Fundraising Prep for a Startup, Part 1: Choosing the Type of Investor & Relevant Reach Out

Capital is the business fuel to drive your product from ideation to execution. Do you want to attract investors for a startup? The first key is to pitch and to concentrate the fundraising efforts on the correct type of investor, investigating what each of them is looking for in the startup beforehand. As a first step, below I will overview the advantages & disadvantages of different types of investors and the ways to find the chosen one.

Investor types, their Pros& Cons

It’s a prerequisite that budding entrepreneurs acquaint themselves with the types of investors available.

Banks

Early-stage startups are unlikely to receive bank funding. However, banks run numerous industry-specific loan programs to promote innovation and support early-stage ventures.

Advantages

• You retain control of your business.
• A bank loan is temporary.
• Interest on the bank loan is tax-deductible as it forms part of the financing costs of the company.

Disadvantages

• Tough to qualify — Banks require collateral or security worth more than the loan’s value before approving a loan.
• High-interest rates — In the unlikely event that a bank approves an unsecured loan, it will charge a risk premium.

Angel Investors

An angel investor is a private investor, typically a high net-worth individual, who supports entrepreneurs by backing their ideas with money in exchange for a share of equity in the company. Networking — e.g., at special idea-pitching events for startups — is the best way to find investors of this type.

Advantages

• Less risk than debt financing — You don’t need to repay angel’s debt in a structured manner while your product takes off.
• Valuable knowledge and astute business decisions that angels, being part-owner of the company, can pass on to you.
• Suitable source to get the business going — Investors want to see your product succeed, as their own capital and reputation are on the line.

Disadvantages

• The loss of complete control — The investor may demand an additional stake in the company without extra capital infusion.
• Higher Expectations — Investors expect heightened profit margins from you to offset drowned startups’ costs in their investment portfolio.

Personal Investors

A personal investor is a person who wishes to invest in your business and is not associated with an investment firm or financial institution. Friends and family are a great resource in case of a financial crunch. Ideally, they will stand by you with seed funding.

Advantages

• A trust relationship with which attracting investment for your startup becomes much easier.
• Simple investment structure — Often, your deal is based on good faith and a handshake.

Disadvantages

• It can ruin the relationship.
• No added value to the company — A personal investor may lack business expertise.

Peer-to-Peer Lending

Peer-to-peer lending (P2P) enables an individual to get financial assistance from another individual directly, without the need of a middleman or a financial institution. P2P lending websites connect borrowers with investors, facilitating the free flow of capital.

Advantages

• More accessible source of funding.
• Flexibility — P2P loans are unsecured, and the terms of the loan can be amended by mutual agreement.
• Lower interest rates.

Disadvantages

• Сhance of default increases due to a lack of proper documentation or formal processes.
• No insurance/government protection of investment.

Venture Capital (VC)

A venture capital fund is a pool of investments managed by professionals. They usually invest in innovation and technology-based startups with high potential and exit after the business achieves the desired valuation. VCs are organized players and will not invest in your business without being convinced that your plan is solid. Therefore, be prepared to be grilled for long hours before receiving a check from them.

Advantages

• Cross-industry expertise and guidance.
• Connections in the VCs network with additional resources.
• No repayment of capital — VCs usually invest in a company through a stake in the company.

Disadvantages

• The loss of ownership — VCs have a say in the company’s management and day-to-day operational matters. They may demand an additional stake in the company without infusing additional capital.
• Higher return expectations — VCs invest in many startups and may pressure you, expecting high-profit margins by hook or by crook.

How to find the investor that will commit to your product

• How to Find a Bank for a Loan Application

It’s important to choose the correct bank and open a separate dedicated business account. Since financial institutions offer several borrowing options, you need to choose the best viable option. Traditional banks offer customized loan products and accounts to meet the needs of businesses of all sizes. Startups might choose to open a business account at the same bank where they have their personal accounts, since doing so usually offers certain perks.

• Best Way to Find an Angel Investor

Occasionally, there are events where startups are invited to pitch their ideas. Angel investors are never far from these stages, as they’re always on the lookout for promising ventures to invest in. Even if you do not attract investment straight away, you can meet a lot of helpful people. Networking is the best way to find investors.

• How to Find a Personal Investor

Friends and family are a great resource in case of a financial crunch. Ideally, they will stand by you with startup money and seed funding. They already trust you and your search for capital can go more smoothly.

• How to Attract a P2P Investor to the Business

P2P lending websites connect borrowers with investors. This facilitates the free flow of capital. Networking is always a great way to track down investors.

• How to Find a VC For Your Startup

VCs are organized players, and they keep a keen eye on the startup scenario. They often specialize in a given sector (often technology) and are receptive to new ideas. However, they will not invest in your business until they are convinced that your credentials and your plan are solid. Therefore, be prepared to be grilled for long hours before receiving a check from a VC. The part below will explain how to pass the test successfully.

The Final Word

In this article, I paid attention to what a startup founder should consider before starting the fundraising campaign.

Stay tuned for Part 2, where I will dig deeper into what investors are looking for in startups they are ready to invest in.

P.S. If you’re not ready to wait, read Django Stars piece on How to Create a Product That Investors Will Commit To