If you are a startup, how do you find money? The other day when I spoke to a class at Chicago Booth we discussed it. The class listed a bunch of the sources, and the pluses and minuses of each source. I will list the ones we talked about, and hopefully in the comments people can list more advantages and disadvantages of raising that sort of capital. I want to be clear, I am generalizing.
1. Friends and Family
Pluses: You know them! Easy to find. They love you, so sometimes raising the money is easier. Terms usually aren’t severe. Not a lot of due diligence.
Minuses: If you fail, family gatherings could get uncomfortable. Because it’s family, often times they think they are entitled to meddle or fix problems. Sometimes the terms they set totally mess up the company going forward. One example might be too high of a valuation. Unless you were born with a silver spoon in your mouth, the capital will run out quickly. Your family might get diluted down hard in future rounds.
2. Government Grants
The US government has several programs to give money to businesses. Generally, I am not a fan of this and would prefer the government gave tax breaks to individuals to invest.
Pluses: Non-dilutive. It’s “free” money.
Minuses: The money isn’t really free since the government paperwork, process and the criteria that are set up are a challenge to get through. The amount of money that the company can raise is usually not enough to get it to sustainability.
3. Bank Loans
Dodd-Frank has put a huge crimp in bank lending because of accounting for risk. It’s killed community banking in the US and made access to capital for small business scarce.
Pluses: Capital is non-dilutive to the equity cap table.
Minuses: Banks almost never lend to a startup, even if they say they are targeting startups. Banks don’t like risk, and will only lend if you have proven cash flow, and have been in business for awhile. The business will have to pledge assets against the loan as collateral. The other problem with debt is the business has to pay it back. If unable to pay the loan back, debt is the sword that will kill your startup.
4. SBIR Grants
Pluses: Non-dilutive. Most medical companies utilize SBIR grants to prove concepts.
Minus: Road to get them is long. Often, the company needs to use a service to help them through the process. In Chicago, iBio/Propel does an excellent job of helping companies get through all the hoops.
5. College Entrepreneurship Programs
CEP’s can be great. The Polsky Center at the University of Chicago Booth should be copied by everyone. But, done wrong they can put startups through unnecessary paces they don’t need to do. Some colleges have small startup funds that will give startups some capital to get to seed stage. I encourage all college students to get active with an entrepreneurship program at their school, especially if they aren’t technical. You will be surprised what you will learn, where your mind goes, and how valuable your skills might be to a company.
Pluses: Often times non-dilutive. Often times it comes with membership, and a place to work.
Minus: Have to be in college to get it! Money isn’t enough to get company to sustainability.
Some incubators, like Tech Stars and Ycombinator are harder to get into than the most competitive schools. There are good incubators out there that aren’t TS or YC. But, you should ask them for their outcomes. You should also interview companies that went through the process to get feedback.
Pluses: Credibility. Mentorship. Focus. Access to the ability to raise capital. Sometimes a space to work with other startups that create support and learning
Minuses: Dilutive capital. Sometimes the time in the incubator doesn’t bring value. Check sizes from incubator not very large. Mentors don’t follow up with company post accelerator.
7. Working Spaces
This is small, and rare. But, they exist. In Chicago we have Catapult.
Pluses: Company gets an office or space to build from. They often get mentorship, and some value added services to help them. Being in a space with other startups helps them learn, and gives them a support network.
Minuses: Often, equity is exchanged for the space and mentorship. The money is never enough to get the company to scale.
8. Individual Angels
Pluses: If they have a network, they can help you. Often times write larger checks. Sometimes angels aren’t looking for a massive return like a VC fund.
Minuses: Can be very hard to get in front of. Can take a lot of time to make a decision, or won’t make a decision. No network, becomes commodity money and they can meddle. Often times they will pull the trigger to sell the company too fast to pull risk off the table. Sometimes they won’t write a follow on round check so money can be inconsistent.
9. Formal Angel Groups
The Angel Capital Association has a list of members on their website. They can be awesome places to go for capital to build a startup. Angels invest almost as much each year in startups as VC does.
Pluses: Access to a huge network and body of knowledge. Stamp of approval if the group has a good brand. Check sizes can be large. The angel diligence process should be good for the company and get it ready for VC funding.
Minuses: Can be bureaucratic. A lot of time, and not a big check(Hint, ask them their typical check size and then ask entrepreneurs). Only invest once and don’t support the company post funding. Hard for angel groups to lead deals and set terms. Different angel groups can have different goals creating problems. Some groups do a lot of deals,(like HPA) some don’t.
I am a big fan of crowdsourcing. I wish the SEC would open it up to every single person in America. As a person who started one of the most active angel groups in the country, crowdsourcing makes angel groups raise their game. If all you need is commodity money and can do it on a platform, try it. It’s also a good place to top off a round when you have momentum and some name investors.
Pluses: Can access a huge group of investors online, and in one spot. Scaled up capital raising. Usually terms are not severe. Great to prove concepts out, especially consumer products and devices.
Minuses: Messy cap table. No value for the capital given. If you don’t have the “right” investors, impossible to fill up a round.
11. Private Venture Capital Funds
Pluses: Bigger checks. Public stamp of approval. Mentorship. Knowledge. Access to employees and networks. Credibility can make it easier to get customers. They generally stand behind their companies, so next round funding is a little easier. They have funding networks, and can organize future rounds-and help with exits. Due diligence should teach you about your company and make you better. VCs swing for the fences.
Minuses: VC can get rid of the CEO. They have their own cadre of management personnel they like to deploy. Terms can be tough, dilutive, and freeze out other investors. They only write a few checks a year, so getting one can be difficult. Can dominate board rooms and worry about their value rather than shareholder value even though they have a fiduciary responsibility to company first. VC firms can be hard to get in front of, and generally it takes a warm introduction. They might not want to sell when you want to sell because they are chasing return.
12. Corporate Venture Capital
This is getting more and more popular. One reason is IPO’s don’t happen as often, so corporations are trying to get into the private market to find firms. Another is corporate balance sheets are flush with cash and corporations have to deploy it to get ROA.
Pluses: Expertise, access to customers, access to mentors. Nice check sizes.
Minuses: The parent company could go through a downturn and VC funding could get cut. Company might not be committed to VC. VC might integrate company before it reaches full potential valuation, cutting payday for founders. VC might steal some startup DNA. Diligence can be sloppy and bureaucratic.
13. Company cash flow (Sales to Customers)
Plus: Don’t give up equity or control. Bootstrapping forces company to stay lean. It can be very good for culture because company is self-reliant.
Minuses: Firm might get too conservative. Firm runs the risk of not focusing on scaling and becomes a lifestyle/consulting type business. Firm might not scale fast and lose out on opportunities.
Some companies have bootstrapped and then had initial customers as investors. Gradebeam was a company I invested in that did that successfully.
Plus: Product/Market fit can be easier to find. Customers understand the value proposition and pain point. They know you.
Minus: Company risks building a product for one or two customers. Product then doesn’t scale to the rest of the market. Company becomes a consultant/lifestyle business. Product can get over featured as customers sometimes don’t know future of the market and can’t anticipate it-they are focused on hear and now.
There may be more. But I think this summarizes it pretty well. When you are fundraising, be persistent. Don’t wait for introductions if you can’t get them. You will have to network. Don’t play the victim card. Fundraising is hard work, takes time away from the business and is a royal pain in the ass. 99% of the time, you will get rejected.