You’ve come up with the idea of the century and you even have a really cool name for your business venture. And, now it’s time to go get the funding you need to get your venture off the ground. You have even imagined venture capitalists lining up outside your door ready to write huge checks for the chance at funding the next Google.
But, that’s not the way it works. Suddenly, you realize that you will need to go to them, but you’re not sure who’s best for funding your start up – venture, vulture, angel or investor. The bottom line is that the type of business you have and the amount of funding amount you need will dictate which type of investor to approach for funding.
In all cases, you’ll be trading equity in the business for funding. And funders are taking a risk, so they’ll be looking for a substantial piece of the equity pie. Here’s what you need to know when looking for startup funding:
Friends and Family
Often, this is the first line of financing for small businesses. For amounts under $500,000 this may be the best option. But since it involves friends and family it also comes with a serious risk of damaging your personal relationships if things don’t go well.
So, if you go this route, make sure you have clear contracts with each investor that clearly state what the terms are and what their equity share will be. You should also be up front about the risks involved and talk about how to handle the personal vs. business relationships.
You may already know an angel investor. They are usually professionals and business people in your community who have money to invest and are interested in championing a promising start up that offers the potential for significant returns. Angel investors are the source of funding for at least one in five startup ventures.
A typical investment from an angel is somewhere in the half million dollar to one million dollar range. They tend to look for “overlooked” situations that have growth potential even though all of the pieces, such as key management, are in place. They are interested in finding a niche venture that has early market entry and solid growth prospects.
Since they invest in the early stage of business development, Angel investments come with high risk for the investor. But, since they are in on the ground floor, they also have the potential for a huge return if the business takes off.
This round of funding is typically followed by some additional rounds of angel investing rounds of or moves up to venture capital funding.
Venture Capitalists (VCs)
Generally speaking if you’re looking for anything less than a couple of million dollars, a venture capitalist will not look your way, unless the funds are the seed money for a series of future funding rounds. But, if your business plan doesn’t require funding beyond two or three million dollars, it is probably not worth their time.
VCs tend to consider only those ventures that have tremendous upside potential and where the profits are realized quickly. This is why VCs tend to favor new technology companies, especially software, where there is potential for huge growth in market share.
Also, VCs tend to work within a private network, which often consists of alumni from successful companies they have previously invested in. Many entrepreneurs whose personal fortunes have benefited from VC funding, in turn become VCs. But unless you know someone who knows someone who runs one of these successful companies, you’re not likely to get any face time with a VC.
Even if you are lucky enough to find an angel investor, they may not be able to come up with the funding your start up needs; however, they may provide the impetus to gather a crowd of investors. Angels with strong community ties and reputations can often attract additional investors, albeit on a smaller scale. They can also provide your venture with legitimacy that can empower you to approach your own network.
Granted, this isn’t a start-up option. Vulture Capitalists are investors who try to profit from buying out an existing business that is in financial in trouble. They are definitely sources of funds, but they are only interested in snapping up troubled businesses that have the potential for being turned around.
While they may present themselves as “turnaround specialists”, their terms for providing rescue capital are often onerous and frequently result in the founder losing a substantial portion of business equity. If vulture capitalists ever come knocking, it probably means that your business may be worse off than you thought, but it also means it might be salvageable. That last point is important to keep in mind when looking at this option. So, proceed with due caution and evaluate whether or not the terms make it worthwhile for you to take this option.