Dropbox, Airbnb, Twitter – all these succesful companies have one thing in common: they became successful using the lean startup model. This method questions traditional business concepts and procedures, and instead promises greater flexibility and innovation. But what do lean startups mean for product development and company culture, and how can you benefit from these new ideas?
Initial capital and long-term financial support are important goals that startups achieve in order to be successful. Startup companies are dependent on an innovative business idea, and are in quick need of money to make their initial growth sustainable. Exactly how much capital a company needs depends on their business model – but what should the company do with the money once it receives it?
In addition to traditional lenders, such as banks or state institutions, there are now numerous sponsors and creditors who have specialized in funding startups. The beginning of a startup differs in part from that of a company with an established business model. What are the options for establishing and funding a startup?
- How does a startup successfully get capital?
- Startup financing with equity
- Startup financing with credit
- Advice and public funding for startups
- Startup financing using the ‘crowd’
- Different phases of funding a startup company
- Bootstrapping as an alternative: Founding and financing a company independently
How does a startup successfully get capital?
If you want to start a business, you will need a certain amount of initial capital. The amount varies from case to case: Some startups need very little money at the start, while others must have five- or six-digit financial backing right from the beginning to set up their business.
Either way, a company needs to establish accurate, long-term business financing. This will make it easier to assess the amount of money required for each area of business. The finances required for a startup are composed of both equity and debt.
Few founders have made enough capital available to start their business themselves, which is why external lenders often have to be convinced to invest in the business idea. There are different ways to attract lenders and investors, but generally, a comprehensive business plan is required. This applies in particular when it comes to bank loans and other institutional subsidies. However, some content startup founders are satisfied with a simple financial or liquidity plan at the outset. You should consider how much time you will be able to spend, and how you will come up with this plan.
Startup funding differs from the subsidization of conventional companies, meaning that startups often operate in a new market, or in a market which does not yet exist. In a less stable business sector, donors can quickly become classified as risk-averse. Financiers are especially reluctant to invest when there is no proven business model yet in the targeted economic sector.
However, there are a number of other ways to acquire startup funding. Our overview gives you clues that might be relevant to your company.
Startup financing with equity
Equity refers to capital that the founder or owners of a company provide when funding a startup, which remain as an asset in the company. Since your startup will not be profitable during its initial phase, you should first be asking: do you have any money that you want to invest in your startup? If not – are there other startup financing options for external equity applicable to you?
Many founders use their personal assets as a contribution when funding their startup. Whoever can finance the operation completely out of their own pocket retains the greatest possible self-determination – but also stands to lose most of their own assets should the company fail. In most cases, external money is required to fund a startup initially. It is particularly necessary to get funding quickly if the business model requires greater investment, many employees, and/or a comprehensive infrastructure.
Borrowing money from the private sphere
Some founders turn to family, friends, and/or acquaintances to secure startup funding. They may be able to help financially by lending a limited amount.
Anyone who chooses to borrow from the private sphere can often do so without interest and may have the option to repay the sum over a flexible period – which has a clear advantage over a conventional loan. However, loans from friends or family members are delicate in their personal nature, and can lead to disputes. You should therefore make sure that you go through all the repayment scenarios together and make clear agreements with the lenders – best made in writing. In general, however, your sponsors need to be aware that startups fail relatively often and that you will not be able to repay your debts immediately.
If you borrow money from your circle of family and friends and bring it into the startup under your own name, it counts as your personal equity at the company. It is also considered to be an equity investment if you give the creditor shares in your company equal to their financial contribution – the difference is that that person then becomes a startup partner.
Private partners and startup sponsors
As a matter of principle, you have the opportunity to win over shareholders for your startup. Initially, these can be those already mentioned, people who are familiar with you (family members, friends) or business contacts.
Startup financers are specifically known as ‘angel investors’. These financiers not only provide the company founders with the startup funding they need to invest directly in the development and economic power of the startup, but they can also generally help with the development and/or expansion of the company. In return, these financiers usually require company shares. In many cases, the shareholders also gain the ability to make co-decisions in the strategic directions of the startup operation, limiting your self-determination. In this instance, it is mainly about how you cooperate with the partners and whether they share your ideas with regards to the company.
Private startup founder centers
In addition to public startup funding, there are various private sector startup centers – sometimes known as business incubators, some as accelerators,company builders, innovation centers, or new business centers. You will have to become a member of these institutions to gain any benefits from them. Depending on their orientation, startup centers promote different kinds of startups (some centers only support technology-oriented startups or student/graduate startups, for example). However, what they all have in common is the fact that they can take advantage of, and nurture, startup companies that qualify for their programs at an early stage. As a rule, startup centers offer financial, advisory, and infrastructureassistance: they contribute capital to the startup (for which they’re usually given company shares) and provide coaching and support for the establishment and growth of the company.
Additionally, they can often help with getting further capital and contacts in the industry, as well as suitable premises for companies (offices, factories, storage rooms etc.).
This article from Forbes outlines basic methods of acquiring startup funding, including incubators and company builders.
Another option for corporate financing is venture capital (‘VC’, also called risk capital). This is off-exchange equity capital, with venture capital companies (affiliates) acquiring company shares in a company that is regarded as liable to risk. These VC companies often take a bigger role influencing business strategy and business decisions than business angels or private business incubators would. This is due to the high sums of money they inject into a startup.
However, startup investors rarely take an active interest in companies that are still in a very early stage – they tend to act later than large-scale investors would. The goal behind their investment is usually to reap the benefits of a profitable sale of the startup shares.
This article from medium.com provides an overview of venture capital providers for startup founders in the USA.
Classic VC companies are active in the financial sector and normally have more capital than business incubators, or wealthy private individuals. Another form of risk capital that the founder of a startup can obtain is Corporate Venture Capital (CVC), which is awarded to startups by large corporations and affiliated groups. By funding a startup which is active in similar sectors, corporations can diversify their offering.
Startup financing with credit
Loans are commonly used to secure startup capital, consisting of funds that are to be repaid within a certain time and are usually subject to an interest rate. Usually loans are taken out from financial institutions.
Classic bank loans
Bank credit is one of the most common ways of funding the start of your company, however, many banks can be reluctant to provide startup funding, as their entrepreneurial plans are often classified as being more risky than traditional business models.
Another reason why banks cannot afford to provide credit to many startups is because the founders usually do not have sufficient collateral. However, you should not write off the possibility of a bank or credit institution immediately.
Loans for business startups
In the United States, there are institutions set up specifically with the aim of providing funding for business startups. The most well-known and reputable of these institutions is the Small Business Administration. The SBA runs a number of loan programs, the most well-known of which being the 504 Loan or the Certified Development Company program. This loan is provided by an SBA-approved lender (generally, a bank) and the proceeds may go towards founding your startup or small business.
Advice and public funding for startups
There are different counselling and advisory options for entrepreneurs. The U.S. Chamber of Commerce provides information and assistance to companies in almost all industries. The Chamber of Commerce has branches all over the USA, as well as a number of affiliate organizations which may also be able to assist you.
Many universities also provide assistance for those seeking information on founding a startup, or acquiring startup funding. Public subsidies are particularly attractive, and are aimed at startups. If you can successfully apply for these funds, you will not only receive help with the financing of your startup company, but also (long-term) guidance. State funding for startups usually offers better terms and conditions to startup founders than loans from private companies.
To receive state funding, an application is required for each individual program. As is often the case, you are also required to do some persuasive work: Those applying for funding have to introduce themselves and their team, and then justify why they deserve the money.
However, the effort required to make your case can be massively reduced if you have a strong business plan that you can base your application on, or be able to tweak certain aspects to meet the application requirements. A suitable tender always provides a good change to improve your startup financials, so it is always worth sending an application.
The most commonly available subsidies can be divided into funding programs and competitions.
Startup funding programs
If your company is picked to participate in a funding program, you will usually receive a loan that is characterized by low interest rates and/or long-term maturities. The start of the program is often considered to be a grace period, where the repayment of debts is suspended. Support programs for startups tend to be specialized in certain sectors. They are often available on a federal as well as a regional level (usually with reference to a state or a city).
In addition, the Small Business Association has a lot of information on corporate finance and financing on its website. For example, you can find various support programs for startups in specific areas, such as those starting a high-tech startup.
Startup funding competitions
Competitions for general entrepreneurs and startup founders do not just focus on winning financial support. In addition to money and material prizes (such as coaching, guidance, and consulting), professional feedback on the business model and media attention for the company are often up for grabs. These benefits may lead to new contact opportunities. Forbes once again provides a concise article concerning startup competitions.
Nowadays, there are many startup competitions, with very different requirements. Some refer explicitly to certain stages in which a startup needs to be in (e.g. still in the planning stages, already established). Furthermore, there are different types of competition, such as the idea or business plan contest. Grasshopper.com provides a comprehensive list of the best business competitions currently running in the Unites States.
Startup financing using the ‘crowd’
Crowd funding, crowd lending, and crowd investing are still relatively new financing possibilities for companies. A ‘crowd’ is a group of people who want to co-finance a particular project, using individual contributions.
Crowdfunding (also known as crowdsourcing) is about winning people over with your ideas, and convincing them to give you their money to implement them. This approach is particularly suitable for financing specific projects or products, but not necessarily for general startup financing. In the startup context, crowdfunding proceeding to create a product prototype or for the development of specific software is not uncommon.
Crowdfunding usually takes place on a crowdfunding platform such as Kickstarter or Indiegogo. On these websites, the campaign founders can set up a project page, where they present their idea and indicate the target amount for the campaign. Usually, this target amount must be reached within a certain time – if the crowdfunding goal has not been achieved by then, all donors will have their contributions returned to them because the campaign is considered unsuccessful.
If the crowdfunding succeeds, backers receive something in exchange for their financial support. It is rarely a monetary recompense, but rather a small gift or token related to the project. Top-level financiers, on the other hand, often receive high-quality, unique tradeoffs. If there is no reward or thanks offered to the supporters (even something like the donor’s name being included on the website) then this is known as a ‘crowddonation’.
Crowdinvesting is a modified form of crowdfunding. The focus is on monetary investment from various donors, who can support a company being founded with small amounts. Just like crowdfunding, the hope is that many different supporters will come together to reach the financial end goal. If a startup is successfully established by crowdinvesting to the point of being profitable, investors can expect compensation for a percentage of their contribution.
There are also various platforms for launching a crowdinvesting campaign (eg. Companisto or Wefunder) Some are a combination of crowdfunding and investing. The chances for general startup promotion are usually higher at crowdfunding websites like Kickstarter and Indiegogo.
Crowdlending is another similar model, which works much the same way as a traditional loan. The loan is provided by several creditors (often individuals) and then bundled into a loan. Applicants usually receive the loan with an interest rate (if the loan does not have an interest rate, it is referred to as social lending). However, interest rates for crowdlending loans are relatively high compared to other traditional loans.
There are several online platforms for securing crowdlending funds. Particularly popular in the USA are LendIt and Lending Deposit. Crowdlending is an attractive option for those people and companies who need a loan, but have no chance of securing a traditional bank loan.
Different phases of funding a startup company
Similar phases can be observed time and time again when it comes to the startup financing. From that, it is possible to create a model for the typical stages of development of startups, which differ significantly from the founding and long-term strategy of regular companies.
Only in the rarest of cases would a startup be financed entirely by one individual’s means. Support from several independent financial sources is far more common: various donors, whose combined capital fund a startup over a long period, are not uncommon. If the startup is successful, it will transition through different stages of funding, whereby it receives increasing sums of money each time.
A distinction is made between the early stages (seed phase and startup phase), the expansion stages (growth phase, bridge phase), and the later stages. What are the reasons for these financing phases, and what kind of donors can be found in each of them?
Early Stages: Foundation financing
Whoever is founding a startup needs a certain amount of startup capital in order to get the ball rolling. How much you need for those first steps depends on your business idea. It is therefore important, first and foremost, to define your business plan early and be aware of your early stage financial options (seed financing phase).
Only afterwards in the ‘startup phase’ do you actually develop the final product (product or service you are offering). Additionally, you also deal with organizing the processes necessary to market the product.
Every company begins with a business idea. During the seed phase, company founders devote everything to laying out every detail and specification of it. The better your business plan, the easier and quicker it will be to secure startup financing and sustainably promote your startup.
Market and target group analyzing contributes to the development of a forward-thinking business model. In addition, discussions with people already involved in the area can help you review and solidify your business idea.
In the seed phase, you should also take a careful look at your team. Above all, you should assess whether you need more employees or expertise for the implementation of your startup. After all, it is not the business plan alone that convinces investors and lenders, but the people behind them and their expertise. Your chances of being awarded a subsidy increase considerably if the team has all the necessary skills, and presents itself competently to potential investors.
Establishing contacts in your industry is another important step when creating your startup. You can profit from the experience of others in terms of corporate financing and a number of other areas. As a founder, you might even encounter someone so enthusiastic about your business idea that they come onboard financially or as an employee or consultant.
What’s more, it is important that you start off by explaining how much money you are likely to need to implement your idea. Well planned and researched financing is not just a matter of being professional, but also shows your investors how much their contribution makes up of the total amount needed. Always keep in mind that subsidizing an unfounded startup is always a high risk for investors. That is why you should always be as transparent as possible and convince them that your project has a good chance of success.
The seed-stage usually lasts approximately one year. The money needed during this period is quite manageable compared to later development stages. Depending on the respective industry and the product, you can aim to raise between $50,000 and $500,000. This is the bracket generally required by startups during the seeding phase. However, the search for funding during this period is generally the most difficult, since initially you will not make a profit and it is rare for founders to have much in terms of collateral. Classic forms of acquiring startup financing for a company during the seed phase are:
- Your own capital: Some entrepreneurs use their own money to invest as equity in their startup. However, it is unlikely that their money will be enough to finance the seed phase entirely, and it is also rare for a founder to use all their savings funding their startup.
- Family, friends, and willing wealthy donors: Individuals within the family and friends circle can also help financially to increase equity. However, shareholders who are impressed by your company concept may also want to invest in it. This group is also known as ‘Family, Friends and Fools’ (FFF). The term ‘fools’ is meant jokingly: If financiers provide money for startups (e.g. because they are so impressed with the business idea or they found the founders to be likeable), they tend to overlook the startup’s weaknesses and/or risks.
- Angel investors and private business startup centers: Startups can source monetary as well as advisory support through angel investors and/or startup centers. Angel investors invest in companies where they see a lot of potential and act as mentors for the founders. Aside from providing equity, they also provide their knowhow and network connections for the startup’s benefit. In return, they get company shares and become co-owners of the startup.
- Public funding programs and grants: Founders can also apply for funding aimed at startups. Many of these funds come from public funding schemes designed for startups, or private sector institutions. There is also the option to participate in a business plan/idea competition for those in the seed phase.
- Financing through the crowd: Crowdfunding, investing, and lending can form the financial backbone of your startup. If you opt for one of these campaigns, you should make sure you are properly prepared. The presentation of your project on the website should be detailed, but not too far-reaching and, ideally, should contain a high-quality video or images.
The beginning of this phase marks the beginning of the startup proper. At this point, everything revolves around making your entry into the market as seamless and professional as possible. To achieve this, you will need to develop your product further and start producing the prototype. You will also need to expand any necessary infrastructure (development, research, production, sales etc.). During this phase, you will usually decide whether to design the product yourself or hire an external designer, and whether to handle the distribution yourself or outsource.
Aside from product development and upgrading your infrastructure, you will also need to focus on customer acquisition. You can start launching and advertising your first marketing campaigns. You should also plan in detail how the startup will be financed over the coming years of this phase. Creating a timetable for this will not only allow you to orient yourselves and evaluate your financial situation at any time, but also helps you acquire new financiers and creditors.
It is still too early a stage to realistically expect to be profitable. The previously mentioned necessary investments will likely result in your startup still being in the red, which is why it is so important to find investors who share your vision and believe in the concept.
The startup stage typically ends with the launch of your product. For some companies, however, this developmental phase doesn’t end until they reach the profit threshold, or start ‘breaking even’. Your startup has reached this stage when the costs and revenues generated equal your manufacturing and distribution costs, so that you are not making any profit or loss.
Overall, the startup phase generally lasts 1-3 years. The costs during this phase will likely increase, as you will need to spend more money on new employees and campaigns, as well as developing and producing your product. To be able to cope with these expenditures, you should make an effort to get involved in startup promotions, which usually come from similar sources as those in the seed phase:
- Startup sponsorships: Angel investors and private startups are often willing to take on existing companies.
- State subsidies for already established startups: Even though many public funding programs and startup competitions are aimed at companies that are not yet on the market, there are some similar options for already established companies. Although there are few that cater specifically to existing startups, some programs and business plan contests also accept applications from startups that are already active in the market for a specific time (e.g. one year). As a rough guide, a business should not be older that 1 or 2, maximum 3 years to have a chance at getting public funding.
- Funding from the crowd: The startup phase is also ideal to gain startup funding from people who are inspired or impressed by your company. Especially with funding from the crowd, you benefit from the fact that potential supporters/investors do not consider their contribution as risky after the initial foundation of the company.
- Venture Capital: Some VC companies only invest during the initial seeding phase, while others are willing to invest during later phases. It is always worth applying for VC funding, as it can take up to 12 months for the final decision to be made as to whether they will finance your company.
After successfully entering the market, your next goal is expanding your startup. This period, known as the expansion phase, is again subdivided into two stages: the growth phase and the bridge phase.
During the growth phase, the first thing you need to do is establish your product on the market. In order to ensure its availability, you will likely need to expand your distribution and production. You will also need to invest more in marketing, to make the product more widely known. If this succeeds, then demand will also increase, which will in turn increase the turnover of the startup.
It is not uncommon for the size and number of competitors in your field to be constantly increasing. This is often the case when a startup is created in a new market area that did not exist before, but is now well-established and full of imitators. The rule of thumb here is: The more competition there is, the more capital your startup will need. Usually, you can only offer your product effectively and secure an advantage over your competitors with a broader budget at your disposal. Therefore, you should invest more money in production, sales, and marketing during this phase.
Many startups expect the company to make a profit during the development stage, however, there are many who won’t be in profit until much later on. If a startup wants to successfully penetrate a market, it is going to involve many costs and is unlikely to pay off until a later date. It is not absolutely necessary to reach profitability during the growth stage.
However, the sooner you reach profitability, the sooner you are in a better position to obtain additional funding that you will need to expand your business. Once again, higher equity will make the company attractive to a larger circle of donors. At that point, there will be even more companies and credit institutions interested in your startup. Income sources often used during the growth phase include
- Loans: As soon as your business becomes profitable, the chances of securing a loan from ordinary banks increases significantly.
- Angel investors:Startup sponsors are usually also involved in the growth phase.
- Venture Capital companies: VC donors are usually more willing to participate in the further startup financing with large sums of money if it can be hedged financially. The corresponding investments are usually within the range of $1million.
Some companies which have made it up to this point and are still able to make a profit then move on to the ‘bridge phase’ (or ‘bridging phase’) by preparing to enter the stock exchange. Accordingly, this development stage is also referred to as a pre-IPO phase (Initial Public Offering – the first time that a company places securities on the stock exchange).
Preparations for an exchange run require fresh capital. But even if entrepreneurs do n ot decide to enter the stock exchange at this point, they will still need capital to buy back shares from their shareholders.
In addition, companies in the bridging phase must continue to deal with their position in the market, and make further investments to solidify it. As competition usually increases during this phase, diversifying your products is usually a sensible idea – it will help your products and your expansion into new markets succeed.
The necessary capital is often paid to companies towards the end of the expansion stage from such sources as:
- VC companies: Startups that are in the bridge phase can also attract new venture capital providers (often corporate venture capital companies). However, these rarely exert heavy influence on the company and do not fulfill much of an advisory role. Since investing in a company during this phase is far less risk-sensitive, they are often referred to as a private equity company rather than a venture capital providers.
- Borrowed capital from banks: As the startups creditworthiness increases, traditional banks are now more willing to grant you a substantial loan.
- Bridge loans before the stock exchange: If a startup decides to enter the stock exchange, it can be financed through institutions such as investment banks or investment funds.
During the ‘later stages’ of startup financing, the company is now firmly anchored in the market as an established company, or even a market leader. During the final phase, funds are used to expand the company’s offering (new products, expansion into other countries, etc.), in terms of marketing measures as well as company management, or for the restructuring of the startup.
If, for example, the founders are interested in parting ways with the company, this is an ideal time to sell. This is then referred to as the ‘exit’ or final phase of the startup.
However, if the founders choose to remain with the company and develop rather than sell, the maturity phase begins. Financing options are quite diverse at this point: progressively searching for further investors and lenders is just as much an option as the increased accumulation of self-generated capital. If the stock exchange launch was successful, profits were also generated.
Exactly what the later stages of a (former) startup looks like cannot be definitively described. Any company that has made it to this point is looking back on a history of successful corporate finance.
Bootstrapping as an alternative: Founding and financing a company independently
Despite the various financing options for startups, some founders deliberately choose to fund the startup entirely by themselves. If the company is created without the aid of external investors, this is known as bootstrapping.
Advantages of Bootstrapping
Typical startup investors, such as angel investors, incubators, or VC companies expect a tradeoff or reward (such as influence over the direction of the company) in exchange for their financial and advisory support. Startup founders who do not avail of their assistance are able to retain complete autonomy and control over their corporate decisions. They also reap full benefits of any profits.
In most cases, companies that finance themselves completely are more efficient than other, externally-financed enterprises. Due to the scarcity of money, unnecessary costs are avoided.
Anyone who uses the bootstrapping strategy and manages to build a profitable company also increases their reputation as a founder and entrepreneur. If you find yourself in need of external funds later in the process, or for a new project, you will be more likely to secure them with a successful reputation. Investors and lenders also have greater confidence in founders who have already been successful with a business model founded from the ground up. Business partners and clients are also likely to be impressed.
Disadvantages of Bootstrapping
Those who do not wish to be dependent on external investors and who want to build up their own company alone, or with their co-founders, usually require more patience and perseverance. As a result, the company’s capital needs to be largely self-sustaining until a large amount of money becomes available through revenue. However, some business ideas require more capital, especially in the expansion phase.
In addition, the risk of loss when bootstrapping is higher: if founders have to provide all the startup funding themselves, and then subsequently find themselves in the red and have to file for bankruptcy, they are solely responsible for the costs. Accordingly, there can be a lot of pressure when it comes to self-financing a company. In addition, you cannot benefit from the advice and experience of external investors when bootstrapping.
There is a diverse range of options when it comes to startup funding
If you have a convincing startup concept, you will be able to select a range of different supporters to finance your startup. In most cases, a professional business plan that is neither too short, nor too long will help you attract potential investors to invest in your company.
The type of financing needed before, during, and after the foundation of your startup can often be very different to financing a typical regular company. When it comes to startups, many investors are not looking for dividends or interest, but rather to acquire company shares with their subsidy. Startup financers such as angel investors or venture capital firms often view investing in a startup as a risk capital investment, which will be worthwhile through sustained profit distribution or through the profitable sale of shares.
Selling company shares allows you to act immediately with greater financial force. You will also benefit from advisory contributions of external sponsors if you do not have any relevant experience in financing and founding a company, and your shareholders support you. This can be done through other avenues aside from advisory functions, such as assistance in business operations. In return, however, many investors require a certain amount of say in the direction and operation of the company, which means that you may lose part of your decision-making freedom.
For founders who have sufficient capital and/or a business model that can be quickly monetized, bootstrapping is also an option. Using this approach, you try to build up your startup carefully without having to rely on external investors for equity. However, unlike when working with shareholders, you alone are liable for the financial risk. Due to fewer financial resources, the company will not be able to grow as fast. However, you do retain 100% control over your business.
Those who do not have the necessary funding for their startup do not necessarily have to sell all their shares to make money. You can also try to secure loans, state startup funding, or funding through the crowd. The financing and development of a startup depends on many factors. As long as you have a promising business idea and a convincing means to secure suitable funding and capital providers, you will have a range of options to finance your startup.