There is a lot of energy and excitement associated with starting a new business and bringing a new or even revolutionary product or service to market. You might be extremely proud of your business idea and may want to share it with as many consumers as possible. Starting a new business is an adventure, but there are also challenges that must be overcome as your company goes through its lifecycle from an early stage company to the growth and expansion stage and on to being a mature and successful company. For instance, one of the biggest struggles that early-stage companies face is finding sources of funding to get their business off the ground.
What Funding Options Are Available to Early Stage Companies?
There are a number of different funding options available to early-stage companies. Sometimes it’s just a matter of knowing where to look. Some of the most common funding sources available to early-stage companies include:
- Personal savings. Many early-stage companies rely on the personal savings of the founding members to get the business started. Often referred to as “bootstrapping”, this type of funding depends on how much capital the founding members are able to contribute to the company at its earliest stages of development. Usually, bootstrap financing takes the form of capital contribution from a founder to the company, which will represent the consideration the founder pays for its ownership stake in the company. Founders may also make loans to the company, which the company will later have to pay back. In such cases it is always a good idea to use a formal loan agreement to record the terms of any such loan.
- Banks. Banks and other typical funding sources for large businesses are typically not an option for an emerging company. Generally, a bank will want to see a certain number of years of existence for the company, and most (if not all) banks will require the founder to personally guarantee any loans made to his/her business. This can be a scary proposition for any founder. We have, on several occasions, negotiated with banks on behalf of an entrepreneur who defaulted on a loan granted to a previous business. (Banks don’t give up easily.) However, if a business can get a loan from a bank, it is worth considering. The company would not have to give up any equity, and a bank just wants to be paid back with interest, and is not concerned with sharing in any upside or participating in the management of the company.
- Funding from friends and family members. Funding from friends and family members is another common source of funding for early-stage companies. Usually, the friend or family member provides a loan to the company, which is paid back by the company at a later date. Again, it is always a good idea to use a formal loan agreement when friends and family members provide a loan to the early stage company. An experienced business lawyer can help you prepare a loan agreement.
- Crowdfunding. The world-wide web has made it possible to solicit funding from anyone who has an internet-connected computer. Rewards-based crowdfunding involves setting up an internet-based web platform where anyone who is interested in your business idea can pledge money to your business, usually in exchange for “perks” such as a prototype product or branded merchandise. Alternatively, companies can conduct an offering under Regulation Crowdfunding, whereby investors obtain an ownership stake in the company. In such an offering, a company sets a target fund-raising goal using a specially licensed “crowdfunding portal”, and prospective investors can pick and choose which companies on the portal to support. If the company reaches its fundraising goal, the company will receive the investments from the escrow agent engaged by the crowdfunding portal. If the company fails to reach its fundraising goal, then the pledges are usually returned to the investors. There is also crowdfunding for accredited investors (Title II), which is likely going to be the fastest and least expensive means of raising funds. If you are considering crowdfunding as a source of capital for your early-stage company, an experienced business lawyer can help you understand and comply with the securities law regulations governing crowdfunding campaigns.
- Business incubators and accelerators. Early-stage companies can apply to participate in business incubators or accelerators. If accepted, the company can gain access to a number of resources, including a network of experienced professionals, business services, and even some funding, all of which can help the company grow and develop into a full-fledged sustainable business. Business incubators and accelerators typically take a small equity stake in a participating company as compensation for their services.
- Grants. Early-stage companies can also apply for various types of grants as a source of funding. Grants are available through state and federal government programs, private institutions, research entities, and various foundations.
- Angel investors or venture capital firms. Angel investors and venture capital firms are two more options that are available to early-stage companies as a source of funding. Angel investors are often wealthy individuals who have an interest in financing companies in the investor’s field of interest or expertise in exchange for an equity stake in the company. Venture capital firms are often groups of investors or managed investment funds that are invested in a company in exchange for an equity stake in the company. Obviously, there are a large number of companies chasing angel investments and venture capital, but some do succeed, particularly when a company can leverage its personal connections. These investors tend to be sophisticated, however, and a promising company should take care to note what exactly it is giving up when accepting such early-stage financing.
There are a number of potential sources of financing available to early-stage companies and each source of funding comes with its own advantages and disadvantages that should be carefully considered. No matter what source you choose, however, procuring early-stage financing can be difficult, and the success of your financing will hinge on your track record and your business’ potential for future growth. If you are considering funding options for your early-stage company, it is a good idea to discuss with a business lawyer the available sources of funding, the pros and cons of each, and whether there are any legal requirements associated with a specific type of funding of which you should be made aware.