Funding your startup is a fundamental piece of the entrepreneurial puzzle. You can’t sell something if you can’t make it, and to make it you need some form of financing. Read on for an overview of the main categories:
- Equity: everyone loves the equity word, but it can be the most difficult source of startup financing. Companies often start with Convertible Debt or SAFEs – they’re convenient, cheap and easy to understand – all of which make sense for early stage companies. If you’re clearly on the venture financing track, then Preferred Stock is inevitable—think Series A, Series B and so on. The technicalities get more complex with preferred terms and so you should get legal advice (which you really should have throughout) and discuss with your mentors and board members. There’s a seemingly endless amount of content online that advises on approach, technique and right-vs-wrong for raising equity—we’d recommend the following sources: Brad Feld, Fred Wilson, Tomas Tunguz, etc. And Brad Feld’s excellent book – Venture Deals.
- Friends & Family: a subset of Equity, friends and family financing is often the first go-to for entrepreneurs. Don’t treat it as evidence of the validity of your vision or product—these providers believe in you individually but may not appreciate the technical and market risks of your strategy. These philanthropic people are, however, invaluable. We recommend The Mom Test as a great overall resource when concept testing your product.
- Debt: This can be harder to secure if you don’t have 1) assets or 2) solid cash flow. Creditors (people who loan you the funds) seek confidence you can cover the interest payments and ultimately pay back the principal (the original loan amount). Assets provide some security—creditors would take a lien over those assets so that were things to go awry with your debt payments they could sell the assets to recoup the funds owed. At early stages, founders often find creditors request personal guarantees as backup to debt financing. This is a tough and risky road to go down, so be very careful when considering this as an option.
- Customer Cash: Recognition of the value in using customer cash to finance your business is growing every day. This is by far the cheapest source of financing: Get your customers to pay up-front for your product or service and you’re on your way to unrestricted growth (albeit generally – be careful to manage risk and profitability throughout). Check out examples like AirBnB and Tough Mudder – they grew to significant scale before accessing the more traditional sources of financing just by thinking out of the box when it came to selling.
- Crowdfunding: the market for this is emerging, but one dynamic is clear: Crowdfunding is a terrific source of customer cash to finance inventory and last-milestone low risk development. You can get capital weeks and months in advance of delivery – a truly exceptional financing opportunity.
- Casino Gambling: Nope. Don’t.
- Sweat, Blood and Tears: Yep, it’s a source of financing. Typically founders give equity to next level directors before there’s any cash to spread around. And the very best founders often get people to work for free. At early stages, your ability to make something from nothing and avoid spending anything is a prime indicator of your potential success.
Remember: the type of financing secured should match the intended usage of the funds. Try not to think of debt to finance risky tech development – you’ll be severely exposed should that development not go as planned. Likewise selling equity to finance purchase of inventory (something you’re pretty sure will sell) is proportionately expensive – you’ve given away one of your most valuable possessions in return for something low risk – use debt in that situation, or one of the other options above. And throughout, make use of experts and advisors—exploring and designing your financing strategy is a constantly evolving process. Knowledge and experience are invaluable in ensuring the best outcome.
For additional reading about startup strategy, check out our blog about learning from failed startups here.