Startup funding: Navigating the issues

It’s been said that securing adequate funding is the most difficult aspect of launching a startup. However, most entrepreneurs are inherently confident of getting funded if they have a unique product and a strong business strategy. The latter view bubbles up because forums highlight the fact that wealthy individuals and institutional investors are constantly seeking opportunities to commit excess capital to attractive, fast-growing companies. Such investors wish to increase their wealth by taking equity stakes in “the next big thing”.

Who wouldn’t love to have been one of the early backers of Google, Apple, Coca-Cola or Goldman Sachs? Unfortunately, there are thousands of failed startups for each highly successful new venture. Perhaps rightfully, each entrepreneur needs to convince potential investors that financial returns will be high and major risks to the forecast have been mitigated.

Fortunately, modern society has come a long way from relying solely on funds from large corporations and wealthy individuals. The timeline and cost of launching a new business continues to decrease dramatically compared to a few decades ago. For example, one can easily go online to incorporate a new company from the home without needing to visit the registration agency. Reminder: two brilliant PhD students developed the original Google search engine project that has transformed into a $300 billion behemoth.

However a huge number of promising startups fail simply due to the entrepreneur’s resources drying up. Most entrepreneurs only have enough money to take the venture from being a brilliant idea to developing a basic product. Sales projections are always over-optimistic, and actual revenue is not enough to build the company. Much more capital is required to hire a team, generate brand awareness and grow the business. If the road gets tough enough, the founder abandons ship and goes back to the job market to earn a living.

Crowdfunding

Crowdfunding gives entrepreneurs and innovators a unique chance to present their startup ideas directly to the investing public. The best aspect of crowdfunding is the ability to easily reach a large number of people who either donate funds or invest in the startup on very favorable terms. There are over 400 crowdfunding platforms that offer various types of services to both the entrepreneur and the investors. However, the business founders need to get comfortable with any potential investors, and vice versa. While crowdfunding is a wonderful way for startups to survive the early periods of existence, there are various risks involved (such as lack of confidentiality and insufficient regulation).

Angel Investors

Angel investors (or “angels”) are wealthy private individuals that seek to invest in promising startup ventures in exchange for excess returns on equity. The ultimate goal of angels is to sell their stake in startups at several multiples of the entry valuation. These individuals are usually “accredited “investors – accredited by a government regulator in terms of possession of a minimum level of assets or income. These individuals are assumed to be capable of making informed decisions to buy into high risk startup companies that have a significant likelihood of failure.

Angels typically want entrepreneurs to have a product prototype, some sort of business plan (or investor presentation), and a successful track record. Extensive diligence is performed before the investment decision is made. The amount of capital provided to each startup by angels and angel investment groups ranges from $50,000 to $1 million.

However, it is imperative to tread carefully before agreeing to get funded by a particular angel. This is because it can be extremely difficult to separate from angels once they become investors in your company. Some angels are very demanding because they’ve put more cash into the company than the entrepreneur who just had an idea.

Venture Capitalists

Venture capital (VC) funding is one of the most popular forms of funding available to promising startups. VC firms provide significantly larger rounds of funding than angels, and therefore have even higher diligence standards and greater return expectations.

Although all VCs are not created equal, VC funding generally comes along with board membership, strategic guidance and follow on capital. Extensive media and public exposure also occurs. These are invaluable benefits that propel VC-funded startups to tremendous growth.

Even though VC funding offers significant rewards, there are some potential pitfalls. Like a marriage, VC investment also comes with strings attached and no holds barred. Getting venture capital too early can overvalue the startup with negative effects on later attempts to raise capital. For example, VC firms have a preset timeframe for selling their stake in investee companies. Missed financial projections and performance milestones can lead to a turbulent relationship, or worse, the initial founder getting completely sidelined.

The Pricing Dilemma

Scratching your head about what to charge for your product? Several factors need to be considered in determining the price of a product. Some of those factors are:

1) Production cost: the price needs to be sufficient to cover (at least) the variable cost of making it. For example, if you need to buy rubber soles to make a pair of shoes to be sold, your price must cover the cost of the rubber soles. If not, the product will never generate a profit regardless of how many units (in this case, shoes) are sold.

2) Competitive offering: Your price should take into account the pricing policy of competing products, especially if your customers are price sensitive. This means you need to carefully and honestly evaluate how your product compares with those of competitors, and perhaps increase/decrease your price accordingly

3) Financing cost: In instances where customers do not make payments immediately, you may be able to reflect the time value or financing cost in your price to maintain profitability

4) Brand value: If your product or company has substantial brand value, you may consider reflecting this premium in your product price (if the competitive environment permits). Brand value often arises because the market recognizes that your product or company is superior to others in the same field.

5) Warranty costs: If you provide a product/service guaranty in the case of product failure, this should be factored into your product price.

6) Volume strategy: If you want your products to fly off the “shelves”, you may decide to reduce the unit price in order to increase demand. This means you need to sell a lot of units to be profitable. This strategy assumes you are capable to producing at high volume to meet high demand, but could lead to a price war if competitors adopt a similar approach.