The world of technology is fast-paced and exciting. Owning a business with unlimited scale and high growth potential is both a blessing and a curse. Here I look at the various capital raising options available to a startup, the experiences I have encountered and the lessons I have learnt along the way.
Let’s start very simply with valuation. Valuation is the monetary value of your company. Internally, company shareholders often agree on a formula to determine valuation in the event of a partner’s death or exit. When looking for venture or angel financing, your valuation is simply whatever you can convince investors to agree on. If you want to raise money for a start-up then you need to expect some hard work. Your business plan must be watertight, your powers of persuasion honed, and your contacts database well-mined.
1. The Bank – Your best friend… until they’re not
In the early stages of a start-up a bank manager is unlikely to be interested in a high-risk idea. Case in point, in 2001 a small digital agency I co-founded required a drawdown of $10,000 to cover any potential shortcomings over the Christmas period. Westpac Bank flatly rejected this request. Ironically, if we were students, the founders could have drawn down $5,000.00 each with no questions asked. Add the additional access to credit card debt and the available funds would have been close to $50,000! The outcome of this experience was to move to another bank, who supported us and continue to service several of the entities sixteen years later (now multimillion dollar businesses).
During the 2008 Global Financial Crisis I saw several of my friends’ businesses buckle and collapse as the banks adopted a change of heart and withdrew lines of credit overnight. Historically banks looked for low-risk loans meaning you needed to put your house on the line and even then, a change of economic climate could place additional strain on the relationship. A bank is not traditionally your first port of call for capital.
2. The Family Mafia – friends, family and contacts
A lot of start-ups avoid the bank and look to family and friends for funding, many of whom may or may not have business acumen. There are obvious benefits to this approach. Those who are close to an entrepreneur are unlikely to demand an extortionate rate of interest and may simply choose to invest in the proposition based on sentiment. Regardless it’s important to make sure that these loan deals are not loose in structure and that there is an expectation that the recipient repay the sum once the business has generated reasonable inflows and is able to make repayments.
My personal stance on this is don’t borrow from friends and family. You must think about the reality of losing a friend and, perhaps even worse, falling out with a family member if all doesn’t go to plan and you lose their money.
3. Angel Investors – better the devil you know?
Angel Investors are accredited individuals who invest their own wealth. They are often retired entrepreneurs who invest out of interest as much as financial return. I’m classified as an Angel Investor (although not retired). My personal approach is one of due diligence and an intimate understanding of the offering and opportunity before I invest. Hedgebook Pro is a specialist FinTech treasury management in the cloud solution. I embedded myself in the organisation for six months, learnt about foreign exchange management and met numerous clients and stakeholders. Some angels will be more active than others, however all will want to know that their money is being put to good use and the company is a sound investment.
The upside is angel investors are not constrained by regulations so you and the angel investor can develop your own investment model. Funds can move more quickly and freely through this partnership. These investors have their own money on the line so they want to see you and your business succeed. They often work as a mentor and may support your growing business in many ways beyond financial support.
The downside is that these investors often expect a large share of your business. You can expect to cough up between 10-50 per cent of your business as angels are looking for a high return to offset their high risk. Worst case scenario is the experienced angel may like your idea but not you and end up booting you out of your own company. So approach angel investments with your eyes wide open.
4. Crowdfunding – Two’s a company, three hundred is a crowd
As the name implies, crowdfunding is a model which combines a lot of small investments from many investors. This occurs over an online platform so the funders act individually and independently from each other.
The upside is since capital raised is a summation of lots of little investments the risk to any one individual is mitigated from the start. The reassurance of the crowd investment provides an added vote of confidence to you and your business. The downside is the interface is hands-off and will only provide financial support (could be considered an upside depending on who you are). You will give up commissions and/or equity to a potentially large crowd, so I advise taking only what you need. You can end up with many small investors with limited knowledge and high expectations.
It’s not uncommon to give up a small stake of equity and have many hundreds of investors which can be an administrative burden. I’ve been involved with both successful and failed crowdfunding initiatives. The key to a successful crowd funding capital raise is to have a strong offering and have secured a third of your funding prior to listing. There is a herd-like mentality and once a subscription gains momentum other investors’ fear of missing out (FOMO) so jump on board.
5. Venture Capital Funds (VCF) – they often look like vultures
Venture capital funds are businesses which make their income from successful investments. They are essentially the middle-man between large sources of capital (large businesses) and small innovative companies. You will typically engage with a venture after you have exhausted your friends/family and Angels. These are recognised as either A or B round capital raising.
The upside is venture capital funders can offer you valuable advice and support along with financial means. They are easier to track down than angel investors. They also have deep pockets and access to vast sums of capital.
The downside is the interface is more structured than the likes of angel investors as the venture capital funders are investing on behalf of others so the funding can be more logistical and take more time. The investment model can also be aggressive. Failing to meet documented Key Performance Indicators (KPIs) can result in dilution and loss of control. While the relationship between a VCF and you are symbiotic, ultimately the VCF has its own interests at heart and will act accordingly and often aggressively.
6. Corporate Venture Capital – they often look like really big vultures
Corporate Venture Capital is the practice of established corporations investing in start-up businesses. These investments are generally made with the intention of financial return and/or mutualistic investments in start-ups who may be of benefit to the corporate’s field of work.
The upside is when the association is mutualistic you’ve already got a buyer and more financial security than going alone.
The downside is they’re big, you’re small. You’ll need to keep an eye on your vision (and your equity stake)… and your back.
Accelerators provide start-ups with development resources including workspaces, networking opportunities and various degrees of business mentoring. Accelerators invest time and money in the start-ups, in return for equity in the company. They’re like a womb for startup businesses, with the exception they often serve beer and wine on a Friday.
The upside is that admission into an accelerator program indicates that they believe in your business and they’re going to help you get it off the ground. Once you’re in, you’re far more likely to succeed. You can also specifically target a genre or niche that is relevant to you and work with like-minded businesses and potential buyers of your business. For example, in the FinTech community, Barclays Bank is considered a leader with global outreach via Think Rise.
The downside is loss of equity.
In conclusion, all the above scenarios require the giving up of control. Whether it’s financial, ownership or governance. The first question to ask is, “am I happy giving up control?”. If the answer is no, a boot-strap model of self-funding out of growth may be more palatable. This may ultimately mean owning a big slice of a little company rather than a little slice of a big company. Understanding how big a slice you want is the first step to success when raising capital.
By Graham Dockrill
Graham is an entrepreneur with a passion for start-ups, especially in the FinTech sector. Having established several successful businesses of his own in New Zealand, the United States and United Kingdom, Graham works alongside start-ups and businesses wishing to grow or move into new markets.
He is currently the President of Sales for Citrus Tree Consultants, a global business consultancy and President of Client Relations at WhosOnLocation, a visitor management software startup based in Wellington with global clients. Graham is also a strategy and client relationship advisor for many startups in New York and the United Kingdom.