In our previous post we listed the main sources of external financing for early stage startups and where you can find them. Today you will find out what you should be prepared to give in exchange for their money, but also what you should be expecting to get. This is a continuation of our series “Hacking your fundraising”. You can see the whole presentation on that topic embedded at the bottom.
1. FFF – Family, friends and…fools
Unless your friends or relatives are experienced entrepreneurs and can give you relevant business advice, the deal is quite simple – what you get is cash to run your business. On top of it, there is however a non-material bonus included. You will be getting an enthusiastic group of fans of your startup, who will cheer for you and talk about your product to everyone they know.
The amount of money you can get will differ on the number and wealth of FFF you involve, but commonly it will be up to 20k USD.
The easiest arrangement you can make is to take money in a form of a simple loan that you commit to repay, with accrued interest, when you start making money. Another good option is to issue a convertible note, which converts into preferred or common stock at a discount (usually 20 percent, although currently often reduced to 10-15%) to the valuation in the next round, which usually involves professional investors. Granting stock in your company in exchange for the investment is much more complicated and should require involvement from lawyers, which at this early stage can be both expensive and time consuming. In any case, to avoid possible misunderstandings that can harm your relation with your relatives or future funding from professional investors, it is better to sign a legal document.
You need to be aware that there may be additional costs of having your friends or family financing your startup, especially if you don’t reveal to them risks involved, or if they don’t full understand them. If you got money from your relative promising that “this is a sure thing and nothing can go wrong”, in case it does, those family dinners may suddenly become very awkward.
Angels are wealthy people with passion for startups, often being former entrepreneurs themselves. For that reason, in addition to money, you should expect to get valuable insights, helpful advice and contacts to grow your business. That is in fact what angels usually promise as their added value alongside the financial investment. Therefore, when reaching out to angels, focus on ones that actually have contacts or experience in the sector that is relevant to you.
You need to remember however, that in order for their involvement to be useful, your angel investor would need to have time and relevant experience to understand your business really well. That may not be a realistic expectation in many cases. Angels are very busy as they usually invest alongside their other fulltime commitments such as running their own business. Don’t let that deter you. Keep hustling even after they invest because the non-tangible value is significant and you need to extract it. Push to arrange regular catch-ups even if it means scheduling several weeks in advance.
Usually, angels invest from USD20-100k, although it may be more if you manage to get an angel group to invest.
In exchange for their investment, angels will want equity or a convertible note, which is a form of debt that converts to equity when pre-defined conditions are met (called “conversion trigger events”). Sometimes angel investors require additional equity in exchange for their advice. If you agree to that, make sure to make granting of equity conditional on them delivering specific results. Otherwise, you risk taking someone on for a free ride. We recommend you use the Founder Institute’s Founder Advisory Template to help you structure the advisory relationship.
Once you have them on board, angels will often require you to send them regular reports about your performance, which means you will need to start sharing details of what you do. Some angels may also require some control of the business, in form of a board seat. It is not a common practice however, so think twice before agreeing to that. It is your business, you take the most risks and you should be the ultimate decision maker. By giving a board seat early on, you also set a precedence for later stage investors to do the same. You also risk that a small investor will have a significant say in the future fundraising rounds. They will push to have their rights protected and their requirements may be in conflict with that of your company, thus negatively impacting your negotiations.
In addition to cash investment in your startup, accelerators usually offer office space, access to professional services (e.g. lawyers, accountants) and other business/technical resources such as free or discounted access to servers or various SaaS tools. However, their biggest value-add is supposed to be access to a network of mentors. These are people with relevant business experience, who will work closely with you during your acceleration program to help you grow your business.
Another benefit of accelerators is the connections that startups establish with other entrepreneurs. In each in of the programs there are between 10 and even 60 startups, all in one place and going together through very difficult times. This means that not only professional relationships, but often strong friendships are formed.
Finally, being an alumnus of a well-known accelerator definitely helps with introductions to VC investors, some of whom you might meet at the accelerator’s Demo Day.
Accelerators take equity for their investment and services. It is usually 6-10%, often in a form of a convertible note, although it depends on the country as in some countries it can be significantly higher (20%+)
4. Venture Capital
If you manage to attract VC investors to your early-stage startup, you must be doing a lot of things right. It usually implies you have a good product (usually post MVP) that solves a well-defined problem in a huge market ($1billion+). In addition, VCs look for a talented and balanced team, as well as impressive traction that can translate into hockey stick growth.
As opposed to most angels, VCs are professional investors that do this full-time, so in theory they should be able to give you more valuable advice and make better introductions than other investors. They may also get involved in the operational side of your business, for example by helping you make a high profile hire, analyze a new market opportunity, plan and execute an acquisition or position your company to be acquired by a large player.
VC investors are the ones you go to when you need more than $1m of funding.
At the early (seed funding) stage you are likely to give away up to 20% of the equity, although many funds, particularly outside of Silicon Valley, would want to take a bigger chunk of the pie. VC funds usually invest more than $500k in a startup, which means they will want some control of your business to make sure you are spending this money on things that help you grow. You can expect them to want to receive regular updates from you and often a board seat.
Remember, with VC investment you are getting a lot of pressure to make it big. They give you rocket fuel for your business and expect you to take them to the moon, then to mars.
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