How to Get Investors and Funding for Your Business
Ok, so you’ve got a business idea, and you’re working to make the dream a reality, but you’ve got to consider funding.
After all, you need money to turn your idea into something tangible. You need cash to pay your employees.
If the money isn’t rolling in yet, it’s tough to build a top notch product or service. That’s why many small businesses and startups look for funding and seek out investors.
Before you even begin to consider outside investment, consider how you can launch the company and get to revenue before you have to raise money. Although it seems hard in the short-term, it’ll be better for you in the long-run in terms of your knowledge of the process, and building your own equity.
So, how do you do it?
Why You Should Bootstrap
Bootstrapping means that you raise money without any help from investors. It’s how we got Grasshopper off the ground. If you can build your business without investors, do it this way.
You might bootstrap and keep your full-time job or quit and use your savings to get business off the ground. Begging your parents for money counts as bootstrapping.
Why bootstrap? You’ll retain complete control. That might not sound like a big deal, but when you’ve got investors’ hands in your company, you won’t be able to build the product you dreamed. Things get mucky when you’re playing with someone else’s money.
Here are some of our favorite resources for bootstrapping:
- Starting Up on a Shoestring | Inc. If you want to bootstrap your business, check out Inc.’s comprehensive list of bootstrapping articles. The list includes tons of stories of entrepreneurs who successfully bootstrapped their businesses.
- Bootstrapped, Profitable, & Proud | 37signals 37signals is famous for being both bootstrapped and profitable. They have a whole page dedicated to companies who didn’t take money from venture capitalists. Read Rework by founders Jason Fried and David Heinemeier Hansson for more info on bootstrapping.
- How to Bootstrap your Business | Entrepreneur Erica Ziela, founder and CEO of Sitting Around, explains how moonlighting helped her succeed. She also discusses how keeping her day job allowed her to pour significant cash into her business
- Bootstrapping Your Startup: 7 Hard-Earned Tips from Real Entrepreneurs | readwrite Real entrepreneurs offer tips and tricks on how to bootstrap a business. These leaders discuss what they’ve learned from bootstrapping, its benefits, and what bootstrapping can do for you.
If you can’t bootstrap, it’s worth learning a little about equity.
The Different Types of Equity
- Equity financing is when you sell “shares” of your company to outside investors in order to finance your business. When you make money, your investors are entitled to a portion of the profits. This type of equity is best for sole proprietors who need some start up cash.
- Equity compensation is when you offer your employees a percentage of company profits as part of their compensation package, typically in exchange for a lower than average salary, or occasionally in lieu of salary completely. This type of equity is best for businesses that are in need of human capital more than physical capital. If you already have an office, a coffee maker, a copier, but need a new software developer, this might be the model for you.
As you get started, it’s worth understanding how to calculate shareholders’ equity, and it’s important to investors. To figure out your business equity, you’ll need to calculate the assets and liabilities of their business.
Start by determining the company’s total assets- these are things that are in progress, inventory, cash, or other receivables. You’ll also need to figure out your debts and liabilities, including salaries and accounts payable. To calculate equity, you can subtract the liabilities from the assets. Accounting software such as FreshBooks or QuickBooks can help you do this.
How to Negotiate Equity
Often startups and small businesses can’t offer huge salaries, so they offer equity instead. When employees start out, they may negotiate equity to a higher percentage. Any employee who is offered an equity agreement should be sure to read the fine print. If there are aspects that are hard to understand, they should hire a business lawyer to help them through it. This is a very important agreement, one that is essential to understand. Whether you’re a business owner or a startup employee, it’s helpful to understand how equity is negotiated.
Here are a few tips for negotiating equity in a startup:
- Ask questions. If you don’t know how something works, ask questions. Keep in mind that whoever is offering the agreement will have answers ready, so don’t be afraid to take the agreement to a trusted advisor or a lawyer. This is a case where there’s no such thing as a bad question.
- Speak the language. People will begin to use fancy words like “vesting,” and you could end up in over your head. Don’t be afraid to read up on equity to understand how it works before accepting an agreement.
- Consider taxation. Your equity benefits are not free of taxation, so make sure you understand how the agreement will affect your present and future taxes.
- Negotiate for ownership. Instead of negotiating for money or shares, negotiate for the percentage of the company that you will own.
- Look for tricky stuff. Sometimes these documents have tricky stuff that isn’t in your favor. Look for repurchase rights for vested shares, termination of stock options, and non-competes.
What is a Royalty?
We’re not talking about kings and queens. In royalty financing, investors lend funds to guarantee a certain percentage of revenue. Usually, these royalty investors get 2 to 6 percent of revenue increases. It’s especially common in industries that are a bit unpredictable, such as in music. This is a great way for entrepreneurs and small business owners to get money without having to relinquish control. The negative side is that these royalties can get very, very expensive.
Royalty financing is just another way of getting investment money for a business. Instead of giving away ownership of your company, you can give investors a royalty percentage based on revenue growth in exchange for a hefty loan. As you grow, you’ll pay back these initial loans to the initial investors.
Equity vs. Royalty
Unlike royalties, equity is ownership. if someone has equity, it means they own a part of the company. This seems great, but it means you don’t have as much control of the company as you did before. Now that an investor owns a certain percentage, they will have ideas about the company’s direction. Royalties have nothing to do with ownership at all. Instead, they’re an agreement based on a loan or asset. That means that an investor will give money in exchange for an agreed upon payment, usually based on revenue. If someone uses someone else’s patent, they have to pay royalty fees for its use.
What should you choose? It depends on what your business goals are, how much money you have, and how much control you’re willing to relinquish.
Too many young entrepreneurs become obsessed with raising angel and venture capital. When this happens, these folks lose sight of the real reason they became entrepreneurs - to launch and grow their company.
Remember that raising money is not a competitive game where you’re out to win. If you focus on the sport rather than building your business, you’ll undoubtedly end up on the losing side.
If you really have no option but to raise money, angels can be a good alternative to smaller VC rounds, but you want to make sure you’re working with the right investor.
Start by learning the three types of angel investors. Then pick the right one.
Angel Investor #1: “I like money and need more.”
There are too many of these “professional angel investors” out there, and they’re the worst. Their only goal is increasing their wealth. This type of investor is actually a person that wanted to be a VC, but couldn’t raise enough capital.
The reason they are so dangerous is that they have too much vested in the small amount of money they give to your business, which then leads to over-involvement and pressure on you for all the wrong reasons.
Should you take their money? No.
Angel Investor #2: “I have so much money, I don’t know what to do with it.”
Every entrepreneur has met one of these investors: it’s the person who has already generated significant wealth and has no real need for more money, and can afford to be a lot less selective in funding ventures. They’re probably in the stage in life when they’re giving back, and part of that can be through angel investments.
This type of investor is ok if you’re looking for just money and maybe some general advice about the start-up process. But don’t expect incredible moral support or stellar advice from this kind of investor on a regular basis - they are likely over-extended in that realm due to their involvement in multiple ventures.
Should you take their money? Maybe.
Angel Investor #3: “I’m passionate about a specific industry, and have tons of connections in it.”
This is the best angel investor, and a selective one, but the kind you should absolutely target. Why? Because this person already has money and isn’t looking to get involved in angel investing to generate more wealth as the ultimate goal. Instead, they’re hoping to serve as a true angel and really come through for your business by offering both funding and insight.
Best of all, they have clear passion for the industry you’re in, and probably the connections that will indirectly help you succeed. They’ll also have something money can’t buy: credibility in your industry and the connections to make good things happen.
Should you take their money? Yes.
Our advice is to look for angels that fall into either #2 or #3. Stay away from #1 no matter how desperate you get.
Startup Incubators and Accelerators
Both startup incubators and accelerators offer seed money, expert mentorship, supplies, and office space to winners in exchange for a share of company ownership.
Giving up company ownership is a huge deal, and it’s not something you want to take lightly. However, if you’re looking for mentorship and a community, joining an incubator or accelerator might be a good idea.
The two are slightly different from each other. Accelerators usually focus on mentoring and refining as a company tries to go to market, while incubators are more involved in getting the ball rolling on making money.
Some of the most popular include Y Combinator, Techstars, 500 Startups, and Capital Factory, among many, many others. These are sometimes specific to certain fields (technology or entertainment, for example), and others will accept applications for all types of ventures.
Given how beneficial they can be, acceptance into incubators and accelerators is typically VERY competitive across all industries.
There are incubators and accelerators everywhere. Just check out this comprehensive list.
If you’ve got a co-founder or other employees that are riding the wave with you, set up a vesting schedule so that they get benefits once they’ve stayed for a while, not right away.
This protects you from any employees who want to jump on to get rich quick, then take off. With vesting schedules, these employees will only own a part of your company after they’ve stuck around for a while.
Cliff vesting – If an employee is part of a cliff vesting plan, they’ll become vested at a specified time (like after staying for 3 years) rather than gradually or incrementally.
Graded vesting – In graded vesting, employees get a certain amount of company ownership over a period of time. Graded vesting is different from cliff vesting because cliff vesting allows employees to become 100% vested after a shorter period of service
More Financial Info
We know a lot about funding and investing, but we strongly recommend hiring a business lawyer to protect you as you go through these processes. Lawyers can help you sort out what’s fair and right as you hunt down money.
Sure, lawyers are expensive, but they’re worth it!
If you’re looking for more info regarding investors, financing, and equity, check out our Equity for Entrepreneurs: A How-to Guide. We dive in deeper there.