Understanding the different types of startup investors
Starting a new business takes resources, and one of the biggest of those is money. Just getting an idea to the prototype stage can quickly eat away at your life savings, even if you are a high net worth individual.
There are all kinds of setup costs for new or small businesses, ranging from buying or leasing premises to machining and prototype costs, trademark and intellectual property checks, and paying a wage to yourself and any employees that you hire.
Pre-seed finance covers the very early-stage costs and is a way to get off the ground if you don't have savings of your own to spend. It comes very early in the process, often before your innovation has proven market value, and it's not uncommon to raise money from friends and family rather than institutions or venture capitalists.
Seed rounds take you to the next stage. It can cover a first full manufacturing run of a product that has proven potential as a prototype or the costs of hiring your first employees so you can grow your company.
There are many different sources of investment at all stages in the life of a business, from pre-seed and seed funding right through to subsequent equity funding rounds. Here are some of the most frequently used sources of funds for startup businesses.
Friends & family funding
Startup funding from friends and family is one of the most significant sources of finance for startup companies and entrepreneurs every year.
The amount you raise in this way can vary from a few hundred to tens of thousands of dollars to cover your setup costs.
Friends and family funding can be quite informal, but you can also protect your arrangement with a friends and family investment agreement so that all the agreed terms are in writing.
Because funding from friends and family is usually for quite small amounts of money, this is a frequent source of pre-seed finance very early in the setup of a new business.
You can benefit from flexible terms and the support of a loved one who wants to see you succeed, and who might not even expect equity or interest in return for their loan.
The support of your family and friend investors can also be a positive sign to angel investors, as it shows that you are not the only person who believes in your innovation.
Just be careful that your business arrangement does not put stress on personal relationships, as many good friendships have ended this way in the past.
Crowdfunding has become a widely used way to raise seed funding for all kinds of business ventures.
If you want to retain ownership of the equity in your business, crowdfunding is a good option, as it often does not require equity to change hands.
Instead, you may accept finance on terms similar to a conventional business loan, where you promise to pay back the loan with interest at a specified date.
Alternatively, some crowdfunding platforms reward investors with perks and preorders, so your supporters might put in a small amount of money each to receive your product when you complete its manufacture.
Crowdfunding can be an effective way of covering the costs of a first full manufacturing run, as you gain the confidence of knowing you have already sold a certain number of the product.
However, remember that crowdfunding platforms often operate on an 'all or nothing' basis, where you must achieve pledges worth 100% of the amount of money you seek before you receive any payout from the platform.
For investors, the 'all or nothing' approach provides some useful protection, as it means if your venture does not reach its funding goal, they will get back the full amount they had pledged.
Crowdfunding is not for everyone, and you might prefer to look to more traditional investors first, but for certain types of venture, it has become a flexible and effective way to raise seed money.
Angel investors are high net worth individuals who aim to add to their wealth by investing in innovative and entrepreneurial business ventures.
The level of investment made by individual angel investors can be quite high, often up to $100,000 or more, so landing an angel investment can be significant for your startup business.
You might also find that an angel investor is not only impressed by your product, but also by you as a person.
Many angel investors choose to mentor the entrepreneurs with whom they work, nurturing their natural talent to encourage innovators to bring more of their ideas to market.
Over time, a business relationship between an entrepreneur and an angel investor can become close and rewarding.
If you have the opportunity to work with an angel investor, try to decide what you want to gain from the partnership, whether that is just a source of short-term funding or more of a long-term mentoring role to help you build your business career.
Not all angel investors work alone. In some cases, several angel investors pool their resources and expertise into an 'angel group'.
If you take startup investment from an angel group, you might deal with multiple members of the group, or you might have a one-on-one relationship like that described above.
One difference between angel groups and individual angel investors is that groups usually have considerable resources available and, therefore, might be willing to invest a more substantial sum of money into your business venture.
The group may also have a broader area of expertise if its members have individual experiences of different sectors, or a deeper understanding of a single industry if multiple members of the group focus on that particular discipline in their investments.
Again, working with an angel group can be the start of a long-term collaboration, so choose carefully and try to decide where you want that professional relationship to go in the future.
Don't be tempted to grab the money just because the offer is there. Any investment is only worthwhile if you are happy with what you get out of it, so make sure you know what to expect and whether or not that aligns with your personal career goals.
Business accelerators exist to help new startups get established more quickly and reduce the risk of them failing due to being unable to cover initial setup costs.
Accelerators can also act as gateways to other kinds of investment; for example, a startup business incubator might be able to put you in contact with angel investors in your chosen industry area.
The sums of money involved are usually in the pre-seed and seed finance range too, from a few thousand dollars to a few hundred thousand dollars.
Unlike the kinds of lending already mentioned above, incubators are usually not looking to enter into a long-term relationship with you.
Instead, startup accelerator investors often lend on quite strict time-limited terms, with clear expectations of what you will pay back and when.
It's normal to have a clear repayment schedule when you take out a business loan, so this is no bad thing in itself.
But if your previous funding came from friends and family, incubator finance can be a big step up into more formal sources of finance.
A family office handles investment on behalf of a wealthy family and can be a useful source of funding if your business venture aligns with the family's interests.
Unlike institutional investors, a family office might base its investment decisions not solely on the balance of risk and reward, but also on more philanthropic conditions.
You might find some family offices more willing to invest if your innovation has clear benefits for the environment or humankind.
However, others may be more profit-driven and merely looking to generate income for the family they represent.
Family offices that represent several generations of the same family may also look for long-term opportunities as a way to raise capital gains over years or even decades.
Again, try to establish what the family office expects from the outset and decide if those aims match your own, whether you want a long-term investment partner or you are seeking investment to act as a short-term bridging loan.
Accelerators and incubators
Business startup accelerators and incubators are a good source of seed funding, as they typically invest at an early stage and encourage rapid growth and maturity of new ventures.
They often focus on a specific industry or field of innovation, such as emerging technologies like next-generation renewable energy or artificial intelligence.
Alternatively, you might find incubator funding available in your area as a way to boost the local economy, no matter what sector your business targets.
Startup funding from accelerators and incubators is likely to come with specific deadlines, so make sure it fits your business plan and financial forecasts.
Accelerator schemes sometimes come with other perks, such as access to business networking groups and help to reach out to other companies in the supply chain, so the benefits to your new venture might not only be financial.
However, you may need to demonstrate the viability of your innovation to secure the funding, so if you plan to approach an incubator for investment, make sure your projections are accurate, rigorously researched and support the level of investment you are seeking.
Venture capital firms
Venture capital firms invest tens of billions of dollars each year and are known for investing some of the most substantial amounts at the seed stage of innovative companies.
But it's not always easy to get investment from a VC. Unlike some of the sources of funding mentioned above, VCs are much more rigorous in their due diligence.
They also see a vast volume of applications and only invest in around 1% of these, so there is a high probability that a VC will reject your application for investment.
To have the best chance of securing VC investment, you'll need a clear business plan and a proven concept that is ready to take to market.
You can also expect to hand over an equity stake in return for the VC investment, so be confident about the valuation of your company and how much of it you will sell if necessary.
In return for an equity stake, you'll usually get close involvement by the VC. This involvement gives you the benefit of their experience and expertise, in exchange for a director-level role and an influence over decision making.
Corporate investors are driven by different motivations, from social and environmental commitments to tax planning or a desire to foster innovation in their supply chain.
What they have in common is their size. These are typically huge corporations that may have a multinational presence and substantial resources to put into your venture.
Everything comes at a price, so the more a corporation invests into you, the more of an equity stake you may have to hand over in return.
But by finding a corporate investor in an industry relevant to your own, you could gain a powerful ally, with a direct route to market and connections across the supply chain that far outweigh your contacts as an individual.
Many corporate investors have established investment programs of their own. The funding they make available may be on terms very similar to a startup business incubator or accelerator.
Look for annual investment programs and 'competitions' that invite you to bid for funding against other entrepreneurs and innovators.
By being aware of these, you can time your application to align with the next round of funding, without missing out on potentially lucrative investment just because you missed the deadline.
Find out more about Startup Valuations & Funding Rounds in Episode 15 of Brex in the Black, with Brex's CEO Michael Tannenbaum.