As it was highlighted in the previous article, obtaining funding is critical for the success of any company, being the lack of it also the main cause of failure for the majority of startups. The funding needs are certainly very different depending on the stage of development of a company. Today we are going to focus on the funding possibilities for companies at the very early stage, a.k.a. Seed stage.
The Seed stage is when the product is still in prototype phase and the business is not yet generating revenue from its customers or users.
We are going to explore some of the most common ways to finance your business venture in its early stage, highlighting the benefits and drawbacks for each one of them, as well as tips to find out if they might be appropriate in your specific case. Although our focus is on businesses with impact, all of the following is applicable to any startup.
Before turning to external funding, advance as much as possible with your own means.
Bootstrapping (own funds)
At its very beginning, nearly every business is a self-funded venture. This phase, a.k.a. in the startup world as bootstrapping, is when the entrepreneur does not count on any external capital to fund its business, but rather relies on its own savings or generating early revenues.
How long the bootstrapping phase can last will be different for each company and depending on the field its founders are working on, their venture might be more or less capital intensive. A company working on a highly disruptive tech solution, that needs several years of R&D before even developing its product will have a completely different funding needs than an entrepreneur developing for example a mobile app, which could usually be brought to a MVP stage with little or no external funding.
Some critical points in bootstrapping:
- begin by assessing your personal financial situation and avoid running unnecessary risks
- minimize your initial set up costs until developing and launching your MVP
How to create early revenue?
- think about your business model as early as possible and about ways to generate cash flow
- while building your product, assess if you could deliver your solution as a service (consultancy, project based work, etc.)
- while still in development phase, try agreeing with first customers on prepaid orders
- if subscription service, try incentivizing early on the purchase of annual plans
Pros:
Focus on cash-flow generation and eventually reaching profitability is the most natural way to finance any business
- using own funds as fuel for the business sends good signals to future investors, proving founders’ skin in the game
- delaying external funding allows for advancing in the development in a MVP and finding product-market fit, which sets the company in a better fundraising position
- avoids giving up big stake of ownership to investors early on
- allows for focusing on what matters the most, the business itself
- gives independence and freedom to decide how to develop the business
Cons (self-funding):
- can put the founders in a very difficult position, in case they do not assess properly their own financial situation
- may not allow the entrepreneurs to focus full time in the project, if still keeping a full/part time job
Cons (revenue generation):
- it is difficult to get to profitability in early stage, given expenses precede revenues
- can be misleading to early customers if company sets unrealistic goals for product development, which they cannot deliver
- can compromise the quality of the product in initial stage if there is a rush to launch too early
Depending on the business’ success to generate revenues and founders’ ambition, external funding can be sought in a later stage in order to scale the business, fuel its growth, expand to other markets or develop new products.
FFF (Family, Friends & Fools)
After burning their own capital, the next place founders usually go to in search for financial support is their own circle, a.k.a. the three “FFF” (Family, Friends and Fools).
As logical as it seems, this does not come without drawbacks.
Pros:
- usually the fastest way to get initial financial fuel for the business
- the terms are much more flexible than what you would get in a bank or an investor
Cons:
- potential negative implications for your personal relationships
- if things do not go as planned, you might get additional criticism from someone not familiar with the business
FFF funding might be appropriate for you if you:
- only need a small amount of capital
- have a good, reputable network
How to avoid pitfalls with your FFF funders?
- make sure they know what you do and explain all the risks, be fully transparent and honest
- think about the consequences if things go wrong, consider worst case scenarios
- manage investor’s expectations: do they do it for the financial return or they are rather more willing to help? Is it because they look to expanding their network, or to be part of something they feel aligned with?
Be aware of the financial situation of your funder, before accepting their money.
- Do not accept their cash, unless they are in a stable financial situation – make sure they do not rely on this money and an eventual loss would not put it in danger.
- put the investment terms on paper
Incubators and Accelerators
In order to succeed in bringing their vision into reality, founders need to test their idea and get valuable feedback, as well as receive guidance by those who have already walked the same path.
There is arguably no better place to get all of this than joining an Incubator or Accelerator program.
What’s the difference between both? In short, incubators focus more in the very stage phase of a startup, while still in development phase and before defining their business model. Accelerators, on the other hand, tend to focus more on speeding up the growth of companies with already established MVP and product-market fit.
Joining an Accelerator or Incubator might be appropriate for you if you:
- have already proven your idea and now want to test it and find product-market fit
- have early users and want to turn them into paying customers
- have early customers and search for a way to scale
Pros:
- especially useful for first time founders, since these programs provide, among others, mentorship, business guidance and orientation towards future funding
- introduction to investors at the end of the program, in the so called Demo days
- access to the partnership network of the organization
- additional perks for you and your team (such as a Coworking space, subscriptions to services, etc.)
Cons:
- giving up on equity (usually around 5-10%)
- it’s rarely non-beneficial, but it might not add too much value, if your niche is out of the scope of competence announced in the program
- even mostly an advantage, programs might be celebrated in a foreign location, incurring additional expenses for the founders and team
Startup contests and Pitch competitions
Even though this might not bring a considerable amount of funding to your venture, there are plenty of reasons to participate in some of the many startup competitions that are launched every year in a local, regional and global level.
How to identify which is appropriate for your case?
- Depending on topic: There are contests that welcome any disruptive project, while there are also those that are specific to a particular niche or field (as for example sustainability, social entrepreneurship or circularity). As an impact entrepreneur, the latter will be for the most part the most appropriate.
- Depending on stage: Some pitch competitions have strict limitation about the stage of development your start up shall be in (such as pre/post-revenue, MVP/prototype built). Make sure to comply with the requirements.
Pros:
- fantastic place to test your concept and business model in its early stage
- great way to rehearse towards future funding intents
- reputation building
- opportunities to find eventual Angel investors & mentors
Cons:
- plenty of startup competitions out there and it can take a lot of time to find suitable ones so to avoid spending unnecessary time in applications
- it can be intimidating and stressful, given public exposure, intensity and unpredictability
- feedback can be tough and quite discomforting for early stage founders. It is important to filter it properly and always search for another opinion.
There are certainly many other ways to finance your impact business in its early stage. Among others, you can resort to:
In most of the cases, however, the latter options are more appropriate for startups that have already some traction (such as built prototype and first customers).
We will therefore explore these and other options in our next article, dedicated to funding in Startup stage.
