Even if you are running your business from your bedroom, most startups have operating costs and need funding to meet them. Maybe you need someone to build your website or to pay for your cloud-based accounting software. Your costs will continue to increase when you build your team, need a larger office or more storage space etc. But for now, getting the banks to lend you the money is likely to be an uphill battle. Who can you turn to now?
The most common lenders to a business are its founders, digging into their own pockets to get their idea off the ground. Some use personal savings, re-financing a mortgage over the family home or even credit card advances.
Friends and family – crawling
While your business might not need substantial amounts of cash in the early days, your own pockets may not be deep enough to cover those expenses. This is where your personal network comes into play: looking to your “friends and family” to help meet the capital needs of your business. The familiar nature of your relationship with your relatives and acquaintances, and the likely absence of a formal pitch deck for potential investors, means this funding is often provided through loans without any legal documentation or due diligence.
Friends and family funding is cheap, fast and relatively easy – especially when your investors believe in you. Remember that you will probably still have to see these people at the next family gathering or social occasion. To avoid misunderstandings and awkward conversations at the buffet table, it is better to document the terms of your transaction with them. Make sure your friends and family understand they are making an investment and, like all investments, it comes with risks – in the case of your startup, these risks are likely to be much higher than Great Aunt Doris’ interest-bearing savings account.
Seed financing – walking
For something named after another thing that is so small in size, a lot of web space has been given to discussing what “seed financing” is and is not. Some say it depends on who is investing, others look to what stage your company is at (early software development or somewhere towards the end of the pre-revenue phase). We prefer to think of seed financing as the first round of financing from third party investors. These investors are the kind that regularly invest in startup companies such as individual angel investors or angel networks. Seed financing can be raised through either equity and/or convertible debt. The documentation for a seed financing does not need to be overly complicated but it must be legally sound to ensure you don’t trip yourself up down the road when it comes time to raise your Series A.
Series A – running
Once your company has a substantially higher valuation than it did during the earlier funding rounds, and the focus has shifted from startup to scaling your model, you enter the world of Series A (and Series B, Series C etc). Series A investors are usually VCs and the amounts they contribute to your company are much larger than previous rounds. As a result, VCs expect higher ownership levels and may bring about changes in your corporate governance framework if they insist on board representation and involving industry experts in your business.
Given the financial commitment and the organisations involved, a Series A financing will probably be both demanding and time consuming for your business. VCs will undertake comprehensive due diligence (legal, financial and commercial) on your business, your management team will need to deliver sophisticated presentations and provide slick responses in interviews.
The documentation will be noticeably more complex than previous rounds of funding and you should get legal advice to help you navigate the considerable restrictions that investors will seek to impose on the company outside its normal course of business. If your company goes through further financing rounds in future, it can be difficult to change the rights granted to your Series A investors so it is important to negotiate your Series A carefully.