Investors and financing

Types of Investors? How are they different? Which may be a good match and when?

 
At some point, almost every startup seeks additional funding to grow, and the right choice of investors can be one of the most important decisions you will make during scaling up your start-up.
Keep reading to check out different types of investors and how each could potentially benefit your company.

Most prominent ways to finance your startup growth: Equity and Dept

Equity investments are made in exchange for part-ownership or ‘equity’ in the recipient company.  The Investors realize a return by selling their share of the company for more than their original investment. Equity investments are only rewarded by the resultant ownership of the company.  Thus, equity investments are seen as higher risk than traditional debt finance.

Debt investments are what we normally think of as a loan.  An Investor may offer either or a combination of both types. Loans are returned by regular repayment at agreed interest rates. Furthermore, debt investments are nearly always secured against assets within the business. In practice, most investment deals combine both equity and debt.

In the following, we will focus on the different types of Debt and Equity Investors that could be interesting for you and your company.

Debt financing

Bank – Overdraft/Loan
Bank overdrafts can vary from a few thousand pounds to hundreds of thousands.  They are often used to overcome short-term cash flow issues.  Although interest rates tend to be higher, there is the advantage that you are only paying interest on the money you actually need.

Bank loans are for longer-term lending.  You get the money under the terms of the loan upfront, or in stages, with a fixed or variable rate of interest.

The bank will ask for some form of security for the overdraft or loan; either a personal guarantee or a charge over the assets of the business.  Your bank manager can talk you through the options.

Invoice Discounters
There is a different approach to increasing the amount of ready capital in your business and is ideal if you are affected by cash-flow issues caused by large or delayed invoice payments.

Invoice discounters advance you an agreed percentage of your invoices for a fee and interest on the money advanced.  They may manage your debtor book for you, freeing you up to focus on your business.  This service is offered by many banks, and other providers that specialize in this field.

Asset-based Lenders
Asset finance is used to buy fixed assets such as vehicles, plant and machinery and office-based equipment, so the money does not have to come out of the company’s cash flow.  Asset finance is available to early stage as well as established companies.  Terms vary depending on the company and the assets.

Property Loans
If you own property, you may be able to raise funds by mortgaging the property to a bank or other lenders.

 

To sum it up, debt financing offers a way to scale your startup that won’t require giving up equity in your company. That means you are able to keep more control of your company and your profit of an exit will be higher. However, that doesn’t mean that bringing in this type of capital will be any easier, since loans require repayment, often when you really need as much liquidity and slack as possible. This can impact your profitability, which may show up when you try to raise money from other investors later.

Equity financing

Friends and Family
The first financing option you can approach are friends, family and close personal contacts. Friends and family financing makes sense, when you are still in a very early stage and have almost no evidence or proof to base a real investment on – an investment does basically mean to invest in the idea and in you as a founder.

This kind of investor usually doesn’t provide a lot of money, however compared to other types of investments, it is rather easy to raise money this way. The typical financing range goes from €1,000 to €200,000.

This should always be your first port of call for funding, for several reasons.  It shows your commitment to the business, to clients, to employees and most importantly to future Investors.  Your friends and family know you best, and the terms should be less punitive.

Angel Investors
Business Angels are wealthy individuals looking to invest in small companies. They are normally approached when it comes to the seed round and beyond. They are willing to fund smaller operations than VCs, may be more flexible in terms, and can offer a lot of value in wisdom and connections.

Angel investors normally invest for one or more of these reasons:

  • financial – to make more money by backing the right business
  • altruistic – to give back to their industry, or small business in general
  • lifestyle – it appeals to their sense of self, status and purpose.

Some invest in a ‘hands off’ manner, others want to get involved.  A good Business Angel will bring much more than money to the table.  They can share a wealth of experience and contacts.  They often take a non-executive position within your company, providing a sounding board and source of support during the good times and bad.

Finding Business Angels can be challenging, but angel networks are a very good place to start. Try to approach them directly online, at live pitch events, and through introductions from other startup founders.

The terms of the deal are likely to be more demanding than with friends and family, but Angels are likely to have considerably more impact on your business.

Business Angels are typically involved in deals in the range €50,000 to €1.000.000.  Deals can be done by one or several individuals, or an ‘angel network’.  They can also be syndicated with other investment proposals.

Angel Groups
Angel groups are groups of angel investors who band together to make investments in startups. This enables them to invest with more confidence, with larger check sizes, and with lower exposure to risk.

Accelerators & Incubators
These vehicles can ultimately be a gateway to a variety of the types of investors on this list. If accepted into one of these programs, you may receive anywhere from €10,000 to €120,000 in seed money to cultivate your idea and gain traction, while benefiting from additional knowledge and resources. If everything is going well, you’ll be pitching larger investors and be introduced to funding sources during their demo days that can help take you to the next level. Just be ready to hustle, these programs want to speed you on the way to the next stage quickly.

Family Offices
Family offices are increasingly being drawn to the advantages of investing in startups. However, family offices can have quite different interests and game plans. Each can be very different. Working with them can vary depending on who is managing the decisions and process. Taxes, long term multigenerational investing, prestige and income may be more important for these investors than others on this list who are pushing for an earlier exit.

Venture Capital Firms
VCs usually come with the biggest checks, the most power to fuel success and gaining market share, and most support when it comes to achieving more credibility and visibility.

More venture capital firms are looking at and are participating in earlier funding rounds. Though it is much more likely these investors will show up in Series A, B and C fundraising rounds than earlier.

We will focus on two categories of venture capital financing, each with its own subcategories:

Early-stage

  1. Seed capital:
    This is initial funding typically sought by entrepreneurs who are just starting out and don’t have a product of organized business yet. There aren’t many venture capitalists willing to fund at this stage, since they aren’t very inclined to invest large amounts of money in an idea that still exists only on paper. Therefore, most of your money often still comes from your personal assets, friends, or family. The sums are generally modest, just enough to help an emerging entrepreneur cover the essentials.
  2. Startup capital:
     That type of capital refers to a sum of money (larger than seed capital) given to a startup, so it can launch its business, e.g. recruit initial staff, acquire office space and permits, further market research and testing, and finish the development of its product or service. Companies seeking this type of funding already have a sample product available and at least one executive working full-time. That said, this type of financing is rare as well, and you have to put in some really serious effort to sell the idea (like creating a solid business plan or building a prototype).
  3. First stage capital:
    First stage capital is intended for businesses that have gotten off the ground and have been operating for two to three years, have a management team in place, and their sales are growing. At this point, you are moving towards profitability as you push your products, services, and even advertising to a wider target audience.

Expansion

  1. Second stage/mezzanine capital:
    This is provided to well-established firms with a multi-functional team and commercialized product, as well as a reasonable sales momentum under its belt. The purpose is to add the fuel necessary to take the business to the next level. VCs that specialize in this type of finances help these businesses begin major expansion, accelerate the growth curve, enter new markets, and/or expand their marketing efforts. Startups are not expected to reach high levels of internal return rate, but rather achieve sustained growth.
  2. Bridge financing:
    That type of capital refers to financing in between full VC rounds with the objective to raise smaller sums of money instead of a full round. Existing investors are usually the ones participating in this type of funding.
  3. Third/late stage financing:
    Third stage financing happens when a startup has reached massive revenue, has a second level of management, and is now seeking funds to grow capacity and working capital, and/or build up marketing efforts even more.

Whereas Angels may have a range of reasons for investing, VCs are companies with shareholders and employees, so their focus is mostly monetary returns (apart from some impact-focused VCs).  However, there still is a certain variation referring to the pressure and the targets some VCs set for their portfolio companies, which depends on the specific business model of the portfolio company.

Some VCs are more actively involved in startups’ daily operation than others and can even help to recruit new members to your management team if necessary. Of course, a more active VC can also mean that they will impose more influence on the management of your company. Some people even say that getting a VC on board is quite similar to a marriage, because you will most certainly be in very intense contact with the VC for the coming 5-10 years. This is the reason why it is very important to know what kind of VC you are getting on board, and if this is the right type of VC for your company and your personal management style.

The size of VC-backed deals really depends on the stage and industry of your startup. In can vary from are €250k to €30million+.

Corporate Investors
Investing in startups carries a variety of benefits for big corporations, including supporting their own growth, diversifying investment, and acquiring talent and technology which can help them fend off industry changes and fuel top and bottom lines. Some corporates have funds to invest in unrelated startups. More are launching their own accelerator and incubator programs and ecosystems for cultivating these opportunities.

These investors can be great allies in taking your business to the next level, though they can be quite different to work with. You should go into a partnership with a corporate carefully and with a lot of patience, since their habits and work style will differ from yours. It’s vital to understand the difference and have some boundaries set up to ensure an enjoyable relationship.

Other ways – State-funded grants

Alternatively, to debt and equity financing, there is also the option to finance your company with grants. These are like donations and with no repayment requirement, awarded according to strict criteria and aimed at supporting and/or stimulating particular areas of the economy.  You probably have already heard about the EU giving out grants to support the most promising innovators. In addition to that, the European Comission has set up Dealflow.eu, which is a program designed for rising European innovators. It supports the portfolio companies via several channels to receive funding and to scale their innovation. You can apply anytime via this link: https://dealflow.eu/registration/

Summary

As you can see from this list, there is a wide variety of very different ways to fund startups. Some investors are very specialized in the stages and funding rounds they will invest at. However, these lines are increasingly blurring.

As your startup grows, different sources of capital will be advantageous and valuable for fueling that next level of growth. Understanding these differences will be invaluable for an efficient fundraising campaign and for targeting the right investors . We wish you all the best with your upcoming investment rounds and on your journey of scaling your startup!