Early-stage company financing options — with alternative sources offering hidden treasure
Great companies start with great business ideas, but turning those ideas into reality requires capital — and sometimes a sizable amount. Many entrepreneurs dream of landing venture capital to meet their funding needs. But in the beginning, that is unlikely to happen for early-stage companies. In fact, according to the National Venture Capital Association, only about 1,000 new companies out of the 627,000 new businesses initiated each year in the United States receive venture funding.
Fortunately, there are more financing sources than ever for early-stage companies. But identifying the ideal source(s) of capital for your business can be tricky. Although early-stage companies may view a windfall of venture capital as the grand prize, we encourage early-stage companies to explore other sources of capital until venture capital funding is more likely.
Traditionally, some early-stage companies fund their businesses through bootstrapping. Young companies bootstrap their funding needs by relying on early customer revenue, penny-pinching and even using personal credit cards to make ends meet.
Friends and family
Friends and family contribute approximately $60 billion to early-stage companies each year, or three times more than venture capitalists, states funds and angel investors combined, according to the Angel Capital Education foundation. Raising money from friends and family for an early-stage company can be a lot less complicated than trying to convince professional investors to believe in the company.
An angel investor, or angel, is typically an affluent individual who provides capital in exchange for ownership equity. Some angels are individual investors, but many band together and invest as a group.
Angels are more active than ever. The median size of angel and angel group financing was $680,000 in the first quarter of 2013, up from $550,000 in the year-earlier period, according to the Halo Report from the Angel Capital Association and the Angel Resource Institute.
Crowdfunding is one of the most exciting innovations in years. Individuals from all walks of life contribute pocket change to the companies and ideas they like best. If enough people like the company’s idea, those amounts can translate into a considerable amount of money.
Crowdfunded projects raised an impressive $2.7 billion in 2012, across more than 1 million individual campaigns globally. In 2013, the crowdfunding industry is projected to grow to $5.1 billion, according to the Crowdfunding Industry Report by research firm Massolution.
Government grants and funding
Companies may be surprised to learn that the government may be eager to support startups. Federal and state governments spend billions of dollars every year funding early-stage projects. A study by ChubbyBrain found that the government invests a median of $1.1 million in every company it supports.
Virginia has the Center for Innovative Technology (CIT), a state-funded organization that makes seed-stage equity investments in Virginia-based technology, clean tech and life science companies.
Startup accelerators continue to grow in popularity. There are now about 200 around the world and the number of applicants they attract has exploded over the past few years. A startup accelerator functions somewhat like an assembly line. But instead of spitting out widgets, it churns out innovative companies.
Accelerators typically run 12–16 week programs to propel startups quickly from concept to product. They offer seed money — as much as $150,000 per company — and mentoring in exchange for equity, normally around 7 percent. Programs culminate in a demo day, during which graduates pitch their startups to investors.
The top accelerators have consistently produced an impressive roster of graduates that have gone on to raise substantial venture rounds.
• Unless you are a serial entrepreneur who has had successful exits and provided large returns to your past investors, consider bootstrapping your new venture until you have at least developed a beta version of your product or service.
• Outside investment to grow your company and reach your intended market quickly could be exactly what your company needs. When talking to investors, consider who will be a good strategic investor — they will have the ability to help you grow your business through their contacts and experience.
• Lastly, always be ready to respond to requests from potential investors. It is encouraged that those seeking capital be prepared with a sound business plan.
Alex Castelli, CPA, is a CohnReznick partner and the national leader of the firm’s Technology and Life Sciences Practice in the Tysons Corner office. He is a member of the Virginia Society of Certified Public Accountants. He can be reached at [email protected] or 703-744-6708.