When you’re working on an early-stage venture, it’s natural to want to spend nearly all your time building your product and talking to future customers, but some of the most important decisions you’ll make when building your company revolve around—you guessed it—money. After all, companies need money to survive, and few businesses become profitable overnight. So, where can you get the funds you need to help grow your new business?
Before I answer that question, let me say that raising money for a business always comes with a price—namely, a stake in your company. So, the first step should be to make sure you need it.
The two questions you should ask yourself are “What do I need to do to get this company off the ground?” and “What is that going to cost?”
Do you need to hire employees? Are there product development costs? Do you need a marketing budget? How long do you need until the business will sustain itself by making revenue? Putting together a conservative set of projections outlining your costs and profits each month will help you figure out what you need—and also help you to gut check that you have a viable business model.
If you see a path to profitability—but will need more money that you can afford personally to get you there—that’s when you’ll want to look into raising a seed round of funding.
And in that case, the next step is figuring out where to look. Here are some of the most common methods that tech start-ups use to raise seed funding to get things off the ground.
1. Friends and Family
If your company needs less than $50K (at least at the moment) and you have friends or family members with money that they can afford to invest, raising money from them can be a great place to get started. Be wary though—turning personal relationships into business relationships can get messy. It’s important to make sure that everyone understands the risks and that you don’t put yourself in a position where relationships will be damaged if your business fails. In structuring an agreement with a family member or friend, it’s tempting to keep things casual, but you’ll want to do the opposite: Use a formal term sheet to delineate what the terms of the investment are. USV’s Fred Wilson does a great job going over the benefits and potential pitfalls of seeking funding from friends and family members.
Technology incubators are a great way to get advice on your start-up, meet other entrepreneurs, and yes—get an investment for your project as well. While they do invest some money, the draw of incubators like Y Combinator and 500 Startups tends to go beyond the cash. Incubators often offer resources ranging from founder networks and expert advice to legal services, office space, professional education, and exposure. If you’re looking for a support network and a little cash, an incubator can be a great starting point. Most incubators will also sponsor a Demo Day, typically several months into the incubator program, which can be a great launching point for additional angel or VC fundraising (more on that below).
You’ll need to plan ahead though, as many incubators have set application periods where they evaluate potential companies. Some require a functioning product in order to submit an application, while others are happy to accept a great founding team. If you’re interested in learning more about incubators, here are 10 good ones for tech start-ups.
3. Angel Investors
Angel investors are wealthy individuals (often former or current entrepreneurs) who choose to invest in start-ups. They tend to invest anywhere from $5K to $200K in any given company, so many entrepreneurs will include multiple angel investors in a seed round. In exchange for funding, angel investors generally either receive equity in your company or a convertible note (a loan that can later be converted into equity). Having strong connections to investors in your industry is obviously very helpful if you want to pursue angel funding, but if you’re new to your space, AngelList is a great place to find people who have invested in your field.
4. Venture Capitalists
Venture capitalists (or VCs, for short) are similar to angel investors, but they invest money on behalf of others and almost always in larger amounts. While many VC firms tend to invest in Series A and later (a.k.a., they make larger investments in start-ups with a little more traction), there are some that focus on seed-stage investments, or have a branch that does. VCs will generally invest in exchange for equity or a convertible note in your company, just like angel investors, but they may also ask for a board seat. (Note: VCs are notoriously difficult to get meetings with. In an upcoming article, I’ll talk about getting your foot in the door.)
Crowdfunding platforms like Kickstarter and IndieGoGo allow you to raise money from individuals who are willing to pay for your product in advance (meaning you don’t need to give away equity in your company). If you’re working on a consumer product that you plan on charging for, Kickstarter is a great avenue to consider (think the Pebble watch, which raised an amazing $10 million). IndieGoGo allows you to fund non-physical goods (like social networks or other online projects) as well. That said—an effective crowdfunding campaign requires a great deal of effort, so make sure you have the time and energy to devote to it. And while there are great success stories, the average Kickstarter campaign raises $5,000, so this may be a more viable option for companies with smaller funding needs. (Check out The Daily Muse’s guide to getting your Kickstarter campaign off the ground.)
Most companies will choose a combination of these platforms for their initial funding after exploring all the options. InstaEDU’s seed round was comprised of one VC firm, several angel investors, and one family member. But we talked to many, many more investors in the process of raising our $1.1 million in funding.
So, what’s next? Before you set up any meetings, you’ll need to get organized and be ready to most effectively sell your company’s story. Next up, I’ll walk you through how to put together an awesome pitch deck.