Financing discussions for early stage technology businesses typically focus on the sexiest and most elusive source of funding: venture capital. But the truth is that VC is not the only option available to companies just starting out. There are other sources of capital that may make more sense at different stages in a business’s life.
This graph maps out in broad terms when different types of funding might make the most sense in a business’s growth trajectory. As most of you have probably already experienced, startups rely on themselves or their friends and family to get their ideas up and running pre-revenue. As you start to grow your concept, angel investors provide small, early sums of money and operating expertise and mentorship.
But from our experience working with early stage tech companies, it’s the next stage—launch and initial traction—that can be the most interesting, exciting, and complex. Funding strategies in this stage vary wildly. Some companies are doing $10k in sales per month but doubling month over month, while other companies are more established, with perhaps $600k per year in revenues, but growing very slowly. So obviously the financing scenarios and options can be very different for each.
At this stage, all the original options from stage one remain on the table. The company is also likely generating operational capital—customer prepays, employees working for equity with diminished salaries, the earliest trickle of a revenue stream. It’s also at this stage that venture capitalists may come knocking. They’ll usually provide a large capital investment (relative to the size of the company) in exchange for equity. VCs can also provide great access to human capital, connections, and guidance to help grow the business—if you’re willing to exchange a fat slice of equity and give up a considerable amount of control.
Another alternative at this stage is revenue-based financing. This debt option offers an upfront investment with monthly repayments based on a percentage of the revenue earned by the business in that month. There is no equity dilution and the cost of capital is cheaper than equity in the long run. It requires no personal guarantee, board control, or debt covenants. It’s also usually a fairly fast and easy application and funding process. Revenue-based financing does tend to be a bit more expensive than bank financing, however bank loans are typically not available at this stage and they almost always include a personal guarantee.
As a business starts to grow and become more established the traditional forms of financing—bank financing, growth equity, and eventually an IPO—become more of a reality. Those sources are more common, so we won’t spend too much time on them here.
What’s important—especially in those in-between years after launch and before stable growth—is to make sure you are aware of all the funding options and figure out what is right for you. Start with the business type and your long-term goals for the business and work backwards through the funding road map to determine what sources of capital are best at what points and ask what type of business you are building. How and when does the company make money? When does it spend it? And where will it be in 1, 5 or 10 years? What is the revenue model? Do you even have a revenue model, or are you building value in some other non-monetary way? (Facebook, for example, had no revenue for many years but tremendous value.) These are only some of the questions that help shape your company’s long term plan and ultimate financing roadmap.