Start-ups today are launching and growing at a pace never seen before. Australia boasts of having a strong eco-system and has one of the highest start-up rates in the world (5.8%).
From the initial ideation stage to the eventual IPO, start-ups need regular funding to take off and keep going. As a founder, you should know what funding options you have and how you should negotiate a valuation with the investors.
This is a comprehensive guide to funding stages that will help you understand the financial consideration and strike the right balance between retaining ownership and securing capital.
Start-up Funding
It’s typical for start-ups to require external funding and cannot only sustain themselves by bootstrapping. Prior to seeking external funds, you must have an understanding of the start-up funding rounds so you have a better idea of growing your business.
Each round of external funding leads to the dilution of your equity as new co-owners are brought on board. Investors get a share of the equity in exchange for funds.
Valuation before funding rounds, the legal documents required and eligibility for equity are all regulated areas and founders will need to enlist a legal expert to help them draft documents and advise you through the process.
Bootstrapping
While bootstrapping is not exactly a start-up funding round, it is the first step for your business. Bootstrapping refers to investing your own money into the business to start working. The first stage is the ideation where you only have an idea. Without any created value, seeking external funding can be hard.
You can also add in people who share your vision and can serve as co-founders. Together with your funds, you can start the business. At this point, it is preferable to keep your overheads minimum and focus on expanding a client base so you can develop a growth trajectory. At this stage, you will have complete ownership of the business.
Family and Friends
Since you cannot go to the public with shares, private companies can take off by inviting family and friends to invest in their business. You can offer equity in exchange for funds. There are two main benefits of this approach: these individuals are less likely to ask for detailed financial projections and statements and since they already know you, it can be easier to get investment. The only downside is that you will be mixing your personal and professional lives which may lead to trouble later.
Angel Investors and Venture Capitalists
This is also called the seed round. At this point, you open up for angel investors and venture capitalists to invest in your business. Angel investors should be accredited investors. They invest relatively small amounts as they spend their own money. They are also more likely to offer on-ground support and advice.
Venture capitalists secure investment for their funds from investors and then use these to invest in start-ups. The main disadvantage for venture capitalists is that you will have to give up a significant amount of equity in return for funds. This means less control and ownership over your business. However, VCs are often very involved in companies and can lead your venture to success.
Often the first venture capital round is called Series A. Start-ups seeking Series A funding often have some employees with low salaries but with some share of the equity. Depending on the growth of the start-up, the business can have more rounds, series B, C, D, etc.
There are also seed firms that can offer to fund. Contrary to VCs, these firms invest relatively small amounts and do so exclusively in the earlier stages.
Accelerator Funding
Start-ups also have the option of accelerator or incubator funding. While this is a less common approach, it does offer some equity finance, alongside mentorship, networking opportunities and working spaces.
Accelerators allow companies to build and develop their business models and meet with potential investors. Incubators run on the same concept as accelerators but are more focused on companies in the early growth stages.
Crowdfunding
Crowdfunding is increasingly becoming popular as a means of raising finance. Websites like Patreon, Kickstarter and Indiegogo have helped the approach flourish.
Crowdfunding is when a company or business chooses to raise finance from the general audience in return for equity. It is usually for a specific project or campaign. Hence, it is an option that start-ups can use alongside other modes of financing. Crowdfunding is easier, hassle-free, and relatively quicker.
Business Loans
Bank loans are one of the traditional options for raising finance. Start-ups opt for loans in earlier stages of development where they can use the funds for their working capital and can focus on growth without diluting their ownership in the business.
To secure a loan, you will need to offer collateral, a good credit score, a viable business plan and extensive accounting records of the business.
For loans, businesses have the option to approach traditional banks or explore new avenues such as Fintech borrowing.
Revenue Loans
Revenue-based financing offers a percentage of the revenue in exchange for capital. In this scenario, a percentage of the gross profits is paid to the lender until the loan is repaid.
Business Grants
Business grants are another way of raising finance. These are usually very competitive but can be helpful if you manage to obtain one. The Entrepreneur’s Programme is one of the many examples of business grants.
Additionally, the government also offers incentives to businesses in certain industries such as research and development. Incentives can include tax rebates, tax benefits and allowances, subsidies, and low-interest loans.
Initial Public Offering (IPO)
An IPO allows the public to invest in the start-up by buying equity. IPOs allow for larger amounts of capital to be raised as compared to crowdfunding efforts. An investment bank can help you prepare for an IPO and act as an underwriter. An IPO also allows investors to have an easier exit opportunity (by selling their shares).
Key Takeaways
- Equity funding methods allow start-ups to raise capital in exchange for partial ownership of the business. The capital allows the business to run operations and grow.
- Seed rounds are used to build the business (series A) and fuel the growth of the company (series B and onwards). Seed funding requires investors to believe that your idea is worth their investment.
- Apart from traditional methods such as IPO, bank loans and business grants, businesses can resort to alternative options like Fintech borrowing, crowdfunding, accelerator funding, etc.
Start-ups have several options available to them. What option they choose depends on the growth stage of the business, their future direction, and their goals for the start-up.
Regardless of what option is chosen, there are several regulatory and legal obligations to be met. Start-ups must meet these diligently to successfully secure funding and pave the way for their success.
Consulting with a legal expert can help protect your business interests and achieve the best outcome for your endeavours. At Lazarus Legal, our start-up experts have helped multiple start-ups to launch and take off successfully and grow. If you have any concerns you wish to discuss, you can connect with our start-up experts today.
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Mark Lazarus
Mark Lazarus, the visionary behind the business and the fresh blood of the Lazarus Legal team, Mark (or Laz as he is often known) owes much of his success to his past experiences. And he’s made it his personal goal to bring that wisdom and formula to the firm.