The Ultimate Guide To Raising Capital For Your Start-Up In 2016

Discussed below are seven alternative sources to collect capital without the interest and servicing costs of taking on debt.

 

The first check an entrepreneur collects is likely to come from somebody near and dear who trusts the entrepreneur regardless of the idea. 

 

While it is the easiest investment option for regulatory purposes, founders should be wary of the risk that their loved ones take on when bestowing precious capital upon a potentially precarious business. 

 

Discuss your idea and its risks, alongside its potential, to ensure you do not alienate a companion should the start-up flop.  

 

Angel investors are high net worth individuals who invest in start-ups on a more casual basis than professional venture capitalists. Angels can put in anywhere from a couple hundred to a couple hundred thousand dollars, partaking in venture investments often or on occasion. 

 

Get to know your angels well: look them up on AngelList, talk to people who know them, and understand that the less often an angel makes deals, the more likely they are to flake on yours.  Target investors who are interested in your industry. 

 

Be aware that federal and state laws regulating the offer and sale of securities prohibit the “general solicitation” of most initial capital raising transactions. Now is not the time to pitch for angel investors on traffic-prone billboards. Also appreciate that from a regulatory perspective, you should avoid compensating (via significant cash or shares) “finders” who introduce you to prospective investors, as broker-dealer licensing issues could arise.

 

Angels often invest collectively in what is called an Angel Group.  Angels combine forces to write a larger check and may conduct more onerous due diligence on your pitch. Each angel will get a piece of the pie in your company. Angel groups are highly attentive to valuation and likely to price their investment significantly higher than a venture capital fund. 

 

Your next option is an AngelList syndicate, where multiple investors can participate in one lead investor’s deals. In exchange, tag-along investors owe a piece of their upside to the lead investor. 

 

As a result, passive investors can contribute to a start-up, with fewer meetings and the attention of an AngelList Advisor. This is the most effective way to raise capital on AngelList; identify angels who run the big ones and find a way to connect with them. The legal structure of a syndicate is a special purpose fund created specifically for each investment, so syndicate investors are not directly investing in the company. Also understand that due to securities regulations, syndicates can usually only accept 99 investors in a deal, lest they are accredited (worth beaucoup.) 

 

 

Venture capital (VC) refers to any private investment in an early stage venture, typically a company that needs substantial capital for fast growth and has a foreseeable turnaround or exit. Venture capital funds make an investment in a new issuance of stock, therefore every round of fundraising after the seed round will dilute equity interests. 

 

VC firms often boast a “value-add,” likely expertise, contacts, or other resources alongside funding to poise a company for critical growth. Note the distinction between resources a VC provides (which complement their check) and resources an incubator or accelerator provide (which generally take direct equity in exchange). 

 

VC investment inherently balances a tightrope between providing oversight to founders without creating friction. As such, be prepared to discuss the terms of your VC deal, not just the price. 

 

In a competitive setting where investors may be vying for their piece of your pie, governance rights will be crucial. Recognize whether you want intimate involvement or a hands-off approach from your investors, the structure of the security an investor receives (regular common stock, preferred stock, or convertible preferred stock), and liquidity rights (who can sell their stock and when.) Do you want the VC to govern your board, or have observer rights? A good lawyer on your side will make a world of difference when navigating the many flavors of a VC deal. 

 

A VC cares about their percentage of ownership in your company, and so should you. Traditional VC firms have fund sizes ranging from $100M-$500M and will do seed deals anywhere from $100K to $2M. 

 

Develop a close relationship to the partner on your deal and be conscious of how many other companies they manage. Micro-VC’s will likely have between $10M to $50M under management and could lead a round but are more likely to join a round. Some are industry specific and some harness a specific value proposition. Research a micro-VC’s portfolio critically for potential synergies with other companies. Mega-VC’s (the Andreessen Horowitz, Kleiner Perkins, Khosla Ventures, Sequoia Capital sorts) have over $1B under management. Some do seed investing, but they are more likely to invest in Series A or B rounds where they can get a significant return on the large amount of capital they deploy. 

 

Acquiring seed funding is tricky: if early shares are issued at too high a valuation, it could potentially scare off future investors and leave you vulnerable to a “down-round” (subsequent financing at a lower valuation, hurting everyone.) In such instances, a non-priced round through a convertible loan can postpone a valuation discussion. Though a convertible loan is technically debt, it operates as equity since it does not bear interest and the funds are never technically repaid—instead, it converts into equity at a future date and agreed upon price. 

 

When pitching to a VC, also be cognizant of essential points founders often omit. Describe your product concisely and effectively—before the why, how, or who, address what you are building. Explain your monetization strategy early and often—investors are, after all, expecting a return. Identify your competitors if you have any and distinguish clearly. Do not be afraid of coming off a little fanatical about your idea; passion does pay.

 

 

By setting up a page on an internet-mediated registry (Kickstarter, Indigogo, Gofundme, etc.), you can propose your venture to large groups of people. Non-equity crowdfunding, or rewards-based crowdfunding, is the most commonly used current model and offers “investors” a perk (eg. movie screenings, album previews, or merchandise) in exchange for their capital contribution. 

 

Equity crowdfunding, similar to AngelList syndicates but broader in scale, is the collective effort of mass investors to finance a new venture. In 2015, the SEC adopted new rules as part of the Jumpstart Our Business Startups (JOBS) Act, also known as Regulation A+. The new offering requirements will enable small businesses to raise up to $50M from the general public, not just accredited investors, as an exemption to the “general solicitation” prohibition (functioning almost like an IPO.)  As Regulation A+ gains traction, start-ups will have an easier time raising funds with fewer transaction costs and increased access to capital from the masses. CrowdCube and Seedrs are Internet platforms that issue shares in a new company in return for small investments from registered users.

 

If your company is already generating revenue and has a steady stream of income, you may consider factoring to generate cash. A “factor” is a third party that purchases your accounts receivable (invoices) at a discount for immediate cash, giving you instant liquidity on your sales if the accounts receivable will take awhile to collect. This is almost like a line of credit, sans debt on the balance sheet. 

 

Most factors are non-recourse, meaning that if your invoices do not deliver, you have nothing on the line and the factor takes the hit. If you do contract with a factoring company, ensure strict confidentiality policies to ensure that they do not advertise their business with you to potential clients without your consent. If your existing receivables arrives immediately and do not strain business, you may be better off raising capital in an alternative manner. 

 

Factoring can be expensive, usurping large chunks of potential revenue if management is not careful. If you are selling a physical product, look into Kickfurther, a crowdfunding-factoring hybrid that gives businesses the opportunity to finance their inventory through consignment, rather than equity interests. Ergo, a business can raise capital from “investors” to fund inventory by offering a return on each unit sold.

 

 

While federal grants are available in areas of medical research, science, education, and technology development, such funding is hard sought to a for-profit venture. However, most states offer grants for women or minority-owned businesses in some capacity. 

 

Explore the Small Business Administration and Small Business Innovation Research grants, as well as the business section for the state of California website, which lists incentives and programs for businesses. 

 

Also research grant programs administered by large corporations or conglomerates (FedEx, Capital One, Google, Huggies, etc.) dominating the industry your venture seeks to enter. Next, research prize competitions. Major universities host them often and will usually require only one qualified team member—a student who could be a great resource to your company anyway. Consider leveraging your network, from cultural to political to professional organizations, for grant opportunities but also be aware of the implications of such an association’s award.  

 

 

Self-funding, also known as bootstrapping, might be the least complicated and lucrative choice for a young company. You are forced to focus on revenue, spend no time raising funds, need not answer to any investors, increase your leverage for future attempts to finance, and are emboldened by the thrill of your own efforts reaping rewards. 

 

Of course, this is not an option for every company, especially if it requires capital to become operative. Even if that is the case, know that running a “lean” start-up, focused on maximizing existing resources before expending effort on acquiring more, fosters efficiency and demonstrates early traction that investors want to see down the road.

 

The road to funding is paved with good intentions. It will not be easy and most companies collapse before any meaningful ROI materializes. Before you get started, determine a few issues to streamline your hunt: how much money do you need to raise, how much equity are you willing to give away to an investor, what kind of investors do you want to involve, what will the terms of the offering be, and can you put in any money of your own to prove that you have skin in the game? In the words of Randy Komisar, serial entrepreneur, author, and venture capitalist, “marry your mission.” Your most important investors will not only believe in your company—they will believe in you. 

 

 

 

 

 

 

Nicole Houman is a graduating law student at the USC Gould School of Law pursuing corporate transactional work for emerging companies and venture capital investors. She is an analyst at a Los Angeles venture capital firm, former intern at the Securities and Exchange Commission, executive in the USC Entrepreneur and Venture Capital Association, and contributor to Los Angeles Legal Technology MeetUps.