Having a great idea for a business is one thing. Getting the financial backing to grow, scale and make it a success is quite another.
Most entrepreneurs approach funding in stages, starting by dipping into their own savings, going cap-in-hand to friends and family, taking advantage of government grants, crowdfunding and potentially seeking angel and venture capital.
The best funding option depends on the business, its track record and growth plans. Some companies stay self-funded forever, while others need the capital injection and expertise from outsiders. Getting the right investment, in the right sums at the right time can often make the different between a startup’s success or failure.
Techvibes has put together a list of common investment options for startups, and pros and cons for each. It will cover the following:
- Government grants
- Angel investing
- Equity Crowdfunding
- Venture Capital
Bootstrapping is a term used in startup circles for companies that aim to grow the business using their own money — either from savings, getting a loan or line of credit, or using credit cards — instead of bringing in outside investors. The term stems from the old saying “pull yourself up by your bootstraps,” and reflects the grit and self determination it takes to start your own company.
Most entrepreneurs begin with bootstrapping to prove their business model and get it off the ground. A few examples include Toronto-based fintech Overbond, Vancouver-based digital production firm Thinkingbox, and Toronto-based real estate listing website BuzzBuzzHome.
“We really believed that if we took funding too early we’d be selling ourselves short,” BuzzBuzzHome cofounder Matthew Slutsky told the Globe and Mail.
Some investors remain self-funded, while others eventually need the cash injection to fuel growth and potentially tap into expertise from entrepreneurs and investors who have been in their, um, boots before.
Below are the pros and cons of bootstrapping your business.
You call the shots: “By self-funding, you answer only to yourself,” Chen Levanon, CEO of bootstrapped startup ClicksMob wrote in an article for Women 2.0.“This provides a wonderful ‘foundation of freedom,’ allowing your leadership to set your agenda autonomously, choosing everything from your direction to when to be acquired… to if you want to be acquired at all.” Bootrapping also allows you to preserve value in your business and build it in your own time.
Focus: With other peoples’ money often comes a need to focus on their needs and expectations. When you self-fund the business, you can focus on which direction you want the business to go, and what your customers want — because they’re usually right.
Frugality: “You can’t waste what you don’t have,” says Karl Ulrich, vice dean of entrepreneurship and innovation at the Wharton School of the University of Pennsylvania, notes in this video. The more focus you have on the bottom line in the beginning, the better chance you have of retaining strong margins in future.
Motivation: When your own money is on the line, chances are you’ll work harder, longer and do just about anything to make your business work. The reward can be sweet, Jack Horton, founder and CEO of UK-based Whites Group, wrote in BusinessZone. “Without investors as partners, every ounce of blood, sweat and tears put into a business in order to make it excel, can be realized in profits once the business hits its stride,” Horton says. What’s more, if you sell, that means more profit in your own pocket.
Less money to work with: Assuming you business is good enough to attract investors, you may be missing out on opportunities to scale with an extra cash injection. That includes money to advance research and development, boost marketing efforts or hire top talent.
Smaller network: We’ve all heard the saying, “It’s not what you know, but who you know.” This is especially important for entrepreneurs looking to build their business. By going out and raising money you’re automatically broadening your network. Even if an investor says no, they may turn out to be invaluable advisor to the business, or better yet, they might know other investors willing to bet on your company.
More street cred: Who’s behind your company could be just as important as the product or service you provide. For example, a company like robo-advisor Wealthsimple, may be more attractive to some investors (and consumers) because they’re backed by big-name investors like Joe Canavan and financial services giant Power Financial Corp.
“Not having outside investors may hurt your company’s credibility in the beginning,” says Levanon of ClicksMob. “Who are these new kids on the block and why do they think their product will be better than others in the same space? Backing by well-respected, credible investors gives many potential customers the confidence to buy in. Self-funding may also highlight a company’s lack of resources and business experience.”
Some businesses can’t be bootstrapped, notes Ulrich. He cites examples of drug companies that need to fund research to advance products. Other may never need an outside investor.
For most businesses, Ulrich recommends a hybrid approach.
“Get as far as you can on your own. It’s amazing what an resourceful entrepreneur can do with nights, weekends and a credit card,” Ulrich says. “Once you’re confident you can productively invest capital to grow you business. Then and only then, seek outside investment and hit the gas on marketing for growth.”
The nice thing about having a startup is that governments want to help. You can argue with that statement all you want, but how else can you get free money to start your company?
Government funding can come as a grant, which you don’t have to repay, or tax incentives, which are a deduction to help encourage spending and investment.
In the U.S., startups can apply for the Small Business Innovation Research (SBIR) program, which supports technological innovation and R&D. There are also funding options as part of the White House’s “Startup America” initiative, which expands access to capital for high-growth startups. This site helps you search for federal grants, based on your industry and/or market.
There are a number of grants and tax incentives available for startups across Canada. Here’s another list here. The most cited include the Scientific Research & Experimental Development (SR&ED), which promotes research & development, as well as the Industrial Research Assistance Program (IRAP). Others include the Futurpreneur Canada Start-Up Program, the Western Innovation (WINN) Initiative in Western Canada, the Investing in Business Innovation fund in Ontario and the Atlantic Innovation Fund in Eastern Canada, to name just a few.
Of course nothing in business is really free, so below are the pros and cons to consider when looking at government grants and other funding sources to help grow your startup:
Free money: Enough said. “In principle, it’s an amazing thing,” says Yuri Navarro CEO and executive director at the National Angel Capital Organization.
Less pressure: Unlike money you might get from your parents, friends or big-name investors, the government isn’t looking for a return on their money – at least not on paper. It can take some pressure off of your business, while still knowing someone is willing to make a bet on your success. “They’re able to take a risk a bank or maybe an investor wouldn’t … especially in the early stage,” Navarro says of the government grants.
Money attracts more money: If the government is giving you money, you must be doing something right, right? That’s at least the impression from potential investors. Receiving government funding is a good thing to have on your business resume.
Foreign investors in particular are familiar with grants such as SR&ED and IRAP, which could mean more outside money and even connections to international markets. You might even get more money from the government. “Once you are granted money from one government source, it’s not uncommon to receive further funding from the source if you meet program requirements,” BDC says on its website.
Narrow focus: Most government grants have very specific criteria. So while there may be a lot of them out there to choose from, your startup may not qualify either because of where you’re based or your product or services. You may be too early stage, or even too far along in your business to qualify for a grant. Read the fine print before wasting your time applying.
Strings attached. Just because you have the money doesn’t mean you can spend it however you want. Some grants and other incentives are specifically for R&D or to hire employees. Startups may also be forced to pay back the money, or could lose a tax incentive under certain circumstance.
Take a grant for example: “Technically, a grant is a sum of money conditionally given to your business that you don’t have to repay,” BDC says. “However, you’re bound legally to use it under the terms of the grant, or otherwise you may be asked to repay it.” An example could be if you sell the company to a buyer outside of Canada. Know what you’re getting into before you take the government’s money.
It can suck up a lot of time, energy and patience: If you thought getting into university or finding a daycare space for your kid took perseverance, you might want to brace yourself for the government grant process. Think paperwork, interviews and more paperwork. Then plan to wait for what might seem like forever to hear back on whether you get the money.
It’s not that it’s not worth it, but startup founders should consider how much time and energy the want to put into applying for grants against how much it would take away from the job of growing the business. Time, after all, is money.
Government grants are a great way to get money to grow your business. However, be strategic about which grants to apply for, how much time you’ll spend on the process (and outside of your daily operations) and what the consequences might be if your business backfires, changes course or even if becomes wildly successful.
The term “angel” was first associated with funding decades back when, as the story goes, it was used to describe wealthy people who provided financial backing for Broadway theatre productions. Then, in the late 1970s, professor William Wetzel, founder of the Center for Venture Research in the U.S., used the term in a pioneering study on entrepreneurship to describe investors that gave seed capital to startups.
Angel investors remain a godsend for many startup founders to this day. These are private and by law accredited investors who invest their own money into a company in exchange for ownership equity or convertible debt. The accredited investor exemption allows startups to raise any amount from qualified investors (see accredited investors link above). “In addition to the accredited investor exemption, there is a separate exemption that is specific to non-arms length relationships (family and friends),” says Yuri Navarro, CEO and executive director at the National Angel Capital Organization (NACO). “This means it’s not illegal to take money from your dad if he’s not accredited (love money) but it is to take from someone you met at a party for example.”
Angel investors often include friends and family members or already successful entrepreneurs looking to make a bet on the next generation of startups.
There are also a growing number of angel groups that have become a “fairly well established part of the Canadian entrepreneurial ecosystem,” according to NACO’s recently released 2015 Report on Angel Investing in Canada. While its impossible to track all angel investment activity in the country, the report says angel groups tracked invested more than $130 million in Canada in 2015, a 48-per-cent increase from 2014.
“The big increase in the amount invested in 2015 was largely accounted for by follow-on investments, which more than doubled over the previous year,” the report says.
Almost every startup relies on an angel at some point in their history. Some continue to use it through various stages of growth. Below are the pros and cons of taking money from angels:
There are a lot of potential angels: An angel investor can be your parents, friends, other entrepreneurs or even complete strangers, if they have the money and meet the qualifications or exemptions (see accreditor investor qualifications and exemptions above) and willingness to back your big idea. Typical angel investments are between $25,000 and $1.5 million, according to Entrepreneurship.com.
You’ve got backers: If you have an angel investor it means someone else believes in your idea, and is willing to put their own money behind it. That can be very motivating and empowering for entrepreneurs.
“You have capital that is at risk with you,” says Navarro. “This investor is taking a bet on your idea and ability to execute and the team you built. They are in it with you: If you lose, they lose. If you win, they win. There is a very direct incentive.” What’s more, if one or more of your angel investors is an entrepreneur with experience in the trenches, you can benefit from his or her experience and advice.
The money comes quick: When you’re startup you need money now. Angel investors usually invest quickly and provide lump sums that can be used immediately to help grow the business.
They’re hands on, maybe to a fault: Don’t expect to get money from an angel investor and then never hear from them again. They’ll most likely want to know what you’re doing with the funds overall, including every penny they provided. Many of them will also offer advice on to run the business, even if they’ve never done it themselves. Parents and friends tend to offer a lot of unsolicited advice, too. You’ll see.
They want to see returns, and they’ll take some of yours: Remember, an angel investment isn’t a loan. Those investors want their money back, and then some. Also, because their money gives them a stake in the business, you’ll be providing them a portion of your future net earnings.
It can get personal: There’s a reason why people caution never to do business with family or friends. If money is lost or the business goes sideways, the personal relationship can change forever. Avoiding friends and family may be easier said than done with startups, many of which can’t make it without the initial support and financial backing of loved ones.
But be warned, it can get emotional, says Jonathan Bixby, a serial entrepreneur, active angel investor and startup advisor. He recommends entrepreneurs think it through clearly: “Are you willing to look a friend or family member in the eye and take their money for your startup?” His advice, to keep the peace, especially when it’s in the family: “Never take money in an angel round that someone can’t afford to lose.”
Most startups would never survive without the support of angel investors. But unlike a loan, angel investors are getting a piece of the company and expect a return on their investment. There are also many strings attached, both business and personal. Unlike venture capital, angels are investing their own money, not a pool of someone else’s. Understand what you’re agreeing to with angel money and if you’re business is ready to take it on, use the proceeds wisely.
Crowdfunding is a way to raise small sums of money for your startup from a large amount of people. The funding concept dates back centuries, but modern-day crowdfunding is being fueled by the Internet and proliferation of social media. Dozens of online crowdfunding platforms have cropped up in response to a growing number of entrepreneurs looking for alternative ways to fund their startups, and more investors seeking alternative places to put their money.
There are two main types of crowdfunding: rewards-based and equity. In this article we’re dealing strictly with reward-based crowdfunding, which is when entrepreneurs presell a product or service without providing equity or shares to investors. Well-known reward-based crowdfunding platforms include Kickstarter and Indiegogo, to name just two.
Some examples of successful crowdfunding campaigns include The Veronica Mars Movie Project, which raised more than $5.7 million (U.S.) in 2013, and Corner Gas: The Movie, which raised a more modest $285,800. It was also a Kickstarter campaign that launched the Vanhawks Valour smart bike. That story didn’t end well, however, with the company last reported to be on the verge of shuttering.
Below are the pros and cons of rewards-based crowdfunding.
Low cost, low risk for founders: Let’s say you have a great idea but you don’t have the money to find out if it will sell. Crowdfunding allows you to test that theory by launching it on a crowdfunding platform and investing a few marketing dollars to promote it there and on social media.
If the money doesn’t come, at least you haven’t invested your life savings (presumably) and can go back to focusing on your day job — or your next big idea.
Immediate cash injection: If you’re idea gets enough financial backing, you can start building your product or service right away.
“Money is the fuel to not just start, but to grow,” says Craig Asano, founder and executive director of the National Crowdfunding Association of Canada. Of course, it’s best to have a budget first to figure out how to spend the cash and increase your chances of being a success.
Instant network of buyers and investors: Through the act of raising money through the crowd you’re automatically generating consumer and investor interest, which hopefully translates into future sales and investment.
“Crowdfunding improves access to cash, but also the crowd — a vast network of potential investors, buyers and supporters who contribute their resources to help realize a project,” says Asano. “It all plugs into an ecosystem that is vying to help companies succeed.”
Pressure to deliver: Now that you’ve raised the money, you need to deliver the product on time — and for your sake, on budget. This is the most stressful part. Not only are you spending a lot of other peoples’ money, but they’re tapping their fingers waiting to see the results.
Your job is to deliver the product as promised, when promised, or start coming up with plausible excuses as to why you can’t.
Everyone else is doing it: There are a lot of great ideas being pitched on crowdfunding platforms today. What makes yours special? Why should someone pledge their money with you, and not the other startup?
“It’s hard to stand out from the crowd,” says Asano. He says startups need to find ways to better compete for crowdfunding dollars, and lure people to their crowdfunding page.
Lots of work with potentially no payoff: We hear a lot about the crowdfunding success stories, but not as much about the failures. Many startups don’t raise enough money through crowdfunding, and have to go back to the drawing board. It can be soul crushing.
“You could go through a lot of work and raise a goose egg,” says Asano. “That kind of hurts. You have to take that in stride. Either you need assistance with online marketing, or the product you though was the bees knees of XYZ wasn’t.”
Rewards-based crowdfunding is a great way to raise money with no string attached. However, it’s not as easy as launching a page and watching the dollars roll in. Startups looking at crowdfunding need to be strategic about how they market online, what they offer investors as incentives, and how they’ll produce and deliver the product to generate happy customers in the end.
After all, for many startups, crowdfunding is the first stage of a larger growth plan. It’s important to try to get it right the first time.
Crowdfunding, again, is a way for startups to raise small sums of money from a large amount of people. With equity crowdfunding, unlike the rewards-based kind, investors get a stake in the company. Their reward is the profit they expect in return for giving you their money.
Until recently, only accredited investors could get in on these private deals in Canada. New regulations across Canada allow regular investors to participate, with various limits depending on which province they live in.
Equity crowdfunding is filling a funding gap that startups and investors alike have complained exists for early-stage companies. Startups like FrontFundr, a Vancouver-based equity crowdfunding platform, are also cropping up to help connect companies and investors.
Below are the pros and cons of equity crowdfunding for startups.
Access to capital: New rules have opened up the number of people who can invest in your startup, which potentially means more dollars to back your big idea. “You can raise a large amount of money in potentially short period of time … and in a regulated market,” says Craig Asano, founder and executive director of the National Crowdfunding Association of Canada. It’s also a good option for startup that may be too early-stage to secure funding from traditional banks.
Transparency: The bonus with new equity crowdfunding rules is that the process is more open and transparent, Asano says. That’s good news for investors and startups because it builds confidence in the system, especially as Canadians become more familiar with the alternative funding and investing model. It also forces startups to get better organized for future funding rounds.
Your business grows faster: Once you’ve tapped the crowd, you can use the funds to grow your business more quickly. Maybe you spend it on R&D, new employees, marketing, or manufacturing to get your product on the shelves sooner. Either way, there’s nothing like money to speed up the pace of business.
It’s complicated, and costly: There are a lot of rules and regulations around equity crowdfunding, and making sure you’re on side with regulators will take a lot of time and money, including getting the proper legal advice for your business. It’s especially complicated given that regulations in Canada vary by province, so what you do in Ontario will differ from in B.C., which will differ in Alberta. “You need to make sure it’s worth the return and all of the effort,” says Asano. “It’s really for companies that are raising capital regularly, because they have to fuel an expansion model or a growth-oriented business.”
Too many cooks: It’s great to raise a lot of money from different people, but remember that with equity crowdfunding they’ve got ownership too. That means a lot of people to keep updated, to satisfy and eventually – if all goes well – to pay if your product or service is a success. Some investors may also be very vocal in their opinions about how you run the business. “With any business, taking money from investors can be very stressful with regards to managing an investor base that is quite demanding,” Asano says. “It’s different when you are giving equity away, as opposed to a rewards-based model.”
Lack of expertise: Many investors you get from the crowd are unlikely to add value beyond their chequebooks. You could potentially be missing out on the experience and mentorship that can sometimes come with other forms of funding, such as angel or venture capitalists, most of who have been in your shoes in the past.
According to an article by angel investor Christopher Mirabile, equity crowdfunding is ideal for first-time entrepreneurs who can’t raise from larger investors, companies that need funding for a specific product or project and one that could benefit from a broad fan base. Mirabile says it’s less ideal for those who need industry expertise, mentors or other value-added investors that can help open doors to other investors or in the industry in general. Understand your long-term business goals before choose the equity-crowdfunding route.
If you’re at the stage of seeking venture capital (VC) for your startup, congratulations, you’re making things happen. VCs are deep-pocketed investors who put their money in startups they believe have the potential to scale, quickly. Of course, there’s no guarantee anyone will wind up getting rich from your business idea, but you’re on the right track.
VCs tend to make much larger investments than other forms of funding. Of course there are some pitfalls to watch out for. Below are the pros and cons of VC funding:
Deep pockets: VCs have serious money to help grow your business. The average investment is usually between $500,000 and $5 million, according to Entrepreneurship.org. That’s the kind of money that can supercharge sales. What’s more, it’s your money. As this QuickBooks blog notes, VCs are gambling on your business.
“If it succeeds, they win big; if it fails, they eat their losses.” That’s unlike a bank loan. “If you go under, you won’t have investor debt hanging over your head.”
Experience: VCs are usually experienced entrepreneurs and investors.
“It’s ‘smart money,’ which means they are a member of your team, effectively,” says Mike Woollatt, CEO of the Canadian Venture Capital & Private Equity Association (CVCA). You not only get advice from people who’ve built and sold successful companies in the past, but also active mentorship around how to overcome challenges and setbacks. Remember: VCs have a vested interest in ensuring your startup succeeds.
Valuable connections: With experience comes connections, says Woollatt, especially in your particular industry. For example, a tech-focused VC will likely have a broad network in tech hubs such as Kitchener-Waterloo, Toronto, Vancouver or Silicon Valley. Those connections can turn into investors. Who knows, one of them may even be a buyer of the company down the road — if that’s your end game.
You have to really hustle, then wait: You thought starting a company and getting it up and running was a lot of work. That’s nothing compared to finding the right VC partner.
“As the entrepreneur, you’ll have to prepare thorough business plans with financial projections, power point presentations and even seek third party counsel to make your proposal more compelling,” notes Los Angeles-based GrowThink in this blog. “Once you’ve created these deliverables, you’ll have to network and contact the right venture capitalist that invests in your sector.”
It could also take time for them to decide if they want to invest in your startup. Entrepreneurship.org pegs it at six months to a year. Business owners who don’t possess the patience of a saint may find that wait excruciatingly frustrating,” they note.
The pressure is on: VCs have high expectations for your business and the money they’ve invested in it. Unlike your parents who, if you’re lucky, may offer a few thousands bucks to help grow your startup, VC funding isn’t love money. It’s all business.
Expected rates of return can be as high as 50 per cent annually, Entrepreneurship.org warns.
Loss of equity/control: In most cases, a VC investment includes equity in your company. That’s not necessarily a bad thing, especially if those equity holders can help grow your business. Problems usually arise when there’s a disagreement between founders and VCs on the future direction.
If it gets really nasty, and depending how much equity you’ve given up, you may wind up losing control of your own company.
VC funding is a blessing for many startups — and a sign of success. If you’re attracting VC money it means you’ve got a product or service that has potential and could make you — and your investors — rich. But that dream could collapse if you don’t find the right VC team that shares your vision. Don’t just be interviewed by VCs, do your own interviewing.
If you want to learn more about what VCs want, here’s an interview McKinsey did recently with Steve Jurvetson, a partner at Silicon Valley-based VC Draper Fisher Jurvetson, titled “Inside the Mind of a Venture Capitalist.” Here’s a hint: They like crazy ideas, infectious enthusiasm and anything that disrupts old-school business models.