Entrepreneur: cracking the investor
“Unless you have fixed costs, you don’t need any capital to create a prototype. Ideally, your co-founders, with sweat equity, can create the product themselves.” — Brian Chesky (Airbnb co-founder)
As an entrepreneur, some of the most frequently asked questions are; How many times is it necessary to raise capital?, What will each stage be like?, And who are the main investors in each of them?
Someone who understood this perfectly is Brian Chesky, what began as an idea to earn extra money, became what we know today as Airbnb. Who could imagine that Airbnb, founded in 2007, would conduct 17 investment capital raising rounds for a total of USD$5.4bn (based on Crunchbase). Airbnb’s story could be anyone’s story, so it’s essential to understand the funding cycle and the actors at each stage of a startup’s life.
If you are an entrepreneur, you will spend your whole life raising capital, so make this part of your daily routine.
29% of the startups fail because they do not have enough capital and 8% because they do not have financing or do not generate interest from investors (CB Insights). In addition to the team, business model and strategy, the other main factors that an investor takes into consideration when analyzing an opportunity are risk-return, ticket size and investment stage.
Not all investors are willing to take the same risks. Investing in an early stage when the entrepreneur only has the idea of a potential business, without proof of concept, market validation and traction of the company, carries a greater risk. Thus, the investor who enters this stage must be compensated for taking these risks with a higher expected return than the investor who would invest at a later stage where the company already has clients, recurring income and has shown accelerated growth in the industry. One of the advantages of investing in early stages is being able to invest a smaller ticket compared to subsequent stages. The different types of investors are explained below according to the stage in which they contribute capital in the life cycle of startups.
1. Yourself (Bootstrap)
At the beginning, the founders of Airbnb met in their living room to develop the idea. They used the bootstrapping strategy, investing their time and money to launch a simple website called Airbedandbreakfast.com
2. Family and Friends (F&F), and angel investors
Although the stories tend not to mention it, the founders usually receive investment from friends and family in the business model design and proof of concept stage. They usually invest in the entrepreneur because they appreciate him and not necessarily because of the potential of the idea. Angel investors also tend to invest in these stages, usually they are businessmen with capital (HNWI’s) or successful entrepreneurs. They support the startup by sharing their networks and knowledge in pursuit of business success and subsequent capital raising.
3. Micro-equity funds
Not all startups will receive investment from a Micro equity fund. However, in emerging economies where venture capital is developing, very small equity funds emerge with low investment tickets that tend to invest in early-stage startups.
Grants are a less-known & used financing mechanism, usually non-refundable (subsidies) and with the objective of supporting and strengthening the ecosystem. This support comes from governments (e.g. Israel Innovation Authority) and company foundations (e.g. Ford, Shell, etc.).
Airbnb in its early stages accessed to an acceleration program, Y Combinator. This program grants USD$125k in exchange for a 7% equity interest. It gives access to business networks and investors and prepares entrepreneurs to grow their businesses.
6. Collective financing (Crowdfunding)
Another option for startups is access to crowdfunding platforms. Their main benefit is usually access to a larger pool of investors.
7. Traditional: Seed, early, late and growth
Coming out of Y Combinator, Airbnb had access to traditional venture capital funds during its multiple funding stages. These funds not only provided capital, but also access to networks, development of corporate governance, strengthening of the product, among others. There are countless venture capital funds that participate in the different financing stages, different industries and different geographies; the important thing is to choose the one that best aligns with the needs of your startup.
8. Corporate Venture Capital (CVC)
Startups may at some point receive financing from corporate venture capital funds. For example, Airbnb received capital from Google’s growth fund (CapitalG) in its Series F in March 2017. The greatest value of this type of investor is the strategic contribution of the organization to the startup, better known as “smart money” (Please review our article: CVC vs VC https://medium.com/@ACV_VC/independent-venture-capital-vs-corporate-venture-capital-a93fca5a3c29).
9. Mega funds
These funds generally invest in later and larger rounds. However, Sequoia Capital (with more than USD$8bn in assets under management) invested in Airbnb at an early stage because of the startup’s high potential and the passion of the founders.
10. Secondary market
Sometimes initial investors have the need or desire for liquidity and sell their equity participation to another investor in the secondary market. The case of Airbnb was no exception, and in 2017–2019 there were several sales in the secondary market.
11. Mezzanine Debt / Venture Debt Funds
Have you thought as an entrepreneur the relevance of raising debt as you grow? Airbnb did, and like many other startups raised debt financing from JP Morgan. The great advantage of this financing source is the non-dilution of current investors.
12. Private Equity
Usually when the startup already has a relevant size, a significant market share and incremental cash flows; investors with higher tickets such as Private Equity funds take an equity stake. Silver Lake (with USD$43bn of assets under management) in combination with Sixth Street Partners (with USD$34bn of assets under management), invested in Airbnb in early 2020.
13. Funds of Funds (e.g. Vintage Investment Partners)
Although the main mandate of funds of funds is not direct investments in startups but investments in other funds, sometimes they tend to invest directly in startups together with other funds. (e.g. Vintage Investment Partners).
Just as Airbnb raised capital from different investors, you as an entrepreneur should consider all the available options throughout the life cycle of your startup. Remember that investors rely on the risk-return of startups to build their investment portfolios. Make capital raising a primary task of your day to day, since you will be raising capital on multiple occasions throughout the growth of your startup.
“The most important thing is not to let fundraising get you down. Startups live or die on morale. If you let the difficulty of raising money destroy your morale, it will become a self-fulfilling prophecy.” — Paul Graham
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Ana Maury Aguilar. Investment analyst at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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