When your business is first starting out you are likely to go to friends and family in order to find an initial source of capital outside of the money that you yourself are putting into the business. This is referred to as the “seed financing” round of your business. This will provide you with enough capital to see you through the startup phase. Seed financing allows you to start on product development and market research for product placement. This is the entrepreneur stage of your business when you are still developing and cannot yet form a revenue projection for potential investors. However family investments alone will most likely not be enough for expansion.
Kinds of Investors
1: Friends and Family: A good place to start for investments. They will help you because they want you to succeed rather than strictly monetary gains and are also more forgiving of late/absent repayments. Make sure to always be professional in your negotiations with friends and family because they are real investors and often the most supportive of your startup. Friends and family generally invest in three ways:
- Gifts: This means that the money is given freely and you owe them no other obligation, of course keeping in touch afterwards never hurts either.
- Loans: Even with family you should structure your loan as you would with a bank. Place the promissory note (including terms for late payment penalties) into writing with a specified repayment period and interest rate. Family may not make you pay interest but otherwise it is best that you offer an interest rate that is fair for your good friends and that is profitable for all involved.
- Equity Financing: Your family and friends can also invest via equity. This will make them shareholders, which means they will be more involved with your business than they would be with a gift or loan, also equity offers them a much greater return on their investment, should you succeed, than a loan.
2: Angel Investors: Angels are affluent individuals who take an active interest in a startup that they have personal interest in. Oftentimes they are retired entrepreneurs or corporate veterans that have a certain industry or product that they are looking to stay involved in. Angel investors can also be great mentors and sources of management advice. Finding angel investors is dependent upon your connections, however they can also be found at local investor group conventions and meetings. There are exceptions but angel investors usually invest purely in equity:
- Convertible Debentures: This kind of security can be sold as either debt or stock. At some later offering of equity the investor can exchange their debenture for stock (preferred or common depending on the offering) options in the company.
- Angel Groups: Sometimes angel investors group their funds together in order to support particularly promising entrepreneurs. These groups raise much larger amounts of money that can range anywhere up to about a million to two million dollars.
3: Venture Capitalists: Another common form of investors are venture capitalist, which are companies that are interested in granting large amounts of money to high-potential businesses in return for substantial equity in the company. Venture capitalists differ from angel investors by:
- Size: While angel investors generally seek out a startup or even a seed business, venture capitalists are looking for established small companies that look promising and offer a reasonable chance of the investors getting a profitable return on their investment. If venture capitalists go for a new company it is usually because that company is highly innovative or has some other aspect that makes them appear more rewarding.
- Interest: Venture capitalists are interested only in the return they are getting on their investment. Whereas an angel investor will have some kind of personal stake in the owner or mission of the business they invest in. Venture capitalists are looking for what will result in the highest profit. Their investments are usually large amounts of money and generate higher risk if the business invested in fails.
- Involvement: Venture capitalists are going to want a seat on the board of your company for their investment. They will be looking to supervise the business to better insure profits on their returns. Angel investors may do the same, but they just as often do not take a board seat and will take a hands off approach to managing their investment.
The Stages of Financing Your Startup:
Stage 1: This is the startup stage where you will be investing your own savings and trying to spread the word to investors. Friends and family are key investors at this stage and are a good place to start, though it is not unheard of angel investors to take interest this early on in the process.
Stage 2: At this point you need to secure angel investors to afford additional development of your product. You are looking to gain and expand upon initial sales, while at the same time increasing your manufacturing capacity to prepare for growth. This will make the financials of your business look more promising for venture capitalists who will take your business to the next level.
Stage 3: By round three your business has more or less made it. You should be proud of getting this far but there is still a lot of room for growth and your financial situation is not yet entirely mature. As you grow your investments your business will start to produce revenues that you can use to increase production capacity and begin to pay back your investors.
Stage 4: At this point your business has made it to a comfortable level of growth and operations that are producing self-sustaining revenues. While investors are not as crucial as they were in earlier stages, venture capitalists are still the key for future growth and expansion.
For negotiating contracts and further information on what terms you should offer your investors, talk with a business attorney to help bring your business vision to life or contact the Goosmann Law Firm at [email protected] or (712) 226-4000.