This week on Subtitles On we give a crash course on the 101 of accessing money for your start-up.
The funding investment gap for women
Everyone needs money to start and run a business and there are lots of different ways to get it. Unfortunately, the statistics for women are grim. Did you know:
According to 2018 research by Boston Consulting Group when female entrepreneurs pitch their ideas to investors for early-stage capital, they receive significantly less than men—on average, more than $1 million less.
According to the CrunchBase EoY 2019 Diversity Report, only 20 percent of global startups raising their first funding round in 2019 have a female founder.
Australian female entrepreneurs do a little better, with a 2017 Fairfax study estimating 26% of female founded companies receiving venture capital funding.
The investment gap really makes our blood boil.
We know that there are various biases that disadvantage women when it comes to funding, but we think that language plays a huge part and boy oh boy is the funding process full of buzzwords that exclude and confuse. (Side note: if you are interested in other biases that cause this investment gap, check out this Harvard Business Review article where the different questions venture capitalists pose to male and female entrepreneurs is discussed. It is really interesting!).
Our mission is to make this stuff easy to understand. So read on if you're keen to understand:
the different sources of funding, eg you, family and friends, debt, government grants, crowdfunding, and of course selling shares in your company;
the different types of investors including, angels and venture capital firms;
the different types of equity funding rounds (Seed, Series A, Series B).
what steps you should take no matter who your investor is.
Where does the money come from?
You (aka bootstrapping)
When it's you who ponies up the cash, it's often referred to as bootstrapping (*BUZZWORD WARNING*). The idea is that you borrow minimal funds or no capital at all. Going nuclear on your piggy bank and personal credit cards isn’t the only option in bootstrapping, some other examples of bootstrapping include:
running the business from your garage (just like Apple and Microsoft) instead of leasing office space
paying employees with shares in lieu of salary
obtaining money from family and friends (see further discussion on this below)
Bootstrapping really is the ultimate proof of concept and investors are often interested to hear that you have put your own money into your business.
Tip: Make sure you consider how much time and money you are willing to sink into the business and how much you are willing to sacrifice to reach your goals.
Friends, Family and fools
As part of bootstrapping, you might convince your nearest and dearest to give you some cash. Sometimes it's referred to as the three F’s – family, friends and fools. You know how the saying goes, don’t mix business with pleasure, so make sure with any F, you get everything in writing and explain the risks in detail.
Typically F's invest at a really early stage and therefore F's will give you money either as:
a gift – meaning you don’t have to pay the money back
a loan - meaning you do have to pay the money back
equity – ie they give you money, you give them shares. To avoid a discussion on valuation at this early stage you might structure the equity investment as a convertible note (*BUZZWORD WARNING*) or a SAFE (*BUZZWORD WARNING*) (Simple Agreement for Future Equity).
These are wealthy individuals (also referred to as high net-worth individuals) who invest directly into businesses in exchange for a percentage of shares. Angel's have been around the block, they love assisting or giving back to other founders, sometimes in the same industry that they worked in / owned their own businesses in. They are not a charity or pursuing a hobby and are looking for solid returns. You should think of angels as ‘smart money’ and look to what other expertise they have that might add value to your business.
Angels typically have a longer investment timeframe, so generally they invest in early stage businesses and investment by angels typically range from $20k to $500k.
Venture capital (VC)
Venture capitalists are fund managers who invest other people's money into businesses in exchange for a percentage of shares. Each VC fund typically has an investment mandate, which sets out the type of companies that the fund can invest in, the risk profile and the timeline that the fund has to make a return on investment (e.g. 2-4 years). This means that VC funding typically has tighter restrictions than angel funding and because of a focus on exit strategy, means that VC funding might only be appropriate when the company is at a certain point in its life cycle.
VC funding is also ‘smart money’ and venture capitalists usually have access to networks which can provide recruitment, potential customers, other investors and partnering opportunities. VC funding will generally result in increased reporting and disclosure responsibilities, might result in you losing some control over the business, and typically sees founders being locked into the business via vesting type arrangements.
There are loads of different grants available from different levels of the government for a variety of purposes and industries. Eligibility criteria, level of funding, conditions attached to funding really differ from grant to grant. You can search for different grants here.
Debt simply means that someone agrees to lend you money and you agree to pay the money back, usually with interest at a future date. An obvious advantage to debt is that you are not giving away any shares in your company, however it can be difficult when you are an early stage company to get a loan (cash flow might be too low to repay debt and lenders are usually less likely to take security in intangible assets, such as IP, rather than tangible assets, such as real property). Also investors might not invest if the debt to equity ratio is too high (*BUZZWORD WARNING*), which simply means the degree to which a company is financing its operations through debt versus funds received from shareholders.
Crowdfunding is a way to finance your business through, loans, donations or exchanging money for rewards or shares. It is commonly done through crowdfunding websites. It can be a great way to gain market validation and avoid giving up shares in your company before taking a product concept to market.
Different stages of funding, also called a funding round
Below are the typical stages of "equity fundraising" ie where you take money from an investor in exchange for shares (equity) in your company.
Pre-Seed Funding or the triple F round “Family, Friends and Fools”
Generally, the first stage of funding, but not normally included in the rounds of funding.
Conducted when you are getting your operations off the ground.
The funders are typically the founders, close friends, supporters, and family.
Funds may be structured as gifts, loans, convertible notes or a SAFE.
First official equity funding stage. Usually ordinary shares are offered.
Typically represents the first money raised from external investors.
Funding is intended to be the "seed" which will help grow the business.
Used to finance first steps of business, eg employing a founding team, conducting market research and product development.
Potential funders, usually founders, friends, family, incubators and angel investors (some early stage VCs will invest at this stage).
The amounts raised vary greatly - typically from $10,000 up to $2 million.
Series A is really about funding for scale. Leading into your series A, VCs want to see that you have laid healthy foundations and that product-market fit is there and that you are now looking to grow.
Series A is to support a business model that works (ie you proved this via seed funding), to scale and prove that the company can reach well defined goals
Series A usually involves a smaller number of VCs and Angels.
May be first round of preferred shares (which simply means that they have additional rights that give a holder a preferential treatment over ordinary shares).
Series A rounds are typically in the amount of $2-10 million.
By the time you reach this stage, your company is usually turning a profit but are facing challenges in scaling without more cash. You might be looking at international expansion or acquisitions or other strategies.
Money in Series B typically comes from more established VC funds. Because the company is more established, a Series B round is more rigorous. Investors will do more due diligence on the company and expect a greater suite of warranties.
The amount invested in this round is between $10 – $30 million.
Series C and beyond
By the time a company is at its Series C, it will likely be preparing for a buyout, might be raising money to make acquisitions itself, or preparing for an IPO.
At this stage, private equity funds are a common player.
Series C and beyond, can see companies raise anywhere from $15 million to hundreds of millions.
What steps you should take no matter the investor
Here are our tips:
Use your family and friends as a great way to practice and perfect your pitch - prepare a pitch deck and a term sheet
Startups don’t just raise a lump sum of cash and then be set up for life. In fact, the number of times startups are going back to the market to raise more capital has been growing.
Each round is designed to give you enough capital to get to the next milestone or stage. This ‘runway’ (*BUZZWORD WARNING*) can be as short as 12 months but some entrepreneurs push it to 6 months.
Make sure you give enough time to close a round, it always takes longer than you think.
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