You've got an exciting business idea and is planning to start a new venture. Or your new endeavour is already at an early stage and you want to further develop your business. In either of these situations, you will need funding to grow your startup. The money could help you afford new research, expand into new areas, improve marketing and open new possibilities.
The easiest way to get startup funding is by using your own savings. However, not everyone has a handsome fortune to finance their startups’ business operations. Under these circumstances, there are other ways that you can obtain funding for your startup.
The first people you should approach are your family and friends. Asking for money from family and friends is often easier than other kinds of financing. It takes little time and the process is not as complicated.
You can borrow a small amount of money from each of your family members and friends. They may be willing to lend you money interest-free. If not, you may need an investment agreement that sets out the interest or other forms of reward for the loan.
However, friends and family funding has its disadvantages. If your startup fails, you risk both your savings and your loved one’s money. This may pose an adverse effect on your personal relationships. Therefore, you may be under immense pressure to do well in your business so you can return the investment of your friends and family.
An angel investor, or a seed investor, is an individual who invests in startups. Angel investors usually ask for ownership equity in the business in return for their investment. The investment type may vary, ranging from being a one-off capital injection to continuous financial support.
The best way to be introduced to an angel investor is through the referral of friends who are investees of the angel investor. Thus, the angel investors will have more confidence in investing in you.
Angel investors can also be found through networking. Attending social events is a way to approach high-net-worth individuals who may be interested in your business idea. You can join business organisations or attend trade events to expand your social circle.
In addition, there are online platforms where you can submit your proposal to potential investors. Here are some websites to find angel investors:
You can first send an email introducing your business to the angel investor. The content can include your referral, company introduction, your previous experience and your pitch deck. Angel investors are interested in hearing your business plan, the market opportunity and working model.
There are also a variety of questions that the angel investor may ask in the following stage, below are some examples:
Here are some business introduction letters to angel investors:
Angel investors often invest through a convertible note, which is a short-term debt that converts into shares. The investor offers the loan in exchange for shares of preferred stock instead of the loan money with interest.
Investing through a convertible note is fast, simple and saves cost. Another advantage is that you can avoid giving the investors control rights as convertible notes normally do not grant the noteholders such rights.
Some of the key terms in the convertible note are:
Venture capital firms fund startups with long-term growth potential. You have to give up some ownership in your business to the venture capital firm. The funds come from individual investors, investment banks and financial institutions.
It is advantageous for startups to obtain funding from venture capital firms because other forms of support, for instance, technical and strategic assistance, may be available as well.
Private equity and venture capital both collect funds from investors and use the capital to invest in businesses. Their goal is to increase the value of the business they invest in and then sell their ownership to make a profit.
The main difference between venture capital and private equity is the type of companies they invest in.
Venture capital firms invest in young companies. They are generally the early investors, participating in Series A and B funding. Private equity firms invest at a later stage, funding Series C and pre-IPO companies.
Here are some top venture capital firms:
Here are some top private equity firms:
Here are some investment agreement templates:
It is important to first research the venture capital firm. Firms usually have a set of criteria in choosing which business to invest in. These criteria include the business stage, geography, investment amount, industry, etc.
For example, some firms may only invest in specific industries such as:
In general, venture capital firms are only attracted to startups which are in industries that promote innovation and long-term development. Much existing venture capital investment goes to products in demand, for instance, mobile applications. Therefore, you have to ensure that your business idea fits the standards of venture capital firms.
If you find that your startup fits the criteria of the venture capital firm after conducting research, you will need to prepare a pitch deck to present your business to the firm. The pitch deck is a presentation to showcase your proposal to the firm.
Some commonly included content are the mission, team, solution to a problem, market analysis, product/ services, customers, technology, business model, marketing strategy and financials. The firm has to be convinced that your idea has great growth potential and that it has already received a certain degree of recognition.
Here is a Guide on How to Pitch to Potential Investors.
Below are also some useful documents to help you start preparing for your pitch:
After the initial pitching, there is still a long process until you can obtain the venture capital. The following are some of the issues that need to be negotiated and handled before the firm officially launches its investment in your business.
The venture capital firm will perform due diligence on your startup. This process is for screening out potential business proposals and conducting a detailed evaluation of the business before moving on to the next stage.
Due diligence is a process of getting the company’s answers to questions. The questions may be related to the management, market, product/ service and business model of the startup. The due diligence process can vary based on the firm’s strategy, market, location and time.
The firm will review your financial statements, contracts, corporate records, intellectual property, liability, government documents, client information, etc.
A valuation of the startup will also be conducted by the venture capital firm. This is a pre-money valuation, which refers to the agreed value of the company before the firm provides a new investment.
The method of valuation is flexible and depends on the firm. With a lower valuation, the venture capital firm can obtain a larger stake in the startup after investment. This creates more potential for the investment and reduces the risk, so the firm will more likely proceed with the investment.
Examples of factors in determining the valuation include the market opportunity, initial traction by the startup, business progress, competitors’ valuation and the economic climate.
A redemption rights provision provides that the investors can vote to make the company redeem their shares at the original purchase price after a period of time, usually five years after the investment, with payments in instalments.
This right is generally limited by applicable local laws. For example, some laws allow the company to not redeem shares when it would cause the company to be insolvent. The redemption rights provision acts as an exit for investors, increasing investment liquidity.
When the venture capital investors want to cut losses and withdraw their investment, the investors can exercise their redemption rights and cash out.
Venture capital investors may insist on having veto rights to protect their minority stake. Some common actions of the company where investors may exercise their veto rights include the creation of a new class of shares, change in the Board of Directors, amendment of the articles of association to change the number of shares and sale of the company.
The venture capital firms may include their liquidation preference in the provisions. The liquidation preference is a right which allows the preferred shareholders to receive a certain amount of proceeds before other shareholders upon liquidation or winding up of the company.
Crowdfunding means a large number of individuals or groups fund your business. The popular way is to present your business on an online crowdfunding platform and attract investors to fund you. There are a plethora of crowdfunding websites which provide different investment options.
Here are different types of crowdfunding.
In equity crowdfunding, investors get a stake in your business for the money they invested in.
Here are some popular equity crowdfunding sites:
You borrow money from investors, which you are obliged to pay back at an interest rate at a set date. If a substantial amount of money is borrowed, security in assets or a personal guarantee may be required.
Here are some popular debt crowdfunding sites:
Unlike in equity and debt crowdfunding where you give up a stake in your business or obtain a loan, you offer products, services or discounts in return for the investment fund in rewards-based crowdfunding.
Here are some popular rewards-based crowdfunding sites:
This type of crowdfunding only applies to startups related to a charitable cause. The investors fund your ideas and demand nothing in return as a gesture of goodwill.
Here are some popular donation crowdfunding sites:
You can obtain business loans from several types of lenders, for example:
Lenders assess your loan application with regards to several factors below:
When negotiating for the business loan, you should pay attention to the following details of the loan agreement:
Here are some loan agreements for your reference:
When you fail to obtain financing from investors or lenders, you may look into business grants. There are schemes to fund startups in order to drive businesses, promote innovation and support different industries.
For grants, you normally do not have to pay back the money given that you satisfy the grants’ goals. However, competition is fierce and a lot of work needs to be put into preparing the application. The amount given in loan may also be insufficient to fully finance your business. Nonetheless, grants can be useful as an additional source of funds.
Below are some points that you should note before applying for a grant:
Starting a business may be daunting, but there are myriad ways in which you can find strategic and monetary support. It is important to be able to effectively pitch your business idea so that investors trust and invest in your startup.
For further information, check out our guide on the Top 3 Capital Raising and Investment Agreements for Startups with free investment agreement templates to understand more about the legal aspect of startup financing!
Please note that this is just a general summary of Startup Funding under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your local legal advisor.
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