You’ve got a killer idea for the next billion-dollar app. One problem: You need money to build it.
If you’ve seen The Social Network, you know that Facebook’s growth skyrocketed following an angel investment. Sounds great, right? What the movie didn’t show is that only 0.91% of startups ever receive an angel investment, according to Fundable.
Besides the rarity of an angel investment, do new founders even know what it means? How does it differ from a venture capitalist investment? What the heck is debt capital?
Your billion-dollar app idea has become a distant memory as you try to make sense of the funding options out there.
Here’s an easy-to-digest overview of the most common types of funding for startups, where the money comes from and what it means for your new business.
Friends and family loans
It’s simple: Founders go to friends and family members with their idea, aiming to raise enough money to get the business off the ground.
As a personal investment, there’s generally little or no equity involved; the same is true for interest. It’s an informal setup where the investors are often providing funding because they believe in the idea (or the person) and aren’t concerned with netting a big return.
While it’s typically a casual setup, it’s still critical that you provide some kind of written agreement with these loans, clearly stating the terms, even if it’s loose. This protects both parties in the case of any issues, and can help to prevent awkward Thanksgiving conversations.
Accounting for 38% of funded startups, this is a very common and risk-averse path.
Angel investors are typically individuals, as opposed to a firm or a group of investors, providing funding from their own personal wealth. As the term “angel” implies, these investors are focused more on providing inspiration rather than handling operational or business decisions. Investment is often based on gut instinct over data.
Angel investments are generally informal, provide less overall capital than other funding sources and may involve any number of return options. Typically, an angel investment would involve some kind of equity stake. When Peter Thiel became Facebook’s first outside investor, he gained 10.2% of the company (cha-ching).
Due to the high profile of a few companies and investors who have seen wild success with this model, it’s the one many first-time founders are attracted to. But as we learned above, it’s extremely rare.
Venture capitalist (VC) funding
Venture funds are made up of groups of investors who have pooled their money together to make investments. Corporations or other groups, like universities, also commonly create their own VC funds. Typically, there is a lead investor or fund manager who is in charge of identifying potential investments for the group.
VC funding is appealing because it’s associated with big money. VCs invested nearly $148 billion into private companies in 2017, but most of that money goes into a small number of companies. VC investments account for a fraction of a percent of all startups that are funded — even less than angel investments.
VC funds are almost always looking for significant equity stakes, expecting a big return for big bets. VCs also typically require a seat on the board of directors, allowing significant influence over the company.
Companies like Airbnb and Uber have received enormous amounts of VC funding, creating a myth that it’s a common path of funding for new startups, but it’s actually one of the toughest roads for founders to travel.
You know the guy on Shark Tank that always wants to provide a line of credit in exchange for payment with interest? That’s debt capital.
Bank loans are the most common form of debt capital, but there are also debt capital funds aimed specifically at tech startups, and other less common debt capital options (like Shark Tank).
Of all the forms of startup funding, debt capital might be the most straightforward: the company takes on debt to provide money for whatever it needs. The payback terms are usually straightforward, and equity is almost never involved.
While many founders might be afraid of the scary “debt” word, this form of funding is more common than VCs or angel investors, funding 1.4% of startups.
Finally, we have the most common way to finance a burgeoning startup: funding it yourself. Utilizing personal finances, savings and credit accounts for 57% of startup funding.
Self-funding your startup means you retain all of your equity, maintain complete operational control of the company and don’t have to come up with snazzy presentations to pitch your idea (unless you really want to pitch it to yourself).
Which type of startup funding is right for me?
It’s extremely rare than a startup grows with only one form of capital investment. Even the most successful startups take on a variety of investments from a variety of investors.
The most likely scenario is that you seed your startup with your own finances or through friends and family, and once you’ve shown the potential for success, VCs and angel investors may take notice.
It’s a lot to unravel, but at least you now understand the basics of getting funded. Time to get back to building that app.