There is a myth about great ideas. It is the fallacy that a winning idea simply sells itself to investors and lenders without too much effort.
But what actually matters most is a founder’s ability to take an idea and mould it into a value proposition that is compelling to parties who have capital to loan, invest or give. Funding can be a tough nut to crack.
When founders have a solid proposition and turned their idea into a viable business, there are a number of different funding options, all of which have their merits and drawbacks. The best option for a startup will depend on a number of factors such as the stage of the business, if the business is generating revenue and the founders’ own strategy for the business.
Here are eight options that can provide founders with the funding to grow their business.
Competition is often fierce but for startups able to access some of the local, state and federal government grants made available to Australian startups, this can be a game changer. Grants have the advantage of being non-dilutive for the founders’ equity position, but they may require matched funding from other sources. Knowing another investor is on board, acts as validation for the government.
In this non-dilutive funding model, early supporters of the business pay in advance for the product.
This option tends to favour startups with an innovative physical product that is easy to understand and has a clear use case. The customer is giving the founder money in advance to help build or create the product.
Websites such as Indiegogo and Kickstarter are helping startups sell innovative products prior to production.
With interest rates at historic lows, bank loans are an attractive, non-dilutive option many startups are considering.
This is not a financing solution for startups at the pre-revenue stage as loans typically require cash flow so that the loan can be repaid.
Founders provide all the resources to get the idea of the ground and this is done in a lean way with no outside capital.
This includes founders’ own money as well as their expertise, time and a huge amount of effort. Those who bootstrap a business will almost always have a majority equity stake.
Angel investors often fill the gap between small scale investing by friends and family and larger venture capitalist investors.
Angel investors are typically individuals who have spare cash available, usually investing in rounds sizes of between $25,000 and $500,000, and are looking to take an equity stake in the startup.
Equity crowdfunding platforms such as Equitise, OnMarket and VentureCrowd give everyday investors such as mums and dads the opportunity to invest in startups in return for small amounts of equity.
Startups must have an annual turnover or assets of less than $25 million and can raise a maximum of $5 million annually.
A venture capitalist (VC) invests in high-growth, scalable startups in exchange for an equity stake. VC investors typically have closed end funds and raise money from sources such as high net worth investors and superannuation funds.
These funds are pooled and invested in a portfolio of startups with an expected investment horizon of around seven to 10 years. At this time the VC investor will be looking for a liquidity event such as the startup listing on the ASX or being acquired by another business to return their investment.
Venture debt is a short-term loan of between one to three years that provides additional capital to support investment into pivotal functions needed to achieve the growth strategy.
Venture debt is often used for the purchase of equipment, hiring or acquisitions at incremental periods between equity funding rounds or when the capital required is too small for an equity funding round.
Often venture debt providers will also want an option on equity or a warrant that gives them exposure to the startup’s success. It is usually a very small percentage compared to that enjoyed by equity holders.
Deciding which funding source to pursue requires careful consideration. For some founders, preserving equity in the early stages is a priority and they may instead take a loan from friends and family instead of their bank. It is also possible for founders to choose a combination of funding options to gain access to the non-financial support that an angel or VC can provide. This could include leveraging investor networks for advice and accessing their contacts as potential customers.
Founders also need to consider what success looks like for them personally. This might be rapid growth and a quick exit, or alternatively they be looking at their startup as a long-term venture. There is no such thing as a superior funding model and one size certainly doesn’t fit all startups.
- Benjamin Chong is a partner at venture capital firm Right Click Capital, investors in bold and visionary tech founders.