Early Stage Funding How Little Cash Do You Need?
Early Stage Funding: Most startups are not highly capitalized. Of course it varies by sector. You are unlikely to find airline startups with hundreds of thousands dollars in startup funds. On the other hand, a landscaping business can start with a second-hand lawnmower and a few hand tools!
However, a young and growing business can find it tough to avoid running out of money—however big it is. Almost all founders complain that cash is an issue and many crash from its lack—you’ve surely heard the corny expression that cash is king.
You may think you can avoid the early stage funding challenge, if you get external equity investment at the outset. My observation is that, great though equity investment from friends and family (about 38% of startups), an angel investor (less than 1%) or venture capital money (less than 0.05%) may be, help from them may not be in your best interest. In any case, nearly 60% of startups are self-funded.
Funding Can Be From Cash Conservation, Too
Chances are high that without the parsimony that comes from bootstrapping the business, you’ll be profligate with spending and your burn rate will run faster than you can pull in the cash.
On the other hand, bootstrapped businesses often lack the funds to expand at the rate they want. This will hold back spending on marketing and sales or holding off on investment, including hiring, that will propel the business forward.
The first port of call for early stage funding is normally the bank. The trouble is that bank lending officers tend to be reticent about lending to new businesses if they lack both collateral and a couple of years in business. This affects especially those that are expanding rapidly (Reducing Risk to Startup Safely). Even with the support of an SBA loan guarantee.
The best form of early stage funding is your own revenue. Growing sales is probably Job #1 for all early stage ventures. Sales showing up on the income statement are great, but actual cash in the bank is even more important.
New founders are often fearful of hounding their clients for settlement within terms in case they might upset the relationship. If you taken the trouble to establish terms and conditions of business, as well as making them clear to customers at the time of the sale, then what’s so awful about getting them to keep their side of the bargain?
Do not be afraid. If you have built a good relationship with the customer from the outset, then don’t be shy about being clear about when you expect settlement of accounts receivable. Be proactive about reminders, maybe a week before due. If there appear to be issues, then raise them and resolve them early.
Your customer contact is probably not be the person who actually pays your invoices. Perhaps it’s someone in the accounts department, whom you don’t know. Ask the person who gave you the order who it is. Ask when in the month the company does a check run. Do it up front, at the time of closing the sale, every two weeks, or whatever. When you know that, you can make sure you invoice by the appropriate date. Make friends with the accounts payable person, so you don’t have to bug your direct contact.
Early Stage Funding from Cash Flow
At the outset of my first business, cash in the bank was the most significant form of funding, despite nearly running out of it in month three.
That was actually a stark lesson: there came a day when if we did not have money in the bank by the following Monday, the bank would have called in the receivers. Happily, we did have strong B2B clients. I called one of them and asked if we could be paid two-weeks early on a nice chunky invoice. We did not have to ask them as second time—and managed a settlement average of 32 days over the next ten years.
The financial underpinning was our bootstrapped start, which included an inexpensive office above a wholesale butcher, leasing not buying, and many other ways of keeping expenses low.
Loans from Friends and Family
Loans from friends and family, are a common form of early stage funding, but they have both benefits and disadvantages.
easier to arrange—not so many hurdles, eg credit worthiness
repayments can be flexible
can be at lower than market interest rates
lenders benefit by helping
risk of differing expectations—lenders and borrowers
risk of tax issues for both parties
mixing business and pleasure can make difficulties
must be based on a promissory note
Early Stage Funding through Convertible Debt
I suggested that angel funding may not be possible or even best for the baby business. However, convertible debt can be a possible route. Convertible debt financing is a loan from an investor (such as an angel) that has a future conversion to equity. The investor gives your startup a loan (like a bank loan), but the outstanding balance is converted to shares in your company at a future date.
It’s only really possible if you intend raising equity finance at a later date. The conversion from loan to equity happens when you do raise equity. Any equity investment in a startup is notoriously hard, because a valuation has to be agreed. There will be either no trading history, only a very short one, on which either side can establish a valuation.
Before you consider this kind of early stage funding, spend $3.99 on an ebook—Convertible Debt—a concise how-to guide for startup founders, from 1×1 Media.
Revenue Based Financing
A revenue-based loan has flexible payment terms, because, as the name implies repayments are based on revenue. Revenue-based loans are not generally available without 12-24 months trading history, and evidence of a steady monthly stream of revenue. The lender needs some assurance that you will have enough income to make your payments regularly. Interest rates may vary between 10-25%.
A revenue based loan does not involve giving up equity, avoids personal guarantees or collateral, but you need to be very careful that the interest rates are not crippling. A service fee may be required. Interest payments will go up or down in line with the business revenue.
There are a few advantages: they involve no dilution of your equity at a stage when who knows what the company is worth. Hence there’s no loss of control when quick decision making may be necessary.
Early Stage Funding by Factoring
There are those who will suggest factoring, but I’m not a fan, unless you are desperate for immediate cash. It involves selling your receivables (invoiced sales) to a factor at a discount. It is generally only available to B2B startups.
The reason for caution is that discount rates can be steep and since you are selling the invoices, that means that in most cases a third-party will be chasing yourcustomers, thus putting your customer relations at risk, even though you are getting money in the bank quicker than otherwise might be the case.
A better route may be to change your terms of business with shorter settlement periods or by offering discounts for early settlement.
Business Grants, Incentives and Competitions
Business grants and incentives (generally by government bodies or local government), or competitions like business plan competitions can be considered free money. However, you are unlikely to build a sustainable startup if your business plan is predicated on some of your funding being based on these sources of funding, which you may or many not succeed in banking. Incentives offered by cities tend to be time limited and can be voted off by politicians any time.
There is an excellent list of small business grants at Fundera. It also includes those sponsored by businesses. Business plan competitions are great, too, but they tend to be restricted to particular kinds of individual, like graduates of a particular college.
Other Forms of Early Stage Funding to Consider
Crowdfunding: equity crowdfunding is now permitted and flourishing. Reward (seed) crowdfunding involves financial donations from individuals in return for a product or service. There are about 19 times as many reward campaigns as for equity crowdfunding. Equity crowdfunding is exactly as its name implies. See my directory of equity crowdfunding platforms in the US.
Halve Your Startup Budget: Well organized startups will plan and organize a startup budget. Once the budget has been costed and estimated, it will almost certainly be wrong, when reality steps in. So, my advice is to attempt to reduce the numbers by half. It will ensure you only include the things that are essential. The process will ensure a parsimonious, not a profligate approach to the budget, and help to keep cash in the business.
Bank Loans (if you can get one): Under 2% of startups get bank loans at the outset. This is hardly surprising because the bank has no way of assessing their risk—unless you offer a personal guarantee, or your house as collateral. My strong advice is don’t risk your home or your family. Risk the business by all means, but not the ones you love. Avoid personal guarantees at all cost. If you do/can go this route, make sure you get an SBA loan guarantee. There are online lenders that may fit better than banks, but most will want performance data—no good for the first year startup.
Summary: Banks will seek to reassure themselves on Capacity to repay; the Capital that you have invested yourself; Collateral—guarantees you can give the lender, such as pledging an asset, personal guarantee; Conditions—what will the money be used for and what is the business climate; Character—the lender’s impression of you ability to repay (character, experience, references).
Gig Economy, Sharing/Access/P2P Economy, SaaS, Crowdsourcing: You don’t need to own all your assets, nor employ all the specialists that your startup needs in order to function. If you do not use a piece of equipment all day, you can find someone in the same position as you and share it (try yardclub.com). You probably don’t need a bookkeeper full time at the outset, so use an outside contractor (try xendo.com). Small tasks can be outsourced without long term commitment (try upwork.com,or fiverr.com).
Incubators, Accelerators and Coworking Spaces:
Some people confuse these three places. Briefly, incubators are like greenhouses for entrepreneurs: lots of help, introductions, networking, availability of shared or individual space and services at modest cost, with occasional events or courses. An excellent one that you could look at is TechRanchAustin, established by a friend of mine, Kevin Koym.
Accelerators are similar, but generally competitive to enter. They are much more ‘hands on’ and generally provide equity for small holdings in the startup. A first step to know more about coworking spaces, take a look at my Coworking Directory—USA.
I have strong words of advice to any budding entrepreneur seeking early stage funding.
Make very sure that the source of the funding has values compatible with your own. You want a partner, not a supplier. The source whether an individual(s) or an institution/company must be one with you are comfortable.
Sure there must be something ‘in it’ for them, but mutual compatibility is vital.