Raising funds for any business is not an easy road. Not only is it difficult to attract investment if you don't know how, but there are so many potential investors out there that it's a minefield to find the best option for you.
In this article, I'm going to explore the best options for raising money for entrepreneurs, highlighting the advantages and disadvantages of each so that you, the entrepreneur, can make the most informed choice for your startup.
Getting the right investor on board is crucial, so let's get to it!
First, let's start with the harsh truth: no matter how good your business idea is, you need to know how to attract investment in order to run a successful company. This involves finding the right investor for your business, having a solid business plan, and then persuading the investor to invest their time and/or finances into your startup.
Broadly speaking, there are three main categories of investment: Credit, Equity, and Royalty.
Each category has its own pitfalls and advantages, and what is the best option for one situation might not be ideal for another.
The credit category of investment is pretty self-explanatory. These are loans that you take out in order to fund your business. A key point here is that loan agreements should not be entered into with an ill-defined idea of how they should be used.
Loans should always be used to reach a specific milestone, such as getting to the next funding round or paying for product development.
Loan investment options involve either a financial institution such as a bank or credit union, a credit card company, a private creditor, or a group of private creditors usually represented by a lawyer or finance manager.
Like any deal, a loan is only as good as the fine print. A loan can be in a company's name or an individual's. If it is the latter, that individual is much more at risk financially, should the repayments become difficult.
A secured loan is leveraged against something you or your company owns. For example, if you own an inventory of stock, equipment, or premises, then these could be used to secure a loan.
The advantage of a secured loan is that the interest payments are usually smaller. However, if for some reason you cannot pay back a loan, the creditor is legally entitled to repossess whatever items or premises you used to secure the loan against.
An unsecured loan does not jeopardize any premises or items directly, but it does usually come with a larger interest payment. Also, entrepreneurs often make the mistake thinking that an unsecured loan can never result in a company's belongings being repossessed.
This is wrong.
Although an unsecured loan does not tie a loan directly to an item or premises, the debt is still difficult to shake if payments cannot be made. If a company cannot pay its debts, then it can go into administration or even liquidation, where all company assets are sold in order to pay back creditors.
Sometimes it's necessary to take out a loan or line of credit to run a business. However, in my view, the best credit options are credit unions. These groups are usually not for profit, offer low-interest payments, and are often more amenable to renegotiating debt if there are payment issues.
Equity investment is the standard form of investment that most successful entrepreneurs court. The benefits of it are that it's such a simple concept: Sell a percentage of your business (equity) to an investor for an agreed amount.
Most funding rounds involve entrepreneurs pitching to investors for straight equity for an investment agreement. These funding rounds are usually made up of angel investors, venture capital groups, and incubators/accelerators.
Angel investors (also known as seed investors and informal investors) are great for initial investment rounds.
These investors are looking to invest in businesses at the beginning of their journey. They assist entrepreneurs by providing the necessary funds for a business to reach their immediate goals. In return, they ask for either convertible debt or equity in the business.
Most of the time, angel investors are affluent individuals who are willing to support entrepreneurs and their visions when larger investment groups are not quite ready to jump in yet.
Equity agreements aside, a convertible debt agreement with an angel is an initial loan which will be converted to equity at a later date.
Angels are the go-to option for startups; however, they are not usually attached to a business for the long haul.
Venture capital groups (VCs) consist of successful companies and individuals who have pooled their money together to invest in businesses.
These groups have, on average, more than 10 times the amount of investment capital available to them than angels. However, they tend to want either a majority share or complete control of a business.
This often equates to a buyout.
Incubators and accelerators are also present at some pitches. They tend to buy a small amount of equity in a business in return for giving access to larger investors, pitch meetings, mentorship, and other facilities.
Incubators and accelerators are fantastic options, but they are usually very picky about the types of businesses they support. You'll need to be on point with your business plan, market research, and vision to persuade them.
Finally, you should consider royalty agreements if available. Like an equity agreement, a royalty investment simply means that an investor provides finances. However, instead of receiving a percentage of your business in return, they are given royalties.
A royalty is an amount generated by one or all of your products/services.
The advantage here is that you don't lose any of your business. The royalty agreement simply means you share the profits with the investor when they are generated. The agreement also needn't be forever – you can stipulate the agreed duration.
All that being said, an M&A Advisor will share that your company won't be able to reinvest those profits into business development or buy that yacht you had your eye on. It will all be paid to the investor with whom you agreed on the royalty contract.
Alejandro Cremades is a serial entrepreneur and the author of The Art of Startup Fundraising. With a foreword by ‘Shark Tank‘ star Barbara Corcoran, and published by John Wiley & Sons, the book was named one of the best books for entrepreneurs. The book offers a step-by-step guide to today‘s way of raising money for entrepreneurs.
Most recently, Alejandro built and exited CoFoundersLab which is one of the largest communities of founders online.
Prior to CoFoundersLab, Alejandro worked as a lawyer at King & Spalding where he was involved in one of the biggest investment arbitration cases in history ($113 billion at stake).
Alejandro is an active speaker and has given guest lectures at the Wharton School of Business, Columbia Business School, and at NYU Stern School of Business.
Alejandro has been involved with the JOBS Act since inception and was invited to the White House and the US House of Representatives to provide his stands on the new regulatory changes concerning fundraising online.