There are multiple sources of entrepreneurial funding. A typical start-up will seek entrepreneurial funding sources during 5 separate stages of business development. Typically the Entrepreneur will develop an idea and fund this research and early stage market research with his own funds, he will then seek out the “FFF” investors who may fund his idea with, lets use $15K as an example.
An accelerated start-up may seek out an Angel Investor after 3 months, netting $200K and after another 6-12 months they may seek a further $2M from a Venture Capitalist.
Before we begin talking about funding, it’s important to note that building a business using the traditional model and leveraging “Entrepreneurial Funding Sources” is not the only way to succeed. Companies such as Mailchimp and others have succeeded using their profits to fund their growth, which is known more commonly as bootstrapping.
So in a nutshell, here’s how Entrepreneurial Funding Sources work. You start off with a pie, that’s your dream, your idea for the business. Its a small pie but its all yours. You decide you would like a larger pie but don’t have enough ingredients (cash in this case) to make it work so you enlist the help of others.
First you get a friend or family member to provide some additional cash to make the pie bigger, you give a share of your pie to the family member who has helped supply the cash.
Next you decide you want an even bigger share of the pie so you seek out additional Entrepreneurial Funding Sources in the form of Angel investors and Venture Capitalists who will provide the funding for a slice of the pie, your slice in terms of percentage get smaller but the overall pie is much larger so you effectively have more pie (Remember it’s cash we are talking).
Finally you want to take the pie public because that where everyone will have the opportunity to supply ingredients – yep cash – to ensure your pie is increased to the maximum size. Each of the pie investors will take a share, and your own share percentage wise may be small but worth a large chuck of… Pie.
So technically the 5 Stages of Funding Sources are:
This is where the idea is yours and/or your partners alone. You own everything in the company and there is nothing to share with anyone else. Family/Friends Stage This stage allows you to seek small amounts of funding from family and friends. The typical amount of funding here is $10-15K and for that the investor would expect in return a 5% stake in the business. This stage is often referred to as the FFF, friends, family and fools stage because it is high risk investing in a business at this early stage however the returns are often very high.
There are two trends of investment that are starting to appear in this entrepreneurial funding sources. We are seeing the emergence of Incubators and business accelerators as a viable alternative to outright investment. The advantage of these funding sources is that they do not only provide the cash they also provide collaborative workspaces and business advisors to work alongside. The asking price is steep at 10%-15% for a $25K investment but often the chance to work with these advisors is worth the equity alone. The second choice is a straight out investment where an angel investor would contribute anywhere from $200K – $1M with the average in 2012 being $600K. (Source: Halo Report) with a typical equity share being 15-25% of the business. This is the type of investing done on television shows such as the Dragon’s Den which is a personal favourite of mine.
This is where things start to get serious. Venture Capital can have multiple rounds and each round takes a share of the equity. VC’s typically invest more than $500K and it’s more likely to be in the multiple million dollar range to get them excited. They will value their slice of the pie as a formula of the companies net worth divided by the amount they are investing i.e. a $4M company valuation, where they put in $2M puts the company at $6M post investment so the VC expects a 33% share of equity.