You’ve come up with a great idea for a business. It’s taken time for you to polish your rough idea, design your product or service, sketch out your business model, and create a plan to put it all into motion. But there’s one big problem – you don’t have the funds to get the wheels turning!
It’s normal to wonder how to raise funds for startup businesses and on top of that, there are a number of fundraising mistakes you’ll want to avoid making in your efforts to obtain funds. Here, we’ll answer the following questions (and more).
- What are the best fundraising strategies for aspiring business owners?
- Where should you look to get small business fundraising?
- How can you navigate the early startup funding stages effectively?
Find everything you need to know about funding strategies for startups below…
What is startup fundraising?
First things first, what is ‘startup fundraising’? Startup fundraising is the process of generating the money you need to turn your company from an idea into reality.
Most entrepreneurs will tell you that fundraising is probably the most difficult step towards starting your business. Unless you’ve got the next big, hot thing, your journey will be filled with painful no’s and empty promises. Startup fundraising is no walk in the park and anyone who says it is, is simply lying. But that’s what makes it so gratifying when you get there in the end, and with a little determination and the right guidance – you will.
There is a popular misconception that you’ll need a ton of money up-front in order for your startup to lift off.
The truth is, every business has to start somewhere.
There’s no reason to wait for a huge investment if you can put some personal funds towards your startup. In the world of entrepreneurs, this is known as ‘bootstrapping’. As a matter of fact, putting your own money into the company will be proof to potential investors that you are serious about your business. Learning to save money in your startup is also a useful tactic to up your funds.
But it goes without saying that if you personally had the money to start your own business, you probably wouldn’t be reading this in the first place. So it’s a good thing that you’re here!
Keep reading to discover pro tips on how to raise funds for a startup…
One important note: Of course, the type of business will affect the kind of industry loans a business needs, as well as the specific circumstances that business finds itself in. Be sure to weigh your options carefully in order to choose the right funding solution for your business.
The different startup fundraising stages
The road to establishing a successful startup has many steps along the way that need to be taken on one at a time. Within each step there are several stages. Each of those stages presents a unique challenge that you’ll need patience and determination in order to complete. For your convenience, we give you the breakdown of the startup fundraising process just below.
The four startup funding stages:
1. Seed capital
The initial funding that your business receives in order to get started is known as ‘seed capital’.
Seed capital is oftentimes overlooked despite the fact that it’s the first of the key startup funding stages because it is such an obvious idea to most new business owners.
Typically, seed capital will come from personal savings, friends, or family members. The amount that the investor is willing to contribute will depend on several factors.
Those factors include:
- Your business
- Financial history
- Professional skill
- Track record of business management
- Quality of services and so on
Seed capital is normally used to conduct product development, market research, prototype development, and basically any steps that are necessary for planning the smooth launch of the business.
Most venture capitalists will stick to investing in businesses that have already proven their ability to do well. As such, it isn’t often that venture capitalists make investments in companies that are still in their early stages of development.
Pro-tip: Offer your seed capital investor equity in your business or a position in the administration as a way to reduce the risk on their end. This might encourage them to make a larger investment, and it doesn’t always mean having to sign a formal legal contract.
2. Venture capital
After an investor assesses your startup and determines that the important factors are up to par, they may determine that there is potential for your business to succeed in the long run.
Venture capital investors may offer you funds, expertise, or other resources in exchange for equity in your company. Keep in mind that with equity, they’ll have some pull in your company’s decision-making process.
Give this careful consideration, particularly if you intend on remaining the principle decision-maker of your business.
Successful small business fundraising means finding investors who have the means to make a sizeable contribution to your startup. These investors are referred to as ‘angel investors’, and many of them started off as entrepreneurs themselves – so they know what it takes for a business to make it.
Obtaining startup funding from venture capitalists means you’ll have to prove your business’s worth and viability. In other words, you’ll need to write up your business plan and proposal so the investor recognizes the ability for your business to not just survive, but to thrive!
Pro-tip: Before pitching your idea to a venture capital investor, do your research on:
- Who they are
- What their previous accomplishments were
- Where they tend to focus their investments
- Which industries they have expertise in
3. Mezzanine financing
If you’re new to the world of small business fundraising, then mezzanine financing is likely an alien term to you. Basically, mezzanine financing is a form of startup loan that a business can take without putting forward any collateral. Though there are pros and cons, mezzanine financing is still recognized as one of the fundamental funding strategies for startups.
Risks of mezzanine financing:
- First, they normally have a high interest rate – typically between 12% and 20%.
- Second, if the business defaults on the loan, there are what are referred to as ‘warrants’ or ‘options’ which give the investor the choice to take equity in exchange for the outstanding balance on the loan.
- Third, if you do default on the loan, the lender will reserve the right to sell their share of your business at their discretion.
Advantages to mezzanine financing:
- You’ll be able to obtain startup fundraising very quickly.
- There is very little due diligence on the part of the lender (although that is because the risks are so high for the borrower).
- Mezzanine financing stands as a lower priority compared to ‘senior debt’ when it comes to the company’s loan repayment obligations.
Pro-tip: Mezzanine financing is normally made available to companies that have already proven their ability to perform well in their industry. Before exploring mezzanine financing options, be sure to have a solid plan for the future of your business.
4. Initial public offering (IPO)
The initial public offering, or IPO, is the process of ‘going public’ that you’ve likely heard before. The IPO is the process of offering shares in your company for the public to buy for the very first time.
Well-established companies see IPO’s as one of the most desirable forms of fundraising strategies. If you’re a startup or small business owner and you’re not familiar with the process, we provide the steps involved in an IPO below.
Steps to begin an IPO:
- A team of underwriters, lawyers, CPA’s (certified public accountants), and SEC (Securities & Exchange Commission) professionals is assembled.
- The team compiles and assesses information pertaining to your company’s financial history and potential for future growth. This report, known as the company prospectus, is then shared and reviewed among the team.
- The team generates an opinion of how many shares should be sold, at what price, and within what time window.
- You file your company’s prospectus, and all other forms, to the SEC for official review.
Advantages of an IPO:
Disadvantages of an IPO:
Easing the process of acquiring or merging other businesses.
Going public means you’ll have to give the SEC access to documents, which may give your competitors an advantage over you
Ability to offer stocks as a form of compensation to employees.
Stock prices go up, and stock prices go down. The constant changes in valuation may distract you and other decision-makers in your business structure.
Chance for future startup fundraising by having secondary offerings to the public.
The act of buying back stock and selling those shares at a higher price to make a profit will be tempting but may be risky in terms of it causing instability
3 Innovative funding strategies for startups
You may be curious to know what alternative fundraising strategies are at your disposal. There are several non-traditional ways to get the startup fundraising you need to get your business off the ground.
Here are three innovative startup fundraising strategies you can employ:
1. Take partners early on
Instead of pitching your business proposal to a bank or investor, first you may want to see what entities already exist that can make use of your products. Finding a company in your industry that can utilize your services is one great way to get hands-on feedback; you’ll also be getting advice from someone who cares about the quality of your services and not simply getting a return on their investment.
Pro-tip: The right partner is one who has as much to benefit from your success as you do.
2. Research available grants
For many industries there exist grant programs that are meant to spur on the development of businesses in specific sectors. These grants may be offered at the federal, state, or city level, and many are specifically aimed at startup fundraising. Do some digging, you may very well find that your business qualifies for a grant that even exceeds the amount you were aiming at obtaining.
Pro-tip: Qualifying for a government grant usually requires having a clear and concise business plan, a list of milestones you plan on achieving, and the timeline of when you plan on reaching those goals. Make sure to have all of that squared away before beginning the application process for a grant, including a business disaster recovery plan.
3. Explore alternative lenders
Over the past few years, online lending solutions have established themselves among the top funding strategies for startups. Whether it’s in the form of a line of credit, equipment financing, or SBA loans, the process of obtaining business loans from alternative lenders has become increasingly simple as financial technology has continued to revolutionize the business lending process.
According to an analysis of our own data, applying for a business loan through Become means an average 15% approval rate compared to the alternative lending industry average of 2-3%.
Pro-tip: Research the different loan options made available by online lenders. Some options will fit your business profile and needs better than others. Be sure to do your due diligence on the loan options, loan sizes, interest rates, repayment requirements, and so on.
The 3 worst startup fundraising mistakes
It requires a sharp eye and careful consideration on your part to avoid the common fundraising mistakes that can stand in the way of successfully obtaining startup fundraising. Here we’ll list the top three startup fundraising mistakes, and provide guidance on how to avoid them.
Three fundraising mistakes to avoid:
1. Making unrealistic projections
Investors will want to know that you’re serious about your business before making any contributions, monetary or otherwise. Part of their evaluation will be how you project the scaling up of your company. As a startup you likely still haven’t started making profits; if you project that in five years you will be earning $250 million in revenue, that will raise some eyebrows, to say the least.
Pro-tip: Better to be realistic than to try selling a pipedream to someone who makes a living on assessing the likelihood of your business’s success. An investor will feel more confident in providing your startup with funds if you show competence and sensibility in assessing the future of your company.
2. Being out of touch with your audience
When approaching a potential investor, you may want to appear attractive by providing them with flashy numbers and impressive projections. If the raw numbers at your disposal don’t quite cut it by your standard, you might even inflate them a bit in order to have a stronger impact on the investor. This is not the recommended way how to raise funds for startup…
Pro-tip: Chances are, if the potential investor has any amount of experience and resourcefulness, they will have done all of their research before even sitting down with you. Don’t lie to them. Honesty is the policy, and humbleness will be just one more way that the investor will be able to tell that you’re serious and realistic about your efforts to build a strong, long-lasting company.
3. Not knowing your competition
As noted above, your potential investor will have done all of the relevant and necessary research prior to meeting with you. One of the first questions they’ll ask is who your main competitors are, and what makes them strong.
You may want to stand out, or at least convince the investor that you stand out, and so you might tell them there’s little or no competition in the market you plan on entering.
Pro-tip: Your product or service has its unique features, but more often than not there will be companies that either directly or indirectly compete with you. Don’t tell your investor that there’s no competition! All that will do is show that you haven’t done enough research into your industry. Do your research, be realistic, and stay honest.
Wrapping it up
You’ve got everything you need to know about:
- What startup fundraising is
- What the startup funding stages are
- Which alternative funding strategies for startups are worth considering
- Common startup fundraising mistakes that you should work to avoid
With this knowledge, you’ll be able to take your business idea and turn it into a business reality. Yet, even with all of the information above, it can still prove to be a difficult road to navigate. Feel free to revisit this page in the future for a refresher. And if there are any questions that have been left unanswered, please leave us a comment below and we’ll be sure to answer.
Best of luck with your small business fundraising!