Startup or otherwise, there is a specific working process followed when it comes to funding. This process, as well as its requirements and complications, may vary according to the type of business, the fund requirements and other factors but hypothetically a startup funding is considered to be a bit difficult. Why? This is because a startup does not have anything to prove as its prior achievements and mostly the lending or funding decisions depend on the personal credit of the business owner.
Typically, if a startup seeks a loan from different sources the amount offered will vary as well. It has been found that:
- When a startup seeks financial help from family and friends they can get a loan of $15,000 with or without conditions attached with it or
- About $200,000 from any angel investor but for that they will have to run their business for at least the first three years and
- About $2 million from a venture capitalist another six months later, of all goes well that is.
To know why this difference, you will need to know the working process and even before that the need for funding first.
As a business owner, funding as something that you certainly need to focus on. Funding is usually done by a third party. On the contrary, if you fund your business from your personal savings it is called “bootstrapping.” Once you find it difficult to continue this way, you will eventually look for sources of funding be it a bank or other private sources such as liberty lending US and its likes.
It is then you will feel the need to know the fundamentals of funding especially its working process right from the start to the end. This knowledge is extremely vital for you because every time you avail such funding, you give up a portion of your company as well. That means the more funding you get, you will give up more of your company.
Sharing the equity
The portion that you give up every time for funding is called the ‘equity.’ Every person you give this equity to in turn becomes the co-owner of your company.
Therefore, the basic idea behind equity is how you will distribute it amongst the persons you have taken money from for your business operations. When you start your business the entire equity belongs to you but as you take on outside investment and the company grows, this equity grows with it as well.
The growth of equity will also depend on the different funding stages and options for a hypothetical startup.
- The idea stage: This is the initial stage that involves only you working on your own ideas. Right from the moment you started working on your ideas you started creating value for your business as well. This value will later translate into equity.
- The co-founder stage: As your idea gets a physical prototype it will start taking longer for you to work on it as compared to the idea stage. This is when you will really feel the strong urge to make use of the skill of another person. Therefore, you will look for a co-founder who is not only smart but enthusiastic and compatible as well to work together in unison and agreement.
If you pay for their service they will become your employee but since you cannot pay them you will offer them to become the co-founder of your company by offering equity in exchange for their work called sweat equity.
However, the percentage of equity that you may offer to your co-founder is a point of concern. If you offer too little the person may not be interested in working with you. On the other hand, if you pay half or even more than half of the equity share you may lose the control over your company altogether in the future.
Therefore, it is important to consider two things at this moment to come out of the dilemma and these are:
- The worth of your company right now and
- The amount of risk the co-founder is taking.
You must come over and beyond the ego factor thinking that it is YOUR idea that created the startup and the co-founder is only working on it with you. You must also consider the ways, in this case the percentage of equity share to keep your co-founder motivated.
Remember, a true and valuable partnership is built on respect which is based on fairness or else it will fall apart very soon eventually. If you want your business to last for a long time, if not forever, offer your co-founder with 50% of equity share.
Sources of funding
Working with your co-founder, you will soon realize that the fund obtained is consumed and you will need further funding. You may prefer to go to a VC straightaway but then you may not have enough of products to show. Therefore, you must look and consider all other options for funding your business along with their pros and cons.
- Family and friends: Probably the best source to arrange for funds for your business. This is because they know you personally and even your capabilities and will perhaps readily agree to help you out. Moreover, there will be no or too little obligations and terms attached with such loans. However, it is best to treat these loans just like a commercial loans and have proper agreements to eliminate chances of relationships getting strained due to several factors.
- Public solicitation: You can also put up an ad in the local newspaper asking for an investment. However, for this you must make sure that you do not violate the state securities laws with such funding.
- Accredited investors: They are sophisticated investors who have large amounts in banks and earn large amount as well. However, you will need huge contacts to get in touch with them.
You may even consider Angel investors, incubators, and accelerators for funding your business. However, since money can strain relationship and even jeopardize your company’s existence, always talk to an advisor first.