Starting a new business involves considerable risk. However, it can be minimized by choosing the right way to finance your venture. Here are the six most popular methods of raising funds for development.
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According to Investopedia, bootstrapping is the most basic form of financing a new business activity. Within its framework, an entrepreneur establishes a company, relying solely on funds from sources other than external investments. Most often these are his or her private funds and savings or the operating income of the new company.
An undeniable advantage of this form of financing is the ability to maintain full control over the emerging business and lack of dependence on external entities. On the other hand, it exposes young entrepreneurs to significantly greater financial risk and the resulting pressure for immediate success. A common practice within bootstrapping is to accept pre-orders for a product and use the funds gathered in this way to fulfill the same orders. This only increases the risk of failure.
Therefore, before deciding to self-finance your business venture, you should consider several factors. The first of these is the very sensibility of bootstrapping in the context of the planned activity. Some of them may require, for example, huge financial outlays from the very beginning, while others - are characterized by slower resource rotation, which may mean a long-term cash blockade.
However, if bootstrapping finds practical justification, the basic step should be the creation of a detailed business plan, which will very precisely determine the expected revenues and expenses over the next few years. A critical aspect of the plan is also determining how funds will be allocated within the company and how they will be used. The biggest risk at this stage is too early withdrawal of funds from the company account and incomplete development of the business.
And although bootstrapping is definitely one of the most risky methods of starting a business, the example of the GoPro company shows that it can work perfectly.
As Jason Gordon, creator of the online business guide The Business Professor, informs, every year even 40% of business ventures receive funds for development from the FFF group – friends, family and "fools" (eng. friends, family and fools). The reason why the latter are included in this category is related to the high risk of this type of investment.
The FFF group most often does not belong to the circle of sophisticated investors, and their decisions about capital investment are based on wishful thinking and faith in the success of a friend or family member. For this reason, people involved in such an investment often overlook all the formalities associated with it, thereby increasing the risk of capital loss. They also do not offer a formal review of the business plan, market analysis of the venture, or professional support in case of problems. They often do not require any loan security either.
The FFF group essentially has only two advantages: flexibility in repaying capital and independence from external entities. However, this is small consolation when not only the success of the entire business is at stake, but also the relationship with the person and their assets.
– Therefore, I strongly recommend that every business loan or investment from the FFF group meet all the formalities typical of a standard loan or investment relationship. Loans should be granted on the basis of a well-drafted bill of exchange, and capital investment should take place on the basis of carefully negotiated terms – advises Gordon.
Business angels are one of the most accessible forms of raising capital for startup development and, consequently, a key part of all investment ecosystems. Angels are most often individuals or entrepreneurs with significant own capital, who in exchange for shares in companies invest in them at an early stage of development. Unlike traditional investors, angels usually pay more attention to the person behind the idea than to the idea itself. And this has a specific practical justification.
According to the study The 5 Types of Startup Funding by the research team of the Startups service, business angels usually make investment decisions independently – they do not have to consult them with other shareholders or their superiors in a larger company or corporation. As a result, the relationship with the young entrepreneur is of the greatest value to them and they see the greatest benefits in it. These are mutual and go far beyond mere financial support. In addition to money, angels also offer valuable specialist knowledge, knowledge of the industry and the prevailing market rules, and numerous connections.
Importantly, business angels often join larger networks, which not only speed up the application verification process, but also help consolidate scattered resources and connect entrepreneurs with more than one investor at a time.
The current economic crisis has, however, forced angels to be more cautious. According to the COBIN Angels report from September 2023, as many as 36% of surveyed private investors from Poland admitted that the vision of recession forced them to much more thorough than before analyses preceding the decision on capital allocation. The difficult market also made investors start looking for startups that not only stand out in terms of high growth prospects, but also have a "higher survival potential" in a difficult business environment.
Market fluctuations also had their reflection in the choice of sectors that angels focused on. The most popular areas were enterprise software, fintech, food and green technologies.
Venture capital funds are most often institutional investors who provide capital to promising companies at early stages of their development. The biggest advantage of VC over other forms of raising funds for development is openness to increased risk and the ability to diversify it. Such investors can afford it because the balance of the entire portfolio matters more to them than the results of individual startups.
However, young entrepreneurs should bear in mind that by cooperating with a venture capital fund, they give up some control. These companies usually scrutinize their potential business partners very carefully in terms of so-called traction, i.e. real skills to bring projects to an end. They also pay a lot of attention to market conditions at the time of investment and make sure that there is a real demand for a given product or service. Therefore, it is necessary for entrepreneurs to have a solid business plan and a well-thought-out offer prepared before meeting with VC fund representatives.
However, it is important that they should also thoroughly examine the fund with which they want to cooperate.
– The cooperation between a startup and a VC fund is a partnership. Therefore, just as the fund verifies the startup, the startup should thoroughly verify the fund – Diana Koziarska, managing partner at SMOK Ventures, argued in a conversation with Digitized.
According to Koziarska, attention should be paid primarily to the investment strategy of the fund: in which industries it places its capital, what its expectations are regarding the speed of building the company, the intended scale of business development and the exit strategy from the investment, and whether these expectations coincide with the startup's plans.
– Most funds operate in a closed model, which has a defined lifespan. Therefore, it is also important at what stage of the investment period a given entity is. The beginning of this period means that the fund will be able to continue its investments in the company, the end - a quick exit from the investment and sale of shares in the company - added Koziarska.
Under current market conditions, the industry in which a given startup operates is also extremely important. A recent report from Crunchbase shows that in 2023, VC funds are reluctant to support young companies associated with Web3, i.e. cryptocurrencies and services based on blockchain. They see the greatest potential in solutions in the field of artificial intelligence.
Crowdfunding utilizes the enormous potential of online platforms to reach visionary ideas directly to consumers. The projects that are most often funded in this way are games, electronic gadgets, accessories for travelers, and sometimes cultural initiatives such as movies.
The biggest advantage of this form of financing activity is access to huge communities from all over the world gathered around services such as GoFundMe, Indiegogo or Kickstarter. These communities, in addition to funds for development, also provide immediate validation of the product or service. After all, it can be assumed that ordinary consumers who will put their own money into supporting a given project will also be interested in using it.
A big advantage of crowdfunding is also independence from external investment entities and the lack of the need to engage own capital. The greatest risk lies with the community, which never has a guarantee that the authors of a given project will be able to implement it.
Entrepreneurship accelerators and incubators are support programs that provide start-up companies with access to funds, mentoring and resources including legal and organizational, which allow them to become stable, self-sufficient enterprises.
Incubators are designed to support startups in the earliest stages of development and often form the basis of their long-term success. Accelerators, on the other hand, focus on companies with a more established market position, encouraging them to scale faster within intensive support programs. These programs also offer access to additional financing opportunities from external investors and thus increase the chances of sustainable growth of the company.
By understanding what phase their business is in, entrepreneurs can better define their current needs and find the most suitable incubator or acceleration program. In Poland, such programs are often implemented with the support of public institutions: Polski Fundusz Rozwoju and Narodowe Centrum Badań i Rozwoju.
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