Most businesses start when the founders decide to fund their business by themselves. Most tech startups start in a small area where they develop the product and ready it for commercial production. As the business grows, the importance of funding arises because it has to cater to a wider audience. The scale of business should also increase, which requires capital commitment. The funds would get blocked in the scaled production. Businesses need funding for operational purposes, including salaries and payment of rent and other bills. Businesses are not risk-averse, which means they have to set some money aside. All these culminate in testifying that businesses need funding(1).
For new businesses, it can be a little difficult to identify sources to secure funding apart from their family members. There are a lot of sources apart from family members’ commitments too.
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Crowdfunding
Crowdfunding is a common method for raising funds. It is one of the newer methods of funding that most startups — tech startups especially — rely on for getting the funding they need without any commitments. It can take the form of loans, investments, contributions, or preorders for the products that the startup offers.
The way crowdfunding works is that the startup that is seeking funding uploads the details about itself and the product it offers. Most startups upload detailed portfolios of how their product will look after it finishes commercial production. People who like it may invest in the product or offer loans. However, these two are highly unlikely in this form of funding. People generally contribute some money upfront or promise to purchase the product as soon as it is released. This promise can be a payment now for receiving the benefits in the future or pre ordering the product at the intended retail price at that time.
Why should you choose crowdfunding? The best thing about crowdfunding is that it acts as a marketing tool as well. With targeted advertisements by platforms like indiegogo and gofundme, it is easy to reach a wider market. This helps create interest in the product and helps establish a target audience before the product hits the market.
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Angel Investors and Venture Capitalists
The terms Angel investors and venture capitalists are often used interchangeably. Angel investors are people with surplus cash and high disposable assets. They look out for promising startups to invest in. Sometimes angel investors work together in groups so that they can screen the proposals before investing in them. These angel investors need not offer just money. Many times, they offer managerial advice and mentorship also. The downside is that the payout isn’t as high as what you’d get from venture capitalists, but they expect equity up to 30%. If they are not happy with the team that the startup has employed but like the idea, they may seek majority control through management of the board until they believe the company is incubated and ready to survive on its own. They may exit or choose to stay on as investors
Venture capitalists, on the other hand, are firms or companies that actively seek out startups to invest. They aim to provide funding for business ideas. Venture capitalism funding is generally used by companies that are just out of the startup phase. These venture capitalists are professionally managed funds whom companies seek out for business startup funding. They usually invest in business against equity and exit when there is an IPO or an acquisition. VCs provide expertise, mentorship, and acts as a litmus test of where the organization is going, evaluating the business from the sustainability and scalability point of view.
The flip side is that Venture capitalists generally have a very short leash. They have strict guidelines on how a firm can behave or the activities it can use during its operations. They generally aim to get back their investment within a short span of 3-5 years. In that time, VCs may require that the companies go for IPOs or other forms of public valuations. In its absence, they may require that their funding be returned with some amount over the funding provided.
Business Incubators and Accelerators, and Government Programs
While often used interchangeably, incubators and accelerators are generally different. Incubators stick with startups until they have commercial viability in their operations. Incubators and accelerators are a great way to get funding because they offer not only funding but also management advice and networking opportunities. These incubators and accelerators are available in every major city. The chief difference between an incubator and an accelerator is that incubators nurture the startup from its inception while accelerators help improve the business after it acquires operational viability.
In addition to these two, there is also the option of government programs. Governments have several programs to promote industrial growth. Various state governments have their plans to improve the growth of industries in their state. Otherwise, the federal government declares some programs as well. These could be tax benefits, rebates, concessions, reduced tax liabilities for a period, or help in the form of a central fund. The money from this fund would be used for offering various services for eligible startups. The programs could also include providing startups with networking and other advice to get a headstart in the business. Sometimes banks are instructed to provide loans at lower interest rates as well. In addition to this, several NBFCs would have been created for this purpose only.
Once you get all the funding, drafting an agreement is an important part of sealing your arrangements with the investors.