Raising capital for a startup is one of the most important factor that promoters has to address at the initial stage of forming a company. For instance, if the legal structure of your business does not allow investors to invest money in exchange of shares, then nobody will be interest to invest. You have to address this type of issues at the time of registration.
Therefore, at the beginning, it is absolutely necessary to prepare a business plan. Your business plan should have a separate section for seeking funding and financial projections to convince potential investors.
At the beginning, most startup will not have revenue, assets and business history to attract bank finance. For them, equity is the most common approach. Generally, equity capital is raised in several stages, on the basis of requirements and on specified terms and conditions.
Here are top 5 funding options for startups and small businesses to raise capital. Typically these are venture capitalists, angel investors, bank and financial institutions, friends and family and crowdfunding.
Raising capital from Venture capitalists (VCs)
Venture Capitalists (VC’s) are private investors who take high risk ventures with a goal to get high returns. Venture capitalists make equity investment in new Companies. In return to their investments, you are not required to pay any interest. Instead, you give a portion of ownership by issuing equity shares in exchange of their investments.
If the business turn out to be unsuccessful or goes bankrupt, then these venture capitalists don’t get their money back.
Venture capitalists can provide large amount of funding to your startup that need significant capital investment to achieve high growth. However, most of these venture capital firms divest their interest after few years period through a public offering or sale of the business to another investor.
Depending on the amount of money invested, VC’s in general exercise control and bring experienced management talent to help guide and grow the business.
Sometimes they invest in several rounds of funding and are part of a larger consortium of investors in the company.
Getting funds from Angel investors
Angel investors are typically high-net-worth individuals or groups who invest their own money as opposed to a venture capitalists or institutions which invest other people’s money. Angel investors specialize in making early-stage investments in startup ventures.
In general, these angel investors provide funding because of their interest in your product or service. They are often willing to invest in earlier stages and with smaller amounts of money than VC’s, in exchange for equity.
They can take passive or active roles in the startup and typically have a longer investment horizon than VC’s.
Debt through Bank loan
Bankers only provide debt financing. For some startups, taking on debt may be a more attractive option than diluting the ownership stake of the founders or other investors through equity offerings. While traditional banks may not be a viable option for most early-stage companies, there are several financial institutions who are willing to take risk for a higher return and lend to startups.
Loans from a bank and financial institutions provides you money to be repaid within a specified period of time, in installments consisting of principal and interest . A loan can be secured or unsecured based on the type of finance you have availed.
Bank loans can be challenging for young entrepreneurs due to their limited business and industry experience, limited credit history and limited equity in the business. However, many financial institutions will be willing to invest, provided you have a solid business plan that addresses their concerns and demonstrates that you have a well-thought-out plan to overcome obstacles.
Banks do not usually participate in equity investments in new companies, but they are a source of loans, particularly for capital purchases when there is some kind of collateral.
Bankers main concern is to get back money plus a reasonable return over a period of time. Therefore, to get a bank loan, you have to show existence of strong and well documented cash flows which can be more than adequate to repay scheduled principal and interest.
You should avail bank loan when your business is generating adequate cash and collateral to secure the loan. Please note, bankers don’t provide seed money or start-up capital to start-ups.
Capital from Family and friends
The first round, often called bootstrapping, will typically come from founders’ savings and credit cards.
Many founders will also reach out to their friends and family members to raise their initial seed capital.
Potential investors will expect founders to have “skin in the game,” and to have made a financial commitment in the growth of their startup. Investors will be less likely to invest if founders have not also taken personal and financial risks to get the startup off the ground.
Crowdfunding has become a popular financing option for private startups. The practice of funding a venture by raising monetary contributions from a large number of people, typically via the internet, has increased due to the number of websites that provide crowdfunding opportunities.
We have several different types of crowdfunding:
- reward-based – pre-sell a product or service,
- equity-based – sell unlisted shares, and
- credit based – borrow amounts that are subject to interest and principal repayments.
You should work with your business advisers to determine which option may be best for your company.