Lack of financing is a major constraint which businesses experience at the startup phase. Seed capital is required for startups to fund their operations and scale, thereby returning profits to founders and investors.
A major indicator that a startup may thrive is the availability of capital. Where capital is low or inadequate, the business operations will be impacted and the startup will likely fail. Research conducted on small businesses in the U.S. indicates that 79% of businesses fail because they start out with too little money and are unable to fund their operations.
It is therefore essential that founders are familiar with the several ways in which capital may be raised and identify the funding path that is best suited for the startup. Below are several funding sources that founders should consider when seeking capital.
The proliferation of technology has seen the emergence of digital solutions aimed at solving every day problems. An example of this is the growth of crowdfunding sites which enable founders raise funds from the public. Crowdfunding[i] entails pitching the business idea of a startup to willing investors via an online platform. Investors may receive equity in exchange or a percentage of interest over a period of time. Crowdfunding is particularly advantageous to founders because they can decide the terms of the investment and easily retain control of their company.
- Incubators and Accelerators
Incubators and accelerators nurture and prepare startups to scale. Incubators are focused on startups at the conception stage while accelerators target startups that are viable and ready to scale. Startups who successfully pass through incubators or accelerators typically receive a seed investment at the end of their program from the incubators/accelerators or investors/mentors introduced to the startups in exchange for nominal equity.
- Business Loans
Although, not typical, startups may apply for loans from banks or microlending companies. These may however attract high interest rates. Startups therefore must consider their revenue flow and ability to repay loans obtained from banks and other lending institutions.
- Angel Investors and Venture Capital Funding
Angel or seed investors typically fund startups at the beginning of their lifecycle while venture capital firms usually provide funds to startups that are viable with a recognized customer base and established revenue stream. These funding sources provide much needed capital in exchange for equity in the startup. The terms of the funding and equity participation are contained in agreements such as Simple Agreement for Future Equity and convertible loan agreements.
Bootstrapping means growing a startup without external funding. Startups would have to rely on funding from its founders to operate and rely on revenue from sales. Bootstrapping is perhaps the toughest method of funding startups as it means that growth might be stifled or delayed due to the absence of funds required to scale their operations. However, where founders subsequently decide to receive external funding, it portrays a sense of seriousness to investors that the startup depended on the sweat and faith of its founders to grow and generate revenue. With bootstrapping, founders are also assured of absolute creative and operational control of the startup.
Although there are several sources of funding which startups can take advantage of, startups must consider which funding source is most suitable by weighing the pros and cons of the funding options available to them.
[i] Equity-based crowdfunding in Nigeria is potentially regulated by the Securities and Exchange Commission (SEC). Please find our article on the crowdfunding rules proposed by SEC here https://pavestoneslegal.com/review-of-the-crowdfunding-rules-proposed-by-sec-nigeria/
You can also watch a brief analysis of the crowdfunding rules by our Partner, Aderonke Alex-Adedipe, here https://furtherafrica.com/2020/05/05/insights-funding-startups-in-nigeria-video/