Sources and Use of Funds
Every entrepreneur seeks to raise capital in order to develop their startup. We are probably facing one of the best funding cycles in Venture Capital. In 2021 alone, global Venture Capital funding to startups reached a record USD$621 bn, more than double that of 2020 (USD$294 bn). In addition, all regions of the world saw record funding, a sign of the globalization of innovation capital.
In addition, in 2021 there were 1556 global mega rounds, i.e. funding of more than USD$100mm. Mega rounds represent approximately 5% of the number of global transactions, but 59% of the capital invested.
If you are a start-up entrepreneur, what is the best source of funding you can access?
One of the options to finance yourself initially is through Bootstrap, which means using your own capital in the development of your company. This capital comes from your savings or assets that you can make liquid to finance your venture.
One of the main reasons to do Bootstrap is not to dilute yourself in the early stages of the formation of your startup. It is important to remember that in each round of financing where you raise capital, you will be diluting yourself typically between 10% to 20%. Another reason is to put your money to work and align interests with the rest of the investors. Investors are usually looking for entrepreneurs to not only be involved in the development of the idea intellectually, but also to put their capital at risk.
Despite having a lot of money, Bootstrap becomes a limited strategy, especially if you want to play the Venture Capital game. For this there are other alternatives that allow you to have funding and grow in an accelerated way. One of them is Crowdfunding.
Crowdfunding is a source of alternative capital funding where a group of individuals invest their capital in the startup of their choice through a digital platform. Some advantages are that you can raise enough capital to continue expanding your company, gain visibility through the platform and media, achieve social validation of your product or service, minimize dilution of equity in the company, increase brand loyalty while building a community and it is an easier process to pitch and raise capital.
However, crowdfunding has elements against it, among them are being a very public process where there is a wide disclosure of information and if you do not raise capital the failure also becomes public, there is a limit on how much you can raise by this method, high commissions depending on the platform and limited network of strategic alliances.
There are different crowdfunding mechanisms, the first one is through donations that can be completely pure donation or a donation with a tangible or intangible recognition. The second mechanism is through a loan where you can return interest only if the project has profits, it can be through presales of the final product or a traditional term loan with the payment of a fixed interest. The third mechanism is through capital, where the investor receives an equity stake in the company.
In addition to crowdfunding there are other debt financing mechanisms, which are very uncommon and whose use will depend on the stage of the startup. One of them is working capital financing, which is used by startups that already have some traction and are subject to credit from a traditional financial institution. Product management startups or fintechs can access this type of financing usually in growth stages. (Search for example).
As the startup progresses, it has the opportunity to access multiple financing that can range from sales-based financing, for SaaS companies, or financing through Venture Debt where the debt provider receives a share in Warrants.
There are multiple sources of funding that a startup can access. An important element is to consider the use of these resources. Openly exposing the use of resources can be an advantage in the fundraising process, since it will give potential investors a better idea of the results they can expect from the venture. The use of these resources should be labeled, among the main categories, are mainly commercial and technology personnel, marketing, offices, among others.
The investors who are entering into the transaction are expecting the company to continue to grow and the money they are contributing is for that purpose. They do not want this new capital to be used for things that are not related to the growth of the company, such as the payment of debts previously acquired by the company.
Today’s entrepreneurs have access to multiple sources of capital to continue building their businesses. It is probably one of the best times in history as there is plenty of capital in the financial markets due to the excess liquidity generated from the great recession of 2008. If you are an entrepreneur or looking to start a business start building relationships and raise capital early. If you are an investor consider what type of financing is best suited to your risk-return profile.
Hector Shibata Salazar, adjunct Professor at EGADE Business School and Director of Investments and Portfolio at AC Ventures Fund
Ana Maury Aguilar, VC Investor at AC Ventures
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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