This article, written by attorney Emily Penaskovic, was originally published on seacoastonline.com and can be found here.
For entrepreneurs launching a new business, one of the earliest and most pressing challenges is finding the resources to fund their vision. There is no one-size-fits-all solution to raising money, and startups should understand the various types of funding that are available in order to target their approach to raising capital. Successfully navigating the maze of funding options can make a critical difference for early-stage companies.
Friends and Family
Initial investments from the founders’ personal network, including friends and family, can provide vital early support when a startup is raising capital. This group tends to invest based on personal trust and belief in the entrepreneur, rather than a strict evaluation of potential returns. In fact, some institutional investors will want to see that the founders have already been able to raise money from those who know them best, as it reflects the founders’ support and personal backing. While this type of funding is usually straightforward and cost-effective, it is crucial to ensure these supporters understand the risks involved with investing in startups. For startups in their infancy, bringing in relatively small investments from friends and family can be an ideal path to kickstart growth. These investors can also help founders to test their hypotheses and hone their story in preparation for later investment rounds.
Angel Investors
During what is commonly referred to as the “pre-seed round,” startups may seek funding from angel investors. Angel investors are accredited individuals that provide early-stage capital, typically in amounts less than $500,000, in exchange for equity. Angels’ involvement often extends beyond money to include expertise, advice, and connections that can accelerate growth. Angel investors typically participate in the company’s earliest priced rounds and purchase common stock, which offers fewer protections and preferences than the preferred stock expected by venture capitalists.
These earliest investors are often amenable to investing using convertible notes and SAFEs (Simple Agreements for Future Equity) as a cost-effective alternative to doing a priced round and receiving equity outright. These are loans that convert into equity at a future point, typically upon the closing of a subsequent equity financing round. In that sense, convertible debt can act like a pre-purchase of preferred stock, and investors may be rewarded for making a riskier investment early by receiving preferable terms like a valuation cap or discount upon conversion. Convertible debt delays the need to determine a formal valuation, making convertible notes and SAFEs an attractive funding option for startups expecting to secure equity financing in the near future and needing to bridge funding gaps.
Equity Crowdfunding
Equity crowdfunding is an increasingly popular framework for startups to raise small amounts of capital from a large pool of investors through funding portals registered with the U.S. Securities and Exchange Commission. This approach presents an opportunity to bring in smaller investments from accredited and non-accredited investors, enabling founders to tap into a broader investor base. While equity crowdfunding is a viable path to raising capital for companies at almost any stage, the most successful companies are those that are generating enough revenue to successfully market the investment round. Founders should have realistic expectations regarding the effort required to have a successful equity crowdfunding round, including outreach to potential investors and marketing the round.
Venture Capital
Venture capitalists (VCs) often get involved in the fundraising process after angels, helping businesses with proven potential scale rapidly. VCs are firms that manage pooled funds from groups of investors, enabling them to invest larger sums (VC investments can be upwards of $10 million). While the specific benchmarks are constantly changing and are very market-dependent, VCs do not usually get involved until a company is generating revenue. They are focused on priced rounds and typically receive preferred equity.
VC funding comes with trade-offs. In exchange for more significant investments, VCs receive preferred equity, along with significant control over company decisions. While VCs tend to expect a high level of involvement in the business, they can provide valuable strategic advice and networking opportunities. High-growth companies that are prepared to give up a portion of control and ownership and that anticipate significant growth and seek a successful exit may find VCs to be ideal growth partners.
Traditional Debt Lending
Traditional bank loans are usually unavailable to early-stage companies lacking collateral or operating history. With that, New Hampshire has several unique lending options that may be available to startups. The state has non-profit regional development corporations that offer hybrid funding options, often combining features of loans and grants, that early-stage companies may qualify for. Similarly, through its Capital Access Program, the New Hampshire Business Finance Authority provides guarantees on term loans and lines of credit that banks provide to early-stage companies with limited revenue. These options are worth exploring for businesses with unique needs.
No single funding option suits every startup. The ideal approach depends on the company’s stage, goals, and growth trajectory. By understanding the available options, from angel investments to bank loans, entrepreneurs can strategically pursue the resources they need to succeed.