Every scalable startup will require external funding. A great team with an amazing idea where there is a clear demand is still doomed without the finances to make it happen.
In fact, a truly great team will integrate future capital needs into their strategy from the very beginning. The question isn’t whether or not you need startup capital; it is whether you get today’s funding with the future in mind (Marathon Investments) or simply meet the needs of the moment by whatever means possible (Sprint Funding).
Most startup funding efforts follow a Funding Lifecycle involving some combination of family and friends, grants, banks, crowdfunding, Angel investors, and Venture Capital firms at different stages of growth and expansion. Progressing through the funding stages from Concept to Mezzanine is a marathon; however, many otherwise high-potential start-ups never make it due to poorly designed deals in the first stages of funding. Agreeing to the wrong terms on Seed Stage and Early Stage investments have the potential to kill future rounds of investment.
Ideally, this is the mentality all entrepreneurs should have towards startup funding. This means practicing a great deal of willpower, careful planning & strategy, and understanding what is and will be the true value of your company. Calculating the valuation of your business can be a difficult, but critical task for future planning. Often times, entrepreneurs will jump the gun and accept investment offers from anyone in exchange for stakes in the company. By doing so, the founders are creating a more difficult situation later on. Founders should maintain a majority ownership of the company, as they are the ultimate decision makers. Holding on to as much equity as possible throughout the beginning stages of your venture will provide better leverage in later investment rounds with VCs or CVCs. A good rule of thumb is for the team to hold onto 25% of their company through the exit.
You’re probably wondering how to bootstrap your company all the way through to the Mezzanine level? This requires a significant amount of sweat equity, research, and many applications. Here are the most common options:
- Cashing out 401Ks or stocks to fund their company (this is a personal risk, but many entrepreneurs take this route).
- Government or private grants will provide funding without losing any equity.
- Startup competitions provide cash prizes and networking opportunities (and even free spots in accelerator programs).
- As of recently, crowdfunding campaigns have boomed for startups. They have allowed them to connect to their customer base and receive funding for the future product in exchange for special incentives.
In a perfect world, everyone would operate on the marathon investment mentality. You will accomplish your goals and achieve success! Realistically, many function on sprint funding (and often to not survive long enough to consider marathon investments). Sprint funding is not a bad thing by nature, but it can create detrimental problems if you depend on it. Here are the top 3 mistakes entrepreneurs make early on:
- Funding debt. Finding investments to pay off debts for product development, operations, or to pay your employees is prolonging critical problem in the company.
- Not operating on a lean model. There is a reason why minimum viable products (MVPs) exist. You are able to have a product that generates revenue and can be modified later on. Consistently seeking more funding to create a perfect product without generating revenue is just digging a deeper grave. Essentials come first, extras are for later.
- Giving up too much too fast. As stated earlier, founders should want to maintain majority of the company. Hold out for better deals, and give you and your company the worth and respect it deserves.
Dianna Labrien, offers the following 5 tips to make the most out of your early financing deals:
Don’t give up pro-rata rights to your first investors.
Restrict your share restrictions.
Avoid having too many people overly involved.
Avoid limits placed on management compensation.
Find investors who “get it”.
Viewing your startup capital needs through the lens of your future situation may slow things up a bit today, but will make fulfilling the vision much easier in the long-run.