“It Takes Money to Make Money”: Start Up Financing Structures
Money is a vital resource for entrepreneurs who are trying to transition their ideas from thoughts to business. There is no limit to the number of times that an entrepreneur can seek investments from external sources. However, one has to be smart about who they seek investment from and understand the pros and cons of each source. The financing structures of these investments will typically fall in the following categories:
No Strings Attached v. Strings Attached
Raising Money- No Strings attached
In Economics, professors like to impress on students that there is “No such thing as a free lunch.” Meaning that there is eventually a cost paid by someone for services that are thought to be “free.” The following finance structures are ways that entrepreneurs can raise money to fund their project. We will classify money from friends and family as well as crowdfunding as “No Strings Attached” because typically there are no terms written between the investors and entrepreneur that creates an expectation to returning the money at some point in the future.
Family and Friends:
When exploring a startup venture the first money invested in your startup should be from yourself, your friends and your family. When looking to invest in startups investors often measure the entrepreneur's commitment to the project by how much the entrepreneur has already committed to their own ideas. A red flag for an investor from someone who supposedly has a great idea or project is that they have no backing from friends and family, or their own “skin in the game”. This may give the investor the impression that you may have a lack of commitment or a lack of skill when it comes to raising money.
Kickstarter is a platform for those with the entrepreneurial spirit to find financial backers to their projects that will bring their ideas to life. Financial backers are primarily funding research and development of early companies by giving resources that will move their projects into the hands of potential customers. The creators in these companies’ goals are not to make money; it is to make progress at one stage, such as the idea stage, then move to the next one. The creators do have the option of rewarding their backers with incentives other than equity or financing repayment. Depending on how much the financial backer is willing to donate, they are placed in tiers that reward them with anything between a thank you note and product.
Indiegogo sees themselves as an “All-in-One Platform” that funds projects at different stages. What differentiates them from other crowdfunding website is that entrepreneurs do not have to meet their goals to keep all of the money that they raised. Entrepreneurs can choose between a fixed or flexible funding package. The fixed funding package allows the entrepreneur to set up a goal, and if the goal is met, they are allowed to keep the money they raised. In the flexible funding package, no goal is assigned and at the end of their fund raising, all of the money is retained. Indiegogo also has unique partnerships that will help entrepreneurs connect with designers, manufacturers and retail partners such as Amazon and Newegg.
Every penny counts right?
Raising Money- With Strings Attached
Other sources of financing for startups are much more sophisticated than crowdfunding and getting money from family members. The financial structures below are often accompanied with term sheets that outline what investors will be getting in return for their investment.
Equity in Return for Shares:
For entrepreneurs who require additional funds to expand, equity may be issued to interested investors. Issuing equity means the investor is investing in the company and in return they will receive shares that entitle them to a percentage of ownership to the company. Equity funding fall in two categories: common stock and preferred stock.
The advantages of issuing common stock are the ability to raise funds for the company without having a contract that says when a return on the initial investment is due. Shareholders have the opportunity to participate in the company's earnings through the issuance of dividends only when the company decides to issue out dividends. The downside of issuing common shares is that you are giving up a percentage of your company and depending on the terms; you may also be giving up voting rights and responsibility to shareholders. In addition to ownership, investors may have an active role in the decision-making process and shaping of the company.
Preferred stockholders get the benefits of company ownership while taking advantage of some of the unique features offered in a bond (which we will discuss later). Preferred stockholders have the option of adding features tied into the term of their investment such as a stated dividend rate each year. If a company declares bankruptcy; preferred stockholders would be entitled to money before common shareholders but after bondholders.
Similar to a company issuing a bond, the upside of the preferred stock to the startup company is that it does not receive voting rights or participation in the decision-making process of the company.
Debt is a claim against company assets. Investors may choose to invest in your start-up and in return, their initial investment is paid back after a stated period along with interest which is the cost of their investment. A term sheet is drafted which details how long the company will hold the investment for, the cost to the company of that investment, and when the initial investment along with the cost of investment (interest) is due.
A convertible note is a form of debt financing that gives the investor the option of converting their notes into equity. The advantages of convertible notes are that they offer the investor some protection on their investment in the event the company fails. Should the company succeed, a convertible note allows the company to realize a greater return from converting their bonds into equity.
Fund raising rounds take time. The investment process includes entrepreneurs finding interested investors, negotiate terms and then navigating proper channels to secure the investment. If an immediate cash infusion is needed to hold the entrepreneur over until investments are secured, they may choose to obtain a bridge loan. A bridge loan is a short-term debt that “bridge the gap” between fund raising rounds. The advantages to a bridge loan is access to cash. The disadvantage is they have higher interests rates.
So where does RVF fit in?
Rebel Venture Fund (RVF) in unique in that we consider investment in the early startup/seed stage companies typically in the amount of $25,000 to $50,000. RVF has invested in equity and convertible notes and is flexible with the needs of the company. So depending on what stage your company is at, RVF will help you find the right financing needs to propel your company into the next stage of development.
Furthermore, RVF looks to not only invest in companies but also build relationships with them. RVF works closely with the portfolio companies and helps them access connections, talents, and resources from UNLV. We are committed to building and supporting our portfolio companies and making sure that they are a success.
About the Author
Nadege Barthelmy is a First Generation student who is a Floridian of Haitian descent. Currently, she is completing her undergraduate degree in Accounting at UNLV. She will continue her education by obtaining her Masters of Science in Accounting. Her aspiration upon graduation includes receiving her CPA designation, working in public accounting and eventually opening up her own accounting firm.
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of RVF or UNLV. In addition, thoughts and opinions are subject to change and this article is intended to provide an opinion of the author at the time of writing this article. All data and information is for informational purposes only.