Got a great idea but don’t know how to fund it? Here’s a run-down on your options for sourcing that “A Round” funding you need to get your start-up off the ground.
The business world seems to be fuelled by buzzwords, and the words on everyone’s lips for the past 12 months have all centred around start-ups, angel investors, incubators and accelerators.
It’s not hard to see why. Almost every time you open a newspaper (or, more realistically, read the business pages online) there’s yet another rags-to-riches story about a start-up that has come from nowhere to take over the world. We’re bombarded by stories of unlikely, overnight millionaires whose bank balances have ballooned off the back of a good idea and a fistful of dollars.
But the reality of the situation is that getting a start-up to start at all is hard work, largely due to the incredibly competitive nature of this business sector. Every man and his dog with a good idea is approaching anyone with spare cash for funding, and there’s only so much money to go around. Business confidence in Australia is pretty shaky at the moment, and investors are uncertain about where and how to invest their money.
Having said that, it’s important to remember that a really good idea for a business – and even some really questionable ideas – will be able to attract funding and investment, provided the people behind the idea know where to look, who to ask, and have planned ahead.
The Lay of the Land
“If you believe the headlines, the US is full of entrepreneurs who have raised millions in venture capital funding for their early-stage start-ups,” says Michael Ford, CEO of Castaway Forecasting. “However, when you dig a little deeper, the real story is somewhat different. Less than two percent of start-ups get early stage funding… and over half of these don’t survive through to the next funding round.”
“The best outside investors are those who offer more than just cash,” Michael explains. “Experience, networks and advice are extremely valuable as a startup. Against this, the downside when raising funds from investors is that you will need to hand over some of your most valuable asset … equity in the business. Sure, those shares aren’t worth much when you’re a start-up, but if the business does well, they could become the most valuable assets you own. Giving away too much equity too early is a classic mistake made by many start-ups.”
That early stage funding tends to take a number of forms, from straight-down-the-line venture capital (VC) investments and business loans, through to angel investors and even crowd-sourced funding. Here’s a quick run-down on the avenues that are open to you.
Early-stage projects or businesses have traditionally been funded by venture capitalists – wealthy investors who stump up the funds to get the company or idea off the drawing board and into the real world, in exchange for equity in the form of part-ownership of the business.
It’s a risky endeavour for the venture capitalists, but even a modest sum invested in exchange for 25 percent of a company can eventually be converted into a hefty pay-day if the business succeeds, and is sold off or floated on the stock exchange for big bucks down the line.
Accelerators & Incubators
The terms Accelerator and Incubator tend to get thrown around a lot, and are used by many as interchangeable names – but they are actually two very different business models, albeit with similar goals.
Incubators work on the principle of bringing an external management model to an ‘internally developed’ idea. The ideas are generated either by an individual, or by a team in a collaborative, shared-space environment, and are further developed by the management team brought in to oversee the process.
Incubators, such as Sydney-based ATP Innovations, work with their ‘clients’ to develop their ideas from the ground up. They do so by providing work space, and assistance in building your team, developing your idea, and raising capital through their investor network or via government grants. That capital is used to create your product, grow your business and, in the end, they will assist you to “exit the business profitably” – at which stage, the incubator will take their cut.
Incubators work on the premise of a longer association, with greater assistance to your business, with a larger slice of the pie for them at the far end of the process.
Accelerators, on the other hand, tend to work on a much shorter timeframe, with less investment and a lower slice of equity for the company. Accelerator programs normally offer shared workspaces, access to capital and mentoring, for a three- to four-month period, at which time the client ‘graduates’ from the accelerator program, hopefully with a well-developed, viable business to take to market.
Angel investors are basically a sub-set of the traditional venture capitalist model, but with a crucial difference. Angel investors are normally wealthy individuals with a background in the field in which they’re investing. For example, a retired or semi-retired software executive might decide to sink some money into a new tech start-up.
Angel investors tend to put their money into a project in exchange for equity in the company itself, and will often be involved with the project itself to a certain degree. That involvement might take the shape of actual, hands-on work on the idea, or simply providing business mentoring for the people running the project. It’s often seen as a way for the investors to keep their finger on the pulse of the industry they’re part of, without having to work full-time.
“Private/angel are investors are an option, but don’t forget these people are often investing their own money, so will be highly focused on risk,” Michael says. “In Australia, there are lots of start-ups chasing a small pool of angel funds, so your idea will need to be compelling to even have a chance.”
In recent years, this sector of investing has seen a rise in the number of individual angel investors forming collectives, to pool their investment resources and provide a broader range of mentoring and business advice. That works well for both parties in the agreement – you get access to funds and rock-solid advice, while the investors can feel comfortable knowing that their investment is in the hands of someone who knows how to listen, and will heed their advice on important business matters.
With a horrifying acronym like ESVCLP, it stands to reason that Early Stage Venture Capital Limited Partnerships can only be a government initiative. Open to businesses with assets of less than $50 million, access to capital is managed through limited partnerships that are registered with Innovation Australia.
It’s not a new idea by any means, but crowdfunding has enjoyed a surge of popularity in the past few years, thanks to the rise of websites such as Kickstarter and Pozzible. The idea is very simple: If you have a project you want funding for, you sign up to the crowdfunding site, and do your best to convince anyone who finds your project’s page to help you fund it – usually in exchange for low-cost rewards (branded coffee mugs, t-shirts, etc) based on the amount of money each individual pledges.
Sites like Kickstarter work well, provided you have a good social media strategy and, of course, a good idea to begin with… When you set up your Kickstarter page, you can nominate an investment goal. If enough money is pledged to your project, Kickstarter will collect the money from everyone who pledged, take a small cut, and forward the funds to you. If you don’t reach your goal, it’s a case of ‘no harm, no foul’ – no one loses any money, and you can use the feedback you receive from the users of the site to refine your idea, and try again.
With so many investment options to choose from, it’s understandable that many business ideas burn brightly, but very quickly die away, as the realities of starting and running a business become apparent. Make no mistake… it’s very hard work for most businesses. What’s important, the experts say, is planning – especially at the early funding stage.
“If you’re thinking about raising funds for your startup, you first need to be clear on 3 things,” says Michael Ford. “Firstly, figure out how much funding you really need. Next, be very clear about what you will do with any money that you manage to raise, and lastly, have a Plan B in case you don’t raise enough money to begin with, or the money runs out faster than expected. Potential lenders and investors will ask these questions, so you need to be ready with the answers.”
“This means that planning is important when looking to raise funding, but it can also be difficult because of the huge uncertainties that face every startup,” Michael continues. “If you don’t have the skills to manage this stage properly, engaging professional help could well be the best investment you can make. Raising capital can be a difficult, drawn-out and distracting process, so having someone with experience on your side can make a big difference.”
Michael also has advice for start-ups seeking alternative sources of funding, if the options above aren’t viable for your business.
“Banks may look at the deal if you have a track record of successfully starting and growing businesses in the past,” he says. “Cashflow from an existing business is one of the best sources, provided that business can afford to invest the cash. Still, self-funding via cash, credit card or mortgage redraw, as well as money from family and friends are still the most common sources of startup cash.”
“With a little entrepreneurial creativity, you might be surprised where the money could come from,” Michael continues. “Perhaps think about approaching a key customer to pay early, or finding a co-founder who will trade hard work and effort for the chance to be part of something really interesting? I started my first consulting business by offering a key client a 25% discount if they agreed to pay for 200 hours of work up-front. That lump sum funded the business for the first 3 months, although I had to be super-tight on spending to make it work.”
“One final caution… It can be easy to get excited by the possibility of raising funds, but that moment is when the hard works starts,” Michael says. “If you do raise funds, you must be clear on exactly what you’ve signed up for. If you’ve raised funds from a lender, the loan agreement will set out payment schedules, bank covenants and personal guarantees that need to be dealt with.”
“If an investor has provided the funds, there will be milestones, investor updates and other expectations that may be even more rigorous,” he concludes. “There may also be consequences that will cost you even more equity if the business underperforms. It is always good practice to agree these requirements clearly up front in a Shareholder Agreement.”
There’s hope for us all
Despite the veritable minefield that many start-ups face in securing funding, we’ll leave you with a story that will either stoke the fires of your resolve to find investors for your idea, or completely shatter your faith in humanity.
One recent, and very unlikely example, is an app called “Yo”. The app allows users to send the word “Yo” to each other… and that’s all it does. It recently managed to secure a cool $1million in funding from tech investment guru Moshe Hogeg. We’ll let that sink in for a second… $1 million for an app that says “Yo”.
Maybe there’s hope for even the silliest of business ideas, after all…