Saturday, March 25, 2006

Sources of Funding

Recently, a question was posed to me about sources of funding for a start-up, and I figured this would make a good posting for my Blog.

The general sources of funding for a start-up in the order they are often obtained are:
1) Bootstrapping
2) The Three-Fs
3) Angels
4) VCs
5) Public Markets

Bootstrapping - bootstrapping means self-funding. The person starting the business uses savings, takes out a second mortgage, uses their credit cards, etc. to pay business expenses. If you can do it, this is generally the preferable route, as you keep full ownership of the company and don't have to go through any hassles of convincing others to fund your business. This was the form of funding I used when I started helpUhire Solutions.

The Three-Fs - the 3 Fs are friends, family, and fools. This terms comes from that fact that the vast majority of new businesses fail, so only friends or family have a connection with you that makes them willing to risk money on a start-up. The money is often easier to obtain (these people are investing because they believe in you, not because they really know if the business will make it), but there is an added risk that if the business fails you may be taking your parent's retirement funds with it. The bike shop I am working with was started by a friend of mine, and I have put up some money as an investment (hopefully as a friend, not a fool).

Angels - Angel investors are rich people, who for some reason decides to invest some of it in startup(s). The reason they do this can be to make more money, but it can also be for other reasons (the thrill of startups, to see a technology make it, etc.). Being that they are already rich, they are often willing to take bigger risks than others, so are usually the first outside funding a company gets (often well before a VC would consider investing). They generally invest between 10's and 100's of thousands of dollars into a company. I have never been involved with getting money from Angels, so don't know the process of finding and courting them.

Venture Capitalists - VCs are people who invest money into companies for the sole reason of making more money (hopefully lots of it). They will invest money in exchange for an equity stake in the company. They do often want a significant stake in the company (often controlling), and have been known to oust founders if they feel that the founder is not getting them to profitability fast enough. They target companies that they think can grow and prosper to the point that in a few years it will be either acquired or can go IPO - which are when the VC is able to cash in any profits. VCs are looking to minimize risks, so won't invest in a company unless they see significant upside - so usually won't talk to you until you have working products, customers, income, etc. (the exception are for the marquee names - the serial entrepreneurs who have started and successfully run companies before, which most of us are not). There is a pretty significant dog and pony show required to get VCs to invest - which is time spent producing reports and presentations for them, and not spent growing your business. One client I worked with had angel funding and was considering VC funding, but felt they wanted too much control for the money they would put in, so decided not to go for it.

Public Markets - public markets are where you have a listed stock on a stock market, and anyone can buy shares in your company. This is not a stage of funding for a start-up, but instead is for a mature company.

There are other sources of money, such as bank loans and supplier terms, but these generally are limited in that the lenders won't want to put their money at risk without some sort of protection (such as collateral, proof that the company can pay for the items, personal guarantees, or similar). The bike shop I am working with is using supplier terms for a portion of their inventory, but the owner had to personally guarantee he would pay off the loan even if the company went bankrupt.

There are some government grants and SBA loans available, but I don't know anyone who has used them. It seems the paperwork and hoops you have to jump through, along with significant limitations, make these funding sources less useful than one would hope.

A good book that covers a lot of this is Art of the Start, by Guy Kawasaki. Guy is a VC in Silicon Valley, and has been involved with many start-ups. Definitely a useful book for those looking for funding, particularly if you think you may want to go the VC route.


At 4:10 AM, Blogger Puru Gupta said...

Got the link from Marketing Profs.
Informative post Peter. learnt something from it...



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