can’t exactly plan for, but for which we can and should prepare.

The impact of Covid-19 is multi-faceted, and a collective effort is called for to come out the other side. And there will be another side. In fact, right now, while many might face problems, there are also opportunities. Strong startups will survive.

As startups grow, gain recognition and commercialise, capital raising becomes a critical

component of success. The funding landscape is constantly changing and investment options are diversifying. Venture capital (VC) still dominates startup funding, but other methods like crowdfunding are gaining traction. 

Deciding what will work for your startup will depend on a balance between your business objectives and vision, your financial needs, and external and market pressures.

Today we are covering a few of the options available to startup founders seeking funding, giving a broad overview of bootstrapping, angel investors and personal networks. 

Tomorrow we will cover equity, debt and crowdfunding. 

 

Bootstrapping

Startups that ‘bootstrap’ start lean and grow without the help of external capital. Bootstrapping relies on a founder’s personal finances and the reinvestment of revenue back into business operations.

Common in the early stages for most startups, some choose this option ongoing as founders retain 100% ownership and control, and can focus on rapid idea generation and building the business without the pressure of meeting the milestones and demands of investors. 

Bootstrapping in some form is very common for startups. One in three startup founders have not raised external funding, and two in three have used personal finances to fund their business. 

However, without external capital, startups can’t scale as quickly which might jeopardise their market position. In the innovation space, the ‘first in’ can leverage a bigger market share

before competitors enter the market. It can also be difficult to grow, develop, iterate and expand unless the founder is independently able to fund marketing and acquisition activities.

 

Angel Investors 

Angel investors provide capital to startups in exchange for an equity stake during seed funding rounds. A typical angel investment is $25k-$100k in return for 5-15% in equity. 

Angel investors might be professional investors, business executives, or high net worth individuals looking for investments with a possibility for a high rate of return. They might be a successful entrepreneur with skills and experience in the same sector or field as your startup. 

As a result, in addition to financial investment, angel investors can offer intellectual and network capital, providing startups with expertise, mentorship, and growth opportunities.

Angel investors fill the gap between small-scale 3F funding and VC funding. They’re more willing to take risks than institutional investors and provide capital for early stage startups. However, they may require higher equity stakes in return, which represents ownership dilution for founders. Issuing convertible notes and SAFEs (simple agreement for future equity) is also becoming increasingly popular for angel investment.

As individual, unregulated operators, angel investors can be hard to find, unlike VC funds which are openly advertised and easy to research online. However as Angels are less restricted, they can write cheques quickly and without lengthy compliance and investment committee protocols.

Angel investors are investing post-COVID, albeit at a slowed rate and with smaller cheques – all the more reason to get your pitch in shape and get in early. Expectations will be high, competition will be fierce, and you may need to approach double the number of investors to get results. But persist.

Angel investors sometimes form a syndicate to share due diligence and risk across their investments. Syndicates allow individuals to pool funds for smaller investments and share skills and subject matter expertise between their member base.

 

Personal Networks 

Friends and family can be an important source of early, seed-stage capital to help get an idea off the ground. They’re a good, fast source of funds as they don’t necessarily require the formality of due diligence involved in commercial loans or investments. The associated risk gives the category its moniker, the 3Fs, with ‘fools’ added to ‘family and friends’ to indicate the potentially foolish nature of early investments. 

All parties need to be aware of the risks so that should your great idea fail, your relationships aren’t ruined. It’s important founders still apply a formal approach to confirm expectations and accountabilities. 

Before seeking funding, founders should know what kind of deal they want – whether equity or debt, what amount, interest rate or return – and it should be clearly included in your business plan. 

Startups should provide family and friend investors with at least a professional business plan as well as a SWOT (strengths, weaknesses, opportunities and threats) analysis.

Holding multiple meetings to explain the business proposition and negotiating terms gives potential investors time to think it over. We recommend following formal protocol and using clearly defined term sheets and investor agreements.

  • This is an edited extract of the Stone & Chalk capital raising guide for startup founders. 

 

The free guide is available here

NOW READ: Stone & Chalk’s ultimate guide to funding startups: Part 2