Identifying the Right Investor for Your Startup

By Michael Whitehouse

Photo credit: http://blog.acrowire.com/

As we tell our members at 1000 Angels, the private investor network that connects startups with investors, a startup lives and dies from its funding strategy. If the correct approach is taken and the right form of investment is secured, then a startup can thrive and establish sustainability. On the other hand, if the wrong type of funding strategy is implemented, a startup may face a precarious future, resulting in stagnancy and, in some cases, even liquidation.

What's right for one company may not work for another. If your startup project requires a continual stream of financing for 1 to 3 years before becoming self-sufficient, for example, then a one-off investment might not cover what you need. Other types of investments may require connections, business and advertising know-how, etc. Investors offering finance exclusively may not be adequate for your company's needs.

It's clear that implementing a funding strategy specific to your project is essential. In order to do this, you'll need to understand the types of startup investments out there and identify which type will best serve your company.

 

Startup Funding: Know Your Options

There are a growing number of funding options out there, even hybrids of popular choices, but for simplicity’s sake we can solidify these into seven investment strategies for your startup. Once you're familiar with each, you will be better placed to choose which is best for you and your business.

Let's take a look at them below:

  1. Family & Friends: It may seem obvious, but to approach friends and family can be a great way to fund your startup; you will not have a serious creditor or investor hanging over your head and can quickly gain access to funds. There is more freedom with this option than most others. You won't need to explain all of your managerial choices in most cases, and often friends and family will be happy to support your project in any way they can as long as the investment amount is reasonable.

    One of the difficulties of approaching friends and family is the rarity and difficulty of raising over $100,000. Not to mention the personal issues which can arise from mixing business with friendship. All investments, even from family, should be documented in writing. There must be an understanding that no investment is a sure thing and that there is a chance the investment might not be returned if the project fails. Of course, if it succeeds, then your friends and family will share in the profits which might offset this concern.
     

  2. Angel Investment: An angel investor provides capital for a startup in return for either equity or convertible debt. Often, such individuals are contacted during a second round of investment after family and friends have been approached. They can provide more lucrative investments, sustaining a business before moving on to more substantial sources such as venture capital. Angel investors use their own funds and are most commonly involved either at the seed stage of a startup to help the business find its feet, or during difficult times when cash flow is an issue.
     

While this form of investment is perfectly valid, you should consider some of the implications of going down this route. Angel investors often seek an active role in the startup they are investing in. They also are unlikely to invest more than once unless they see returns in the pipeline, so if you need more than a one-time cash injection, another funding strategy might be preferential.

3. Business Plan Competitions: Often overlooked by startup entrepreneurs, applying to a business plan competition involves submitting your business plan to be judged by a panel against others, with the winning entry receiving some form of funding. Such a panel normally represents a group of investors who are willing to supply capital to those with the most attractive business plan. There are many such events like this worldwide, but the terms of submission must be explicitly followed. A business plan competition might ask for hands on involvement in the startup in return for investment; if this is not something you wish to entertain, then ensure that you are applying for those competitions without such stipulations.
 

There is usually nothing stopping you from applying for as many business plan competitions as you can. If you yourself are not best equipped to create a dazzling plan, then it might be worth hiring someone to do it for you on a one-off basis. This plan can then be submitted to any competition you wish.

4. Accelerator and Incubator Programs: These programs are designed to foster startups during the seed stage for a defined period. Good example of this could be TechStars. This usually occurs over a few months and includes office space, funding, access to B2B or B2C networks, and mentoring. Experienced businesspeople will therefore help shepherd your startup at the beginning and get it off the ground. This is typically done in return for equity in the business.

Working with the right businesspeople can be a valuable opportunity for your project, but it requires careful consideration. While you gain access to the experience and capital of someone who knows how to make a startup a success, this is given in exchange for a permanent stake in the business which many mentors may sell to other parties outside of your control, as soon as a profit presents itself. The emphasis here is often on the quickest turnaround time possible. If you are looking for a co-founder and investment of time then check CoFoundersLab.

5. Bank Loan: Most banks offer loans to small businesses. All that is needed to acquire a loan is a good credit history, a business plan clearly defining costs and how profits will be made, and a well researched overview of the marketplace for your specific product and/or service. If the business already has capital of its own this can hugely help in persuading a bank to approve funds.

As with any loan, there are dangers which should not be overlooked. If a loan is not paid on time then it can put a startup into a precarious position. Any creditor will expect to be repaid the amount owed; if they are not they will consider legal proceedings which could destroy your business. High interest rates can also be an issue, so it’s critical that you try to secure the best deal available before agreeing to take a loan. A credit union may be a better option, as they will provide capital to members for a much lower annual interest.

6. Crowdfunding: There is no doubt that crowdfunding has changed the way fundraising works. By showcasing the concept behind your startup and offering perks in return for money, rewards-based crowdfunding can provide substantial amounts of capital. The greatest advantage here is that it isn't really investment; at least not in the traditional sense. You receive money from those wanting to support your project, but contributors do not hold a stake in the business. They expect to see the project come to fruition, but there is no legal obligation for this to occur. Crowdfunding can attract hundreds of thousands, and in some cases millions, of dollars worth of capital without giving away one single share in the business. Equity-based crowdfunding platforms like 1000 Angels provide a chance to reach a slightly wider pool of investors, but still raise a good chunk of capital in exchange for equity.

There are downsides to crowdfunding, most pertinently in terms of reputation. If you do not bring the startup to a position where it can produce its goods or service, or you do not honor perks/commitments which were traded in return for investment, then your brand and you personally will acquire a toxic reputation. This can negatively affect future ventures and can all but destroy any faith the consumer might have had in your startup. For this reason, crowdfunding should not be entered into lightly.

7. Venture Capital: One of the most desirable forms of investment for a startup is to attract the interest of a venture capital firm. Most VCs represent a pool of investors who are willing to commit substantial amounts of capital to the right project. With a huge amount of available funds and access to expert consultants who will help your business, venture capital groups provide an enticing option to startup entrepreneurs looking for a large round of funding.

Unfortunately, venture capital firms tend to require a big return on their investment. This can be a large portion of profit as well as a substantial stake in the business. Caution must be taken here; if too much equity is given away, you might find yourself out of the decision making process for the startup that you created. Furthermore, venture capital firms stick to rigid guidelines when it comes to due diligence. It can take them months to decide whether or not a startup is worth investing in, so they are not the ideal choice if you are seeking a quick injection of finances.

Which is the Right Investor for Your Startup?

Unless you have access to a high level of personal wealth, securing investment for your startup is a must just like we outlined on our piece discussing thoughts on hustling stating the differences of why some founders win and other loose. Even after a certain period of bootstrapping, there's no other way to get to the next level. Deciding on which type of investor to approach is entirely up to you. They must be the best possible option for your business and your financial situation. Get that decision right and your startup could grow exponentially, from a small project to an internationally renowned brand.


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