THE FUEL THAT STARTS THE ENGINE: The fundamentals of fundraising

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Ever felt like you have an idea of a product or service that initially came right out of the top of your head, but the thought kept knocking around inside your head, and the more you put your thought, time, and research into it the more it kept on seeming like a promising and lucrative opportunity for the venture? The perfect business plan! Yes, that’s what comes to your mind every time you think of implementing your ideas to reality. Maybe the scheme behind the product is extremely unique and innovative, something that is completely out of the box, and probably there is a huge gap for something like this in the current market. A product like this would surely win the demand of thousands of customers (or at least, that’s what you think!). Yet, you’re sitting right there, doing your typical 9 to 5 desk job, constantly fantasizing about your elusive business plan and wondering about ‘what could have been’. A lot of it maybe has to do with the fact that initiating an ‘impactful’ startup requires a huge sum of capital. An amount that perhaps you, along with the support of your family and friends will not be able to gather. But does that mean you will never be able to start your so-called dream business? Not entirely. This is exactly where the idea of fundraising kicks in.

Why do businesses require capital, or more specifically, money? Well, it’s obvious. These startup ideas need money to rent factories and offices, purchase machinery and furniture, hire personnel, advertise their product, and make all the other necessary cash outflows that are required prior to making them operational in reality. In short, startups need money to grow. The capital that is initially raised by a company is called the “seed” capital. Before a high-growth company can count profits, it needs consistent “fueling” or a burning down of its capital. Money allows a company to gain a “competitive advantage” over its competitors in the market. This way, the startup can enjoy a larger market cap. Also, launching the business on a larger scale allows the company to enjoy greater economies of scale. As a result, they will be able to offer the product at lower prices to the consumers, increasing demand for it. Moreover, this will also help the company gain recognition among its consumers and credibility to suppliers and retailers.

Additionally, one more good aspect of fundraising is that there actually are plenty of investors out there who are keen on investing their money into prospective startups that seem to carry genuine potential. For example, you’re a computer engineer and you have been developing this software or website for months that you think has the potential to be revolutionary. Now you wish to market launch or publish it on a large scale, however, you don’t have the adequate funds for doing so. Under these circumstances, you think of Uncle Tom, an extremely wealthy friend of your father who is likely to have a lot of cash at hand. If Uncle Tom finds your software and business plan impressive, he may choose to give you a loan or invest in your business in return for a share. That way, Uncle Tom is either lending you money that you have to return within a designated period or he will take the risk of investing into your business and enjoy the profits if it turns out to be successful or bear the losses if it fails.

However, there is a third outcome as well, which is the likeliest to occur. Uncle Tom could just find the idea absolutely “ridiculous” and choose to turn your proposal down. You see, raising funds isn’t all that easy and fun. It can be long, complicated, tedious, monotonous, and ego-deflating. Investors take a lot of persuading before they agree on cashing in. First of all, the idea needs to stimulate excitement in the investor. It needs to be something unique and innovative. But the idea solely cannot get the deal done. There needs to be thorough research done on the product as well as the desired target market that demonstrates pieces of evidence that back up the founder’s claims. The founders must gain the investor’s credibility regarding their skill set, vision, and proficiency to take the business forward in the best way possible. The investor must realize that the opportunity for profitability is substantial and there is vast scope for growth.

Investors today are not simply impressed by merely an idea. They require at least a prototype of the product that they can physically see and handle. They also want to know if the product is fit for the current market and if it actually is experiencing growth. In some cases, a soft launch of the product to gain some sort of customer adoption is considered preferable. This helps prove to the investor that the product has existing demand in the market, and that further funding can expand the horizons for the business. That is actually the best time to undergo the procedure of raising capital. It gives assurance that operating on a larger scale will potentially take the company a long way. This means that the founders should raise money once they have worked out the market opportunity, the desired market segment, target customer base, and the rate at which the product they designed is being adopted.

Now, what rate of adoption can be considered satisfactory? Although there is no fixed algorithm for determining an interesting rate of adoption, a 10% increase per week for the first few weeks post introduction can be considered admirable. A fine example of this is Instagram. Instagram was developed by Kevin Systrom, a then Stanford University student who had no formal training in computer science. Systrom, who worked part-time at NextStop learned coding at night and on weekends. After intensive work, Systrom developed a web app prototype. Initially, he launched it with the name ‘Burbn’, inspired by his taste for fine whiskey and bourbon. Immediately, people seemed to take quite a liking to the app and it received a tremendous response. In March 2010, at a party for Hunch, a Silicon Valley-based startup, Systrom met two venture capitalists from Baseline Ventures and Andreessen Horowitz. Long story short, Systrom had quit his job to focus solely on Burbn and within two weeks he raised $500,000 from both the Baseline Ventures and Andreessen Horowitz for the development of Burbn. Fast forward 2 years, by March 2012, Instagram was taken over by Facebook for $1 billion.

Now a question is likely to arise in your mind. What options shall I consider once I develop my business and start looking to finance it? Well, there are plenty of alternatives. But first of all, let’s discuss the two major types of financing: Equity and Debt Financing. Remember the Uncle Tom example? Well, if Uncle Tom decided to lend you some money that you would have to return to him within a certain period, that’d be considered debt financing. And if Uncle Tom gave you the money and asked for a share in your business, that is enjoy a portion of the profit or bear a portion of the loss then that would be considered equity financing. Now, a lot of startups are exceptional and don’t require any funding at all to reach profitability. That is called bootstrapping. It is formidable to be able to do that, however, that is not always the case.

Most businesses require funding and the most appealing source of funding is personal savings. Personal savings is the most preferable source of funding because it doesn’t involve any obligations or accountability to anyone. It means total control and not owing anything to anyone. Right after that comes family and friends, since they are the easiest and most accessible potential investors of your business. They also accept flexible payment methods. Another option for raising business capital is crowdfunding. Crowdfunding involves a large number of people chipping in small amounts of money for a startup usually over the internet. Although a lot of exposure can be gained through this process, it is quite time-consuming and results are uncertain.

The 4th source of funding is angel investors. Angel investors typically are wealthy people who give their money to acquire a share of the startup. Angel investors often have a big network of contacts from which the founders can benefit, as well as years of experience in the specific industry which means they can give valuable advice. A 5th source, venture capitalists, work almost the same way and invest only in businesses that can potentially provide good returns on their investment. A prevalent way to accumulate capital is through bank loans. And although bank loans are enticing, they do require a lot of education on the best possible options and the obligation to pay up regardless of the business’s outcome. And finally, some government administrations are devoted to assisting small businesses.

They are called ‘small business administration (SBA)’. These administrations help ensure that small businesses get the capital required for them to succeed as well as providing them with a specific proportion of contracts that are awarded to the small businesses. However, there is no prescribed solution manual to ensuring the right recipe for funding. Even if you follow all the aforementioned steps and leave no stones unturned, chances are there that nobody might be interested in investing in your startup. And it’s alright, not everybody can see the potential in a startup and a lot of startups that didn’t receive any funding, in the beginning, have eventually achieved tremendous success. In the end, problem-solving remains an integral part of entrepreneurship.

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