A Beginner’s Guide to Funding a Startup
You’ve got that brilliant idea, and now you’re ready to go out there and take the day! You’re ready to bring it, and make your idea into the largest, meanest startup that’s ever existed.
You may even have taken some of the first steps in hashing out your baby business—maybe you’ve chosen the right business model, locked down a co-founder, and drawn up a goal pyramid to outline your first steps.
But there’s that one big hitch—your brilliant idea has no funding to back it up. Not only that, you don’t even have a clue as to where to start. It seems like every entrepreneur you hear about has some kind of connection, some friend of a friend, or the kind of entrepreneurial network that provides the opportunity to wander into an elevator with a hotshot investor. But not all of us have the chance to hobnob at Bay Area mixers with Evan Williams.
So what do the rest of us do? Dreams destroyed? Stuck at a corporate job forever? Don’t give up quite yet.
A lack of funding is a serious issue for many entrepreneurs, and it is a major reason why many businesses never even get off the ground. Plenty of would-be business owners have the drive and passion, but not the dollars and sense to bring these into reality.
In fact, this is one of the most common challenges that people in the Foundr community run into. When we’ve asked readers what stage they’re in as entrepreneurs, a large number of them say they’re in need of funding to either get started or take things to the next level. So you’re not alone by a longshot.
And clearly some entrepreneurs do get funded. After all, this is the golden age of entrepreneurship! So how do they do it, anyway? That’s what this blog post will reveal: 6 ways to get your startup funded.
If you’re just not sure where to begin, and always wanted to see a clear-cut menu of funding options out there in this magical modern world of startups, this post is for you.
The Basic Categories of Funding
There are two models of funding that exist: that which costs you equity, and that which costs you debt. There is a third, grants and gifts, but this is less common for profit-seeking businesses.
Grants are much more common for endeavors like charities, nonprofits, or social enterprises. Don’t be envious, though, even for those entities, it’s hard work to get a foot in the door with a grantmaker, and often funds often come with stringent requirements and oversight. As far as gifts go, well, here’s hoping a bag of money lands on your doorstep.
Debt, a form of funding so many of us are familiar with, unfortunately, is money that you are obligated to pay back with interest over an agreed upon time period. This can be in the form of a bank loan or just racking up a bunch of money on credit cards. The latter is probably the easiest and fastest way to scare up some money, but there’s a reason—it’s a bad idea! Rates are usually terrible and if you don’t have a lot of cash flow, you can end up saddled with that burden for years. Small business loans are one traditional avenue for funding, but they are often restricted to people with existing cash flow or some kind of collateral to put up.
Equity, on the other hand, means pieces of ownership in your business offered up at market value in exchange for money. This is what investors will typically deal in. Clearly, to offer equity to an investor, you need to have some perceived value or proof of concept to instill confidence. If you’ve ever watched the show Shark Tank, this will be familiar to you, as the sharks will often haggle over what kind of stake they get in exchange for the money they’re going to sink into the business.
Entrepreneurs tend to want to reduce the amount of equity they give away, because this means lower profits for them in the future. This can also be risky, because if more than half of a company’s equity is sold, that means a potential loss of control.
Now, how do you get your entrepreneurial paws on this cash? On to the juicy bits:
Six Ways to Land Funding for Your Startup
1. Bootstrap as long as you can
I know that’s not what you wanted to hear, nor is it quite on point with the purpose of this article. Technically, this isn’t really a source of funding. You’re just paying for it yourself with your hard-earned cash, minimizing expenses such that you can still cover bills.
But this hard medicine is what you need to accept when it comes to funding: It will be many times harder to convince someone, anyone, to take a chance with their money on your idea if you haven’t done the same first.
That means working on your project as a side-hustle, self-funding it as much as possible, and burning the midnight oil to cover labor yourself. Or, that might mean saving up enough money so you can have a few months of runway, building out the basis for your idea before seeking out external funding.
A lot of people swear by bootstrapping, and for good reason. In fact, Foundr itself was a bootstrapped business run by our CEO, who moonlighted in the early days and gradually scaled up the business over time. This can be extremely gratifying, like building something with your bare hands. And it’s great for first-time entrepreneurs, because it proves you can hack it, making it easier to land funds as you launch future businesses.
This is not to say you can’t seek funding after you’ve bootstrapped. As Chris Strode of Invoice2go once told Foundr:
What I’d tell…every other early entrepreneur out there, is to bootstrap your startup for as long as possible. Founders are often eager to raise funding and take their businesses to the next level, but if you can build a profitable business on your own, you’ll be better positioned to have a favorable conversation with VCs when the time is right. Focus on getting your product right where you want it for your users, and grow it from there.
This method is advantageous in that it lets you grow an audience and a user base that will serve as awesome validation, and possibly even lead to revenue or profit before you seek out additional funding. And, of course, you get to keep all of the equity.
2. Your family and friends
A great piece of business advice is to start with your inner circle and branch out when it comes to selling your business. What does this mean? Start seeking funding for your business from family and friends.
I know, this might send chills down some of your spines. And depending on your relationships with certain friends and family, it’s clearly not an option for everyone. But the important thing here is to take stock of your existing network of support. So often, entrepreneurs try to build something utterly from scratch, as if they have to concoct success within a vacuum. When the fact is, most of us have a lifetime of connections all around us, many of whom may very well have tremendous confidence in us, and even may be part of our target audience.
Although these people may not have the most bucks to throw your way, the money they are able to support you with may come with many advantages:
- Those close to you are much more likely to take a chance on you and your idea in good faith, and lend you money at a low interest rate or even no interest rate, or may ask for a lower amount of equity.
- Money coming from people you know makes you much more committed to success and providing a good return for their money.
- There is a better chance that your friends and family will stay at a supportive distance instead of breathing hungrily down your neck like some investors might.
The thing to remember here is that you’re not looking for a handout. Rather, it’s a kind of partnership with a like-minded person you have an existing connection with. If that person or multiple people truly believe in you and your business, they’ll be excited to get on board, and you couldn’t ask for a better backer than that. And if they’d use your product or service themselves, you’ve also got a potential test market and early adopter rolled up in one.
At the end of the day, though, this is a very personal decision that needs to be taken very seriously. Some of the best startups in the world resulted from friendships, as did some classic disasters. Tread cautiously.
But if the issue is that you’re simply embarrassed to ask your family and friends to back your startup, then maybe it’s time to rethink your business idea. If you’re shy about going to people who know and love you, then it’s not going to be any easier approaching investors.
3. Crowdfunding platforms
Crowdfunding has rapidly become a premier way for entrepreneurs to get their startups funded. Since platforms like Kickstarter and Indiegogo came on the scene, it has cracked open virtually infinite possibilities for companies to get started.
Long story short, crowdfunding involves getting a large group of people to back your company with relatively small amounts of money each. These backers will not always get a say in how your business is operated, depending on the platform, and they collectively share a relatively small risk each, because together they enthusiastically want the project in question to exist.
Even veteran investors like Shark Tank star Barbara Corcoran told Foundr she’s been blown away by the potential of crowdfunding:
The access to capital isn’t at your local bank—it’s online. I would say that at least 40 percent of all the entrepreneurs we met on Shark Tank had already raised a lot of money online through crowdfunding. You can teach yourself how. Analyze successful campaigns. Figure out what works.
This funding model can not only be used to gather up some initial funding, but can be used for subsequent fundraising for future products and services. Just for one example, chosen completely at random, there’s our first print publication, Founder Version 1.0, which we funded with our first Kickstarter campaign. It went great!
Crowdfunding is a great way to land some cash, but it’s not for the faint of heart. It’s both art and science, and now that it’s such a widespread practice, it takes some real work and even investment of its own to build up and execute a successful campaign.
4. Getting a government grant or loan
This is an often overlooked way to get your startup funded.
Many people don’t know that their government is probably offering convenient loans or full-on grants for the aspiring entrepreneurs in their midst. Because new businesses are a large source of economic growth in industrialized economies, governments have it in their best interests to support the individuals looking to throw their chip into the ring.
If you are young (say, under 35 years old), or if you are creating a new business in science or technology especially, you’ll have a decent shot at landing some funding. What’s more, governments at various levels tend to have their own individual loans available. To find this funding, search at the city, province/state and federal levels.
For example, I live in Toronto, Ontario, Canada, and here’s what a casual Google search was able to unearth for Toronto:
Just look for the keyword “entrepreneurship grants” or “entrepreneurship loans” plus the name of your city/province/country, then deal with the next challenges of applying. If you’re in the United States, a great place to start looking is Grants.gov, which is a searchable directory of more than 1,000 federal grant programs. The process is long, but it doesn’t cost you any equity and the loan terms are usually exceedingly favorable compared to a bank.
Now we’re getting into the fast lane. If you are looking for much more than a simple bit of money tossed your way, accelerators are a great option to consider.
Accelerators focus on supercharging early-stage business growth by providing short programs (usually 2-4 months long). They will take applications, dole out funding to those that pass in exchange for equity, plus usually welcome you, your business and your small team (if you have one) into their program.
The program will often feature an enticing mixture of mentorship and office space. These programs are usually grueling affairs, but if you are looking to speed up a stage in your business growth, these are the best option. One of the defining factors is their short-term timeframes (incubators, by contrast tend to last a few years), often culminating in a big presentation session, or “demo day.”
These accelerators also tend to present startups with great opportunities to network with other startups and mentors in the business world. In fact, it’s worth noting that accelerators are often much more focused on developing the entrepreneurs or founding teams themselves than a business’s idea.
Applications for accelerators tend to be very competitive, especially for “elite” accelerators such as TechStars and Y Combinator. These two accept only between 1% to 3% of their applicants.
But there are actually quite a few of them, something like 200, and more are always starting. Most of the top accelerators are based in California, including Alchemist, AngelPad, and 500 Startups. But not all of them, and TechStars actually runs 20 programs all over the country. Sometimes they’re broad, others are industry-focused.
To see the latest assessment of the startup accelerator landscape, check out this research project’s rankings.
Before diving into the intricacies of how they operate, let’s look at the basic definition of an investor.
An investor is a (usually) wealthy person or person who otherwise has control over some pool of assets, who invests money into a project in exchange for shares, which means they are not neutral actors in your business. Investors will have expectations that you use the money in frugal and wise ways, such as for expanding market share through marketing, and not wasting funds on unnecessary expenditures. Second of all, investors by definition expect a return on their investments within a certain period—this return is often a 10x return within up to 5 years. This usually occurs either when your company goes “public” or is sold off.
These expectations can make dealing with investors difficult and stressful. The emphasis will often be placed on growth, and pressure to expand your business asset will be coming from outside you and your team. Still, just as with bootstrapping, there are entrepreneurs who swear by raising capital. As Ankur Nagpal, co-founder of Teachable has told us:
“I’m always very impressed with bootstrap startups, but I feel that funded startups get a bad rap because of the way funding used to work. In the past, people would think, ‘Why would you want to raise funding and lose control?’ But if you look at term sheets available right now, you never actually give up control. We never gave up any operational rights to any investor, and we don’t report to an investor. It’s the best of both worlds. We have the capital to make mistakes—because ultimately that’s what the value of capital is—but we still control our own destiny.”
Also, if you are looking to grow a huge business, accepting investment is usually the only option, There’s a set of entrepreneurs for whom it’s the only way to go, and companies that grow large and fast can usually only do so through accepting an injection of investor cash.
Now onto the types of investors. They fall into three main groups: personal, venture, and angel investors.
Personal investors are typically in the form of friends and family, as described above.
Venture Investors, or Venture Capitalists, usually come in the form of experienced investors looking to make large returns by investing in business ideas. Rather than a loan, which a recipient is legally bound to pay back, a VC accepts a certain amount of risk that they won’t make the money back, in hopes that some of their investments pay off huge. Although there is acceptance of risk, they are very selective of who they support.
They will rarely be interested in pouring money into a new/unproven idea, and will demand a track record and some demonstrable value before placing money into a business endeavor. Venture capitalists don’t deal in 100s or 1,000s of dollars—we’re talking in terms of millions of dollars invested. If you are just starting out, a VC is probably not the breed of investor you should seek out.
Angel Investors are the investors that you’ll be looking for if you are a burgeoning young business. These are investors who are looking to give relatively small amounts (tens of thousands or hundreds of thousands usually) into businesses usually in exchange for equity, and will often be tolerant of other forms of growth besides revenue. That could mean number of users, for example.
They are often other entrepreneurs who have wealth of their own, as opposed to huge pooled investment funds, and are looking to seed people or businesses they believe in at the early stages of their growth. They sometimes fill a gap between friends and family support and larger forms of investment such as venture capital.
In contrast to Venture capitalists, angel investors may not require a part-ownership of the company. Instead, he or she may request a percentage of return on her/his investment. But, as with venture capitalists, there will be situations where angel investors require ownership and management decisions in your company. Places to find angel investors include business competitions, and websites such as:
In conclusion, there are many different ways to raise funding for a startup, and a lot of it really varies based on your experience level and track record. For early entrepreneurs, we here at Foundr are big fans of bootstrapping as long as possible, as attested by many of the entrepreneurs that Foundr has featured.
However, when that option is no longer possible or becomes a hindrance to growth, there are several great options to select.
Any other great ideas or tips for landing funding? Or any questions on these sources? Hit us up in the comments.
Good luck, and happy funding!