Financing Early-Stage Companies

Listing the five ways to raise money - financing and funding - your next bright idea

January 6, 2014

According to the National Venture Capital Association, only about 1,000 of the 627,000 new businesses launched in the U.S. each year receive venture funding. So, how do early-stage companies get the capital they need to get started? Fortunately, there are numerous financing sources available.

Friends and Family

Friends and relatives contribute $60 billion annually to early stage companies, roughly three times more than VCs, states funds, and angels combined.

Pros
It’s probably the quickest and easiest way to raise money because, unlike other investors, friends and family do not need to spend time getting to know the start-up and conducting due diligence.
Cons
A business owner can destroy valuable relationships if the company fails and would not get the sophisticated business advice from friends and family that they could from professional investors.
Action
Present a detailed business plan that explains the business and its capital needs in a way that anyone can understand. Be clear that investors could lose all of their money or that it could take years before they see a return.

Angels

An angel investor is typically an affluent individual or group of investors who provide capital in exchange for ownership equity.
Pros
Angel investors are often successful entrepreneurs with a wealth of experience and a network of contacts.
Cons
Angels will require an equity stake in the business – typically about 25 percent ownership of the company or a percentage of the profits, often 10 percent or more.
Action
Angels generally prefer to invest close to home, so look for angels in your own backyard. Eighty-one percent of all deals are completed in the angel’s home state.

Crowdfunding

In crowdfunding, individuals contribute pocket change, typically $10s and $20s, to the companies and ideas they like best. Crowdfunded projects raised $2.7 billion in 2012 across more than one million individual campaigns globally.

Pros
Since crowdfunding financing is typically philanthropic, founders generally retain full ownership of their ventures.
Cons
The early-stage company now has potentially thousands of investors eagerly awaiting its product. Having all these investors can become a nightmare if a milestone is missed or a product shipment is delayed.
Action
Early-stage companies should tap into friends, family, and social networks to contribute or invest. By establishing momentum in the beginning, they are more likely to succeed.

“Crowdfunded projects raised $2.7 billion in 2012 across more than one million individual campaigns globally.”

Government Grants

Federal and state governments spend billions of dollars annually funding early-stage projects.  Many also offer tax credits or grants for certain technology companies.
Pros
Most government grants are “free money” and there is no dilution in ownership for the entrepreneur.
Cons
Grant funding can be competitive, slow, and require extensive paperwork and compliance requirements.
Action
Companies should research government funding sources, including low-interest loans, through websites such as Grants.gov.

Accelerators

Accelerators typically run 12-16 week programs to propel startups quickly from concept to product. They offer seed money—as much as $150,000 per company— and mentoring in exchange for equity.

Pros
Good accelerators foster a strong sense of community among entrepreneurs, alumni, mentors, partners, and investors. They also provide access to industry luminaries that can help early-stage companies reach the next milestone.
Cons
A significant stake in the early-stage company’s equity is given to the accelerator. Some accelerators take just 5 percent of equity, but others will demand 20 or 30 percent or charge up to $25,000 in cash to participate in their program.
Action
With just a few spots available for most accelerator sessions, a great application is critical. The company must demonstrate that it has a well-rounded startup team and a real passion for its product.

What does CohnReznick think?

Early-stage companies should put their own money in first before asking others to invest.  Sweat equity is expected and generally does not take the place of your invested cash. However, when seeking outside capital, companies must be prepared with a current and well-organized business plan. By demonstrating that they are operating a real business with a plan for growth, an early-stage company is more attractive to investors.

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