The world of startup financing can be daunting to new founders with its esoteric jargon, like “rounds,” “angels,” and “accelerators”. It’s easy to get lost in the weeds, especially as new ways to secure capital evolve and surface (think crowdfunding and initial coin offerings). But understanding sources of startup funding doesn’t have to be complicated. There are tried-and-true methods that have helped propel some of the world’s most successful companies to the top. In this article we’ll walk through:
- The benefits of bootstrapping
- Top funding sources for startups: grants, accelerators, angels, and venture capital
- How venture debt differs from venture capital
Bootstrapping your startup
Now that you’ve fleshed out your business idea, you’re ready to bring your startup to life. And, that requires funding—often your own if you’re a first-time founder.
What is bootstrapping?
Bootstrapping your startup means using your own financial means to grow your idea into a viable business. Many founders have no choice but to bootstrap their company, and do it out of sheer necessity.
Advantages of bootstrapping your company
The big upside to bootstrapping is you retain full control over your startup. Once you acquire funding, investors typically have a say in your business and you may also have a formal board to answer to. On the other hand, bootstrappers miss out on the valuable mentorship and industry connections that come with funding models like accelerators and angel investors. While managing the expectations of investors can be a challenge, so is carrying the financial burden of a scaling business, especially when cash flow is strained.
Many founders manage to build and scale their startups without ever relying on outside investors (other than, perhaps, generous family members and friends). However, for founders with high startup costs who want to scale quickly, acquiring funding early is often essential. Once you raise venture capital, you have more capital to scale with, but you are also on the clock and must reach critical milestones within certain time frames.
When the time arrives to seek outside funding, there are a few sources to consider.
Sources of startup funding
1. Grants and subsidies
Startups may be able to receive funding from government agencies in the form of grants or subsidies. Unlike a loan, a grant does not need to be paid back, but startups are legally bound by a grant’s terms, and may have to repay it if the criteria is not met. It’s important to keep in mind, once you’re approved for a grant, the funds are often disbursed after you’ve incurred the expense, so they may not help with cash flow in the short-term.
How do government grants work?
Government grants typically fund specific projects or activities versus everyday operational costs and are often tied to social causes or certain industries. Startups may also be required to match the grant (or a portion of the grant) with their own investment into the approved project. Hiring grants, for example, may provide wage subsidies for startups that hire youth or underrepresented groups, while expecting you to cover a portion of the salaries.
If you’re an early stage founder with big plans to scale quickly, you may want to consider a startup accelerator for pre-seed or seed funding. Accelerators first entered the startup ecosystem with the launch of the Y-Combinator (YC) program in 2005. Y-Combinator incubated some of the fastest growing and influential companies we know today, including Airbnb, Reddit, and Twitch. Others that followed suit, such as Techstars and 500 Startups, have had similar results. According to the 2021 Global Accelerator Network (GAN) Report, there are more than 7,000 accelerators around the globe.
An accelerator offers two critical things for new startups and founders: preliminary capital and mentorship.
How do accelerator programs work?
An accelerator offers two critical things for new startups and founders: preliminary capital and mentorship. If you’re admitted into an accelerator program, you become part of a select cohort (or “batch”) that gets a crash course in funding, sales, and growth over a few months. Your startup may receive a nominal investment (around $100,000) in exchange for equity in your company. Think your idea is going to change the world? The injection of capital enables you to test that assumption.
Just as important to the success of an accelerator program is the mentorship it provides. Accelerators connect new founders with seasoned startup founders and funders. Who better to help you start a company than someone who has successfully accomplished it (often multiple times)? Other key benefits are building a valuable support network of like-minded entrepreneurs and exposure to investors.
Mentors provide personalized one-on-one guidance to help startups tackle early stage challenges and develop the know-how to raise seed investment in the future. Consider this: in 2020, startups around the world raised over $400K within 12 months of finishing an accelerator. Whether it be through pilot customers or beta testing, you can refine your business model before hitting the market or pitching investors through the program’s rigorous process. What you accomplish will depend on your startup stage. If you’re ready to launch while attending the program, an accelerator can help you determine the best way to present your product to users and the press.
An incubator is similar to an accelerator and the terms are often used interchangeably. Like accelerators, incubators help an early stage startup build a viable business, but they don’t always provide capital investment. Incubators often have co-working spaces as well, and may not be tied to a specific timeframe.
3. Angel investors
If you’ve completed an accelerator program and tested your product and business model, an angel investor is a typical next rung on the funding ladder. Angel investors are wealthy individuals who provide seed capital to companies that show high growth potential. Like accelerators, angel investors offer substantial advice and networking to founders and invest early in the funding continuum. The angel investing ecosystem comprises both individuals as well as angel syndicates, which invest as a group. Due to the collective nature of a syndicate, it can provide greater access to those with experience and expertise.
How does an angel investor work?
In 2021, angel investments averaged $346K per investment in the form of convertible debt, equity, and SAFEs (Simple Agreement for Future Equity.) Like an investing accelerator, founders have to give up some control of their company to secure an angel investor. [BT1]
Angels have long been a vital aspect of the innovation industry. Companies like Meta (Facebook at the time) may have never reached their level of success had it not been for the angel investment from Peter Thiel in 2004, or Jeff Bezos’ investment in Google in 1998 (strangely enough). Canadian startups that have benefited from angel investors include Shopify and SkipTheDishes.
Angel investment in Canada topped $212 million in 2021, with $1.38 billion deployed in the last decade.
Unicorn opportunities and success stories such as these attract more angels every year. According to the National Angel Capital Organization, angel investment in Canada topped $100 million in 2020, with $1.1 billion deployed in the last decade.
4. Venture Capital
If we compare a startup to an ember, accelerators and angel investors are the sheets of newspaper that spark the flame, and venture capital is the fuel for a roaring fire. Venture capitalists (VCs) invest a sizeable amount of money into a high-growth company that’s targeting an acquisition, an initial public offering (IPO), or another potential buy-out mechanism within several years.
How does Venture Capital work?
When a venture capital fund backs a startup, its main goal is to help the company reach the metrics needed to raise the next round of capital. The startup continues to raise rounds of capital until it has exited, usually via acquisition or IPO. This funding strategy has propelled some startups to become the highest value companies on the planet: Apple, Amazon, and Tesla, to name a few.
You may wonder why you would give up equity to acquire venture capital if your startup is growing all on its own? Startups are quite different from the average business; they’re not focused on profit or paying dividends. They operate at a loss. A startup’s goal is to aggressively grow its revenue and valuation quickly—but this requires substantial funding.
Similar to angels and accelerators, VCs provide funds and expertise in exchange for equity, but on a grander scale, offering more capital and a longer-term relationship (though not necessarily the same level of mentorship). Because of the high failure rate among startups, venture funds may get no return on investment. This is why startups are considered a high-risk asset class.
The expertise and network provided by most venture capitalists can be beneficial to fledgling startups. But, to ensure a good fit, founders should consider which VC offers the most relevance in terms of industry expertise and connections when choosing an investor.
There are a myriad of reasons why a VC may choose to invest in a particular startup, but they all funnel down to one: growth.
What does a VC look for in a startup?
There are myriad reasons why a VC may choose to invest in a particular startup, but they all funnel down to one: growth. Whether through its product development, revenue, or users, the founder has signaled to investors that the startup is growing, or poised to grow, rapidly. Given that the average venture capital fund has only a 10-year life span, this is essential.
According to the Canadian Venture Capital Association’s 2022 report, venture capitalists deployed $10B across 706 deals. Of all the disclosed deals in 2022, 81 per cent were valued below $20M. You can see that VCs are betting early to secure a sizable chunk of the company’s ownership with their sights on a home-run sized return.
Venture debt vs venture capital: Know the difference
Venture capitalists recognize they will lose money on many investments, with the expectation that a few unicorns will more than compensate. This is not the case with venture debt investors. Venture debt bears interest and must be repaid by the startup, or refinanced on the next round.
Venture debt is only accessible to startups that have already raised venture capital. In fact, it is often closely tied to your latest equity round (typically around 20 to 40 per cent of its size.) Unlike venture capital, the funds are meant to boost your balance sheet— you should already have a cash runway of at least 12 months.
This may be the right funding source for startups that are past the seed stage and scaling rapidly. Some startups may never actually use this capital, but rather have it as backup, as interest is only charged on any principal drawn.
Which source of startup funding is best for you?
The entrepreneurial path is not an easy one. Wrought with one challenge after the other, an exciting high can quickly be followed by a disappointing low. Finding the right formula to fund your startup ambitions can be a difficult, yet necessary part of that journey. While bootstrapping is an essential first step for almost every startup, the next step depends on a variety of factors, from the speed with which you plan to scale to your ability to attract an investor. A startup’s path from pre-seed stage to IPO is never straight, but thankfully there are funding sources and mentorship opportunities to help you along the way.
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