View All ArticlesStartups & Entrepreneurs: Options and Strategies for Funding Your Startup or Growth Company
September 27, 2022
Jason Acevedo and Kennedy Munro - Klehr Harrison Harvey Branzburg LLP
A key aspect to a successful startup is identifying and acquiring the right kind of funding. The first step in determining what type of funding is right for your startup is understanding what kinds of funding are available.
Bootstrapping
One of the first questions potential investors ask is, ‘how much of your own money have you invested in your business?’ While going into debt beyond your comfort level is never advisable, startup founders should recognize that using their own savings and credit cards is frequently the first step towards funding their startup. Similar to a credit card, if you’re trying to maintain as much equity for as long as possible and your startup qualifies, a bank loan might be the right decision.
What We Like
- Division of equity stays the same.
- Keeps the parties making decisions small.
What We Could Do Without
- The business is likely the only one getting paid.
- Likely limited cashflow and capital.
- You’re not sharing the risk with any new investors.
Convertible Security Financings
If you’re willing to relinquish equity, but aren’t ready to negotiate a valuation yet, this could be an option. With convertible security financings, you don’t need to settle on a valuation with the investor before receiving a check. Instead, in exchange for their investment, the investor receives an enforceable IOU that will be exchanged for stock at some future time when other investors are negotiating an equity deal with you. Prior to converting into an equity deal, the investor does not own stock or have voting rights in your startup.
In exchange for “investing early,” convertible securities typically provide investors a discount on the next round’s equity price in the form of a discount or business valuation cap.
Sometimes, convertible securities take the form of debt with an interest rate and maturity date.
What We Like
- Maintains control and equity for the existing stockholders.
- Delays valuation negotiations.
- Quicker and cheaper than equity financings.
What We Could Do Without
- Only kicks the can down the road – dilution of your ownership will eventually happen.
- Discount and valuation caps will still need to be negotiated.
- If convertible debt, repayment will be required upon maturity if you fail to close an equity financing.
Equity Financing
If you’re willing to sell off a percentage of your business and negotiate a business valuation, this may be the path for you. In exchange for a mutually agreed upon percentage of your business, you get a set amount of money. Often, an investor also receives certain governance rights (e.g., a seat on the board) and preferential economics, such as the right to be repaid their investment first.
What We Like
- No debt/future interest payments.
- Increases reputability.
- You get brain power and a growing business network in addition to the money.
What We Could Do Without
- You’re now answering to others about your decisions and growth plan.
- You and the investor will have to agree on the value of your business – if your business is just starting, this could require you to give up a material percentage of your ownership.
- A slower timetable that requires more resources and money to the funding.
Crowdsourcing
The rewards-based method blasts your product to the masses through a website where they can view pictures and videos of the product with an option to buy it at a discounted rate.
The equity-based method uses online platforms to raise capital in exchange for equity rather than a product. This brings in securities laws that can mean higher costs for the startup to ensure compliance.
What We Like
- Best way to test market validation.
- If successful, creates validation, brand awareness and investor interest.
- Raises capital to cover the cost of demand.
What We Can Do Without
- Requires an established strong operational structure for the rewards-based method.
- High legal costs for equity-based method.
- The funds generated may not be enough.
Co-authors Jason Acevedo, partner and Kennedy Munro, associate are members of the Venture Capital & Emerging Growth practice group in the Corporate and Securities Department at Klehr Harrison.
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