Starting a business from scratch is no walk in the park. From start to finish, founders have taken extreme measures to bootstrap their business to success. But, for some startups, there comes a time when outside investment is necessary. So how do you go about raising seed money?
Before you even think about looking for potential suitors, you have to be honest with yourself about your business. Remember, when you open up yourself to new investors, you open your ideas up to criticism. And if you take on that risk of dealing with other people’s money, you begin to take on an entirely new level of responsibility and pressure to get your business to succeed. Before going after your first or next round of startup funding, ask yourself these questions:
- How much money do I need to raise?
- Can your business withstand the due diligence process?
- Does your business fall under any of these criteria
- What type of security will you offer that’s mutually beneficial?
Still here? Let’s look at the different avenues of startup seed funding that you could use.
Rollover For Small Business: Getting Started
If you have a 401k, traditional IRA, or other eligible retirement account (excluding Roth IRA) with at least $50k, you can borrow up to 100% of your retirement savings. The upside here is that you are betting on yourself with your own money. It also means you don’t have debt to pay off, your retirement savings could grow if your business succeeds, and you don’t impact your credit score.
On the downside, there is an initial fee of $5,000, along with $1,500 annual fee. ROBS also requires you to run your business as a C Corp, and opens you up to the potential for a financial audit. To top it all off, you run the risk of losing your entire nest egg. If you aren’t comfortable with the risks and regulations of this option, let’s move onto some of the other possible options.
Before considering this option, you would be well served to consult a tax professional and financial advisor to weigh all of the risks associated with this form of funding.
Friends & Family: Getting Started/Growing the Business
If you have a small growing business that is in need of a small cash injection, a personal investment from family and friends is usually the route of least resistance. It’s also a great opportunity for you to practice your pitch, which you will need to hone as you go after larger investments in the future. If you can’t sell your family and friends on an idea, your chances of securing outside investors could be significantly harder.
If you decide to go down this route, be aware of the other risks you take. A bad business venture could lead to the loss of friends and family. You will need to understand the balance between formal business relationships and informal personal relationships. To mitigate this potential disaster make sure you outline the risks, business plan, and rules behind your new relationship before you take any money.
Donation Based or Equity Crowdfunding: Growing Your Business
There are two different ways you can go about crowdfunding. For the most part, traditional crowdfunding is used by entrepreneurs looking to get their new business idea off the ground. Platforms like Kickstarter allow entrepreneurs to raise large sums of money, without having to incur interest or debt.
On the other end of the spectrum, equity crowdfunding is primarily used by business who already have a customer base and are looking to expand their business. Depending on the type of equity crowdfunding, startups are able to raise $1 million or more from accredited and non-accredited investors. Unlike traditional crowdfunding, startups must offer some type of security to investors in exchange for their investment in the company.
Crowdfunding has become a hot topic between startups and serial investors. While many startups look to the crowd to fund their ideas, many don’t realize the costs and risks incurred in going through with it. As more startups adopt these platforms, the competition for consumers attention increases. Unless you have a life changing idea, you will need to spend money on marketing in order for your product to gain visibility. From creating assets to advertising online, you need to understand the time and money that goes into creating a solid campaign that will allow you to hit your goals. If you go the equity route, you will have additional costs that revolve around diligence and filing preparation. Current rules also require yearly public reporting on the health of the business.
Successfully raising money from a venture capital fund or angel investor usually means that seasoned accredited investors see potential for high, rapid growth. Even though people may use these terms interchangeably, there are a few differences in how each group works. Angel investors are typically stand alone investors that go after earlier stage deals, offer a smaller amount of funding, and look to come in during the last stage of technical development and early market entry. Venture capital groups are usually a consortium of angel investors that pool their money together to invest a larger amount of money in later stage companies, who need assistance with rapid growth and developing market share.
While funding from seasoned investors and entrepreneurs is appealing, both come with caveats. Usually, the biggest cost for founders is time. Both parties will perform some degree of due diligence, and in some cases venture capital firms may spend thousands of dollars on researching your business and its potential. You also have to be aware that you will most likely be giving up a certain amount of equity and control. Most serial investors are looking for some type of exit or liquidity event in order to get their money back within a 3 to 5 year window. Bringing on an investor with that type of mindset could be conducive to your vision, or it could be the complete opposite of how you want your business to run.
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