Financing is needed to start a business and ramp it up to profitability. There are several sources to
consider when looking for startup financing. But first, you need to consider how much money you
need and when you will need it.
The financial needs of a business will vary according to the type and size of the business. For example,
processing businesses are usually capital intensive, requiring large amounts. On the other hand, retail companies typically require less money. Whereas tech-enabled startups may require moderate to considerable investment.
Debt and equity are the two significant sources of financing. Equity financing could be in different forms: seed capital, angel investment, venture capital, private equity, and, eventually, IPO.
Seed Funding
Seed capital is the amount needed to seed a business. Seed funding may come from various sources, such as family members, friends, banks, or angel investors. Often, this is the first source of funding an entrepreneur receives for their idea. Therefore, it’s a critical element in launching a successful startup business. Seed funding is also referred to as seed capital or seed money.
Seed capital is typically used to support the planning of a business up to the point when the company starts selling a product or service. After that, it usually covers expenses until the industry can make money, i.e., revenue to attract more investors.
The seed capital investors generally get an equity stake in exchange for the seed money they invest. Once the entrepreneurs have the seed capital, they can kick start their business by hiring skilled people, initiating sales and marketing campaigns, and getting the product or services ready for the market.
Angel Investment
Angel investors support small startups and entrepreneurs through funding, either with a one-time investment or as an ongoing source of finances, to help fledging businesses get off the ground. Angel investors typically act alone and may choose to be hands-on or hands-off in other areas of the business. Angel investors invest in the individual starting the business more than the viability of the business itself. They are more focused on helping an entrepreneur get started than any possible profit that could be gained.
Angel investors are affluent individuals who use their money to build capital for new businesses in exchange for ownership equity or shares in the business. In short, they get involved in projects because they are personally interested. The relationship between an angel investor and an entrepreneur takes on a mentor-owner relationship. The downside of an angel investor is that they don’t typically have access to vast sums of cash for additional financing.
Venture Capital
Venture capitalists generally involve a group of individuals, a company, or a business rather than a single individual. They are more interested in investing in well-established businesses, as opposed to startups by new entrepreneurs. Their involvement usually includes an added role in the company, such as a seat on the board of directors. Venture capitalists are more likely to invest in a company after the concept has been proven and revenue has been generated to grow the business more quickly. Yet, they may also consider investing in seasoned entrepreneurs who have proven their abilities with past businesses.
Unlike angel investors who use their own money to fund startups, venture capitalists seldom use their own money to invest. Instead, they may use institutional funds, such as sovereign funds, pension funds, or money from third-party investors, to make an investment they believe is worthwhile that will also generate a high rate of return. The disadvantage of pursuing a venture capitalist is that a business must be more well-established, and its owners will usually have to relinquish some control of the business or a seat on its board.
Other Investment Options
Instead of getting funds from venture capitalists, other options include getting loans from banks and funding from peer-to-peer networks. These networks connect people who need money to people that have money they want to invest. Remember, with both these options, you have an interest rate to pay back.
An investment from a private equity firm or independent investor is referred to as a private equity investment. Private equity is invested in private companies and sometimes public companies (companies on the stock market), where the investor may buy out the company and be delisted from the stock market.
Bottomline: How to Make a Choice?
Angel investors are wealthy investors who put their own money into the growth of a new business while potentially contributing their advice and business experience. On the other hand, venture capitalists involve multiple professional investors whose money comes from various sources to invest in businesses with high growth potential.
Venture capitalists insist on participating in the business’s operations and usually take on a formal advisory role or a seat on a company’s board. As a result, new businesses are best suited to earning the favor of angel investors. In contrast, businesses with a little more time and experience are more likely to catch the eye of venture capitalist investment.