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The Startup Financing Model

Knowing when and how much to ask for which investors is critically important.

Global Influencer

Global Influencer
Global Influencer

There is a lot written out there about how to raise capital for your startup and where to find it. Generally, there is a defined structure in terms of when and how much to ask for from investors.

The funding model starts with a Friends and Family seed round through to Angel investors, Venture capital mergers and acquisitions and strategic alliances. When you are bringing in revenue and growing you will want to look at the venture capital guys. The final stage to which a lot of startups aspire is the IPO, the initial public offering when your little startup takes the big step to go ‘public’. This is usually where the big things happen and all the money is made – supposedly!

Finding Seed Funding

In the startup field, we are always talking about the family and friends option as an entry-financing model. This is where you ask Uncle Bob for $5,000 and go through your relatives one by one until you have enough money to start your dream. You will also find out whom your friends are when you ask them to contribute to ‘your dream’.

Referred to as the first seed round, this is where you develop your idea, create prototypes or proof of concept, maybe rent an office and hire a couple of people. You’re creating a startup and you have passed phase one by asking family and friends to support you.

But there is more to a seed round that asking your family for money. A Seed Round, according to Wikipedia, is a form of securities offering in which an investor invests capital in exchange for an equity stake in the company. The term seed suggests that this is a very early investment, meant to support the business until it can generate its own cash flow or until it is ready for further investments. Seed money options typically include friends and family funding, angel funding, and crowdfunding.

Moving on to Angel Investors

Family funding might bring you in a hundred thousand in small amounts but it may not be enough. This is where the angel investor comes in. In Vancouver, a typical ‘angel investor’ will invest around $250k in a startup although, for the most part, angels will like to invest in the $25k-$100k area. When an angel gets involved your equity in the business starts to dwindle. Startups are risky business and you will pay for the angel’s money. They are looking for the potential you offer and probably won’t sign a non-disclosure because they get so many deals they don’t need you. Get your ducks in a row for any investor before looking for money. I had a guy from Texas call me the other day looking for an investment but he only had an idea and a far fetched one at that – next?

Is Crowdfunding Right for You?

Crowdfunding seems like a wonderful idea to raise your startup money but I have yet to see anything come of these unless you are creating hi-tech items that appeal to the ‘investor’ and you give those away as part of the fundraising. I tried to raise money to buy the City of Detroit on Indiegogo a couple years ago but didn’t raise a dime. OK, I admit, it was far-fetched and yeah I was trying to raise $1.7 billion to buy Detroit out of bankruptcy. I still don’t think Crowdfunding is a good model for startup capital.

Preparing for Venture Capital

As you start to grow your business and develop a sellable product as well as generate some traction in selling the product you might need a venture capitalist’s money to help you sustain growth. Venture capitalists are generally high net worth individuals who are willing to invest in startups because they can earn a massive return on their investments if these companies are a success and can afford to lose their money if your company is a dud.

You’ll have to impress these guys because they are looking for a good product, a great management team, a large potential market and a competitive advantage. Getting several together will help you raise $1-2MM. Some angels I know will collaborate with a few others to raise a significant amount but will spread the risk over angels in Seattle, Vancouver and Toronto. You can offer smaller rounds of financing as you grow so you can keep as much equity as you can.

With the growth you are now experiencing after securing some money from an angel group, you‘re probably realizing that things are close to spiraling upwards at a speed you may not be able to manage yourself with your small team. You may consider bringing in seasoned professional management or advisors or strategic alliances to help or you may consider a liquidity event.

What’s a Liquidity Event?

Investors love liquidity events because everyone gets more money for their investment. As long as you are still maintaining a healthy equity in your company, you will be all smiles as well. A liquidity event allows your investors to take some or all of the money they put into your startup with a healthy return. It could also be a merger with or an acquisition by another company. Liquidity events are always being considered in the growth stage of a startup partly because it’s an indicator of how good the company is doing. Investors usually think of a liquidity event in terms of a period of time usually three to five years before they want to recoup their investment.

When people talk about stock and shares they always assume the company is public, but stock in private companies is soaring partly because of high returns from the hi-tech sector. Because of the risk associated in private companies there is a great deal of government control to maintain the risk is informed and kept to the minimum.

Much of the stock in private companies is very inexpensive allowing it to be ‘an investment for everyone’.

To IPO or Not To IPO?

Private Equity firms directly invest in private companies and consolidate institutional investors and accredited investors, who can dedicate substantial sums of money for extended time periods. Quite often the liquidity event will be an Initial Public Offering (IPO) but this is changing.

While a lot of startup founders see the IPO process as ‘having made it’, the IPO is a risky proposition and in my mind not always the best model to follow. Using private equity to raise money is less stressful, easier to do and you can still raise considerable amounts of investment. An IPO by its nature of being public is subject to enormous external forces, regulations and control issues. Technology companies in particular need wiggle room to explore, experiment and make adjustments. The stock market is averse to seeing too much change in a public company.

If you look at the area of private equity versus public offerings, many companies who had the goal of ‘going public’ are realizing that finding investors is easier in the private market and without all the red tape private financing makes more sense.

As we are so fond of saying, all you need is three things to succeed in a startup: a good product/service, good people and money. If you have two of the three you can find the third. Follow the advice of professionals and don’t move up the ladder two fast or you might find the gold at the end of the rainbow is a bucket of bolts.

Long-shot third parties are everywhere this season. That says something about Americans’ perspective on the economy.