You have an idea and are willing to put in plenty of sweat equity but you need capital. Now what?  Raising seed money is the first challenge entrepreneurs face.

However, finding the right source of capital is far more complicated than just getting cash to fuel your business idea.  Some entrepreneurs are so eager to get money that they do not apply enough scrutiny in assessing their investors.  The decision where to raise money will impact your ability to succeed as a business and has far reaching consequences.  So entrepreneurs should choose wisely and be aware of the downside of bringing investors in.

The two well known ways to raise money for a startup are a) investment from friends and family and b) venture capital.  However, each of these options has downsides and may not be optimal.

  • Venture capitalists may bring valuable experience and different level of support in getting off the ground and running.  Some venture capitalists would help you with marketing, building out a team and general management oversight.  For example, ff Venture Capital has 23 staff members who support entrepreneurs with common business challenges such as office space, marketing, and accounting. Reputable venture capitalists are usually positioned to bring follow-up capital and participate in later rounds. The downside of venture capital investments is that these could be expensive.  You may need to part with a bigger share of the company’s equity than you are comfortable with.  Also the venture firm partners may not have the same long-term strategic vision as the founders and may force your o aim for short-term financial returns that match the investment timeline of their fund.
  • Friends and family members may be willing to put money in your business because they like and support you, but probably know little about the space you are focused on and therefore, may be unable to add meaningful value beyond just capital.  Getting an investment from friends and family does not validate your business idea and it may thus, be harder for you to raise follow up capital from reputable investors. Additionally, holiday dinners quickly become investor meetings.  At best these are awkward and at worst can destroy close relationships. In For Better or for Work,  Meg Heshberg writes: “Relatives make a profound gesture of love and trust and then along come doubt, fear and the complicated family gathering.”

In a tighter economy, sources of investment are scarce and as a result entrepreneurs are getting resourceful. The best investors not only provide funding, but also propel your company forward, unlock value in your business beyond just financial upside, and allow equity to remain with the employees of the business.  I have listed some of the more creative ways, I have either used myself when raising money or have seen others successfully apply.  Not every funding venue is suitable for every business model so before you pursue investment channels carefully consider your company’s product, customers and competitors.

Find the right co-founders

Creating the right founding team is by far the most important decision you can make as an entrepreneur. I often see cofounders with very similar backgrounds  For example, two former investment bankers starting a fintech company or two technologists building a product that will revolutionize social media.  Working with someone you know who has a similar way of thinking may be expedient but counterproductive in the long run because your founding team may lack valuable foundational skills. An alternative and more effective approach is to find a cofounder who has complementary capabilities based on the business model you want to implement.  Thus your new venture would be more self-sufficient and would require you to hire less people early on.  If you are starting a technology company, make sure the founding team has strong technical skills.  If the consumer space is of interest, ensure you have marketing experience. The core functions of your business should be covered by your founding team.  For example, I co-founded Marto Investment Partners, a single family home aggregator, with Tom Briggs who complimented my asset management and financial services background with strong operational real estate capabilities.

Look for strategic investors

Strategic investors are the best type of investor you could find for your business because their interests align with your start up.  Additionally, strategic investors may give you higher valuation because they see benefit from your business idea beyond the financial upside. Who is a strategic investor? A strategic investor is expecting to gain more than just a financial return from the success of your venture.

Strategic investors can be both companies and individuals. Look for companies with mature business models that aim to expand in new areas.  Such companies invest in startups to either solve a problem they currently face or to expand into new markets  Many large corporations, such as State Street, IBM, Intel, Lucent have venture arms that invest in startups. Google and Microsoft are companies with significant cash reserves and venture arms that make both early and later stage investments and add tremendous credibility. Other companies may be willing to do so opportunistically. In addition to investing early on, corporate strategic investors can end up being clients, promoters, go to market partners, and even potential acquirers.

Individual angel investors with deep knowledge of your marketplace help not only in terms of financial support but also through advice and validation.  Such angel investors may join your board. Many experienced professionals make angel investments to stay engaged in the business world.  Other may invest because they perceive a potential future partnership between their own business and your startup.  For example, Ben Gordon, a prominent logistics investment banker/consultant, invested in Whisk, where he knew that he could add significant value.  Doug Rotella and Rick Flynn, founders of Homebridge, the eleven largest mortgage bank in the United States, invested in Accordance Technology, understanding the complexity of the compliance space. While angel investors often work independently, there are angel networks that review and make investments as a team.  The three largest angel groups in the NY region are New York Angels, Golden Seeds, and Harvard Business School Alumni Angels of New York.

Find a clients that would pay you to build a product

There is no bigger validation for your product or service than getting a target client to invest in your company. Client investment comes in different ways:

  • A client may be willing to be an early adopter and pay to cover the cost of an initial prototype development.
  • A client maybe willing to make a direct investment in your business.
  • If you have a product with little viable competitors, a client is more likely to help you build your business than if there are many available solutions.
  • Typically, a client would want you to share the downside of your startup not delivering because there is operational risk in selecting an unproven service provider.

Fledging businesses have to watch out that a large first client, especially one that is investing, does not absorb all their resources or does not shape their product into a highly customized solution that would not be applicable to other clients.

Break even from day one

An increasingly popular way to build a business is to self-fund the early expansion.  Any form of non-capital intensive business line could fully or partially fund the development of more capital intensive products.  For example, consulting, advisory, and recruiting are a good way to be profitable from day one. Talantism’s founder, Jeff Hunter, is a big believer in the self-funding model. Jeff drives revenue from day one from strategy consulting and recruiting while at the same time invests in developing the firm’s intellectual capital. Jason Segal and Tony Lent atAldwych Environmental Merchant Banking aim to disrupt the financial markets for renewable energy, water, waste and agribusiness.   The business model generates revenue from day one by advising investors on how to capitalize on inefficiencies of resources.

Founders have to be careful to find the right balance of immediate revenue generation and long term strategy or they risk getting distracted.  The design of your business can impact your future valuation as well.  Most services that deliver immediate revenue trade at lower multiples. For example, consulting is approximately valued at a multiple of 1 or 2,  while software at 5 to 8 multiple.

Participate in business plan competitions

Business schools and many other organizations have business plan competitions that are open to alumni and students.  You can find a complete listing of entrepreneurship contests, elevator pitch events, and business plan competitions at businessplancompetitions.com.  If you enroll in startup competitions, at a minimum you would perfect your elevator pitch and would learn what investors look for.  You would also be able to see other entrepreneurs pitch their ideas and learn from that. Winning a business plan competition can provide some seed capital without diluting your equity, lend you credibility, give marketing exposure, and attract venture capital.  The downside is that the funding coming from business competitions is rarely sufficient and you may need to pursue other sources simultaneously.

Utilize crowdfunding platforms

Crowdfunding is a recent but growing phenomenon with a mixed reputation. Crowdfunding has been criticized as it may bring unsophisticated money to unsound ideas. However, crowdfunding can be a good early validation of your business idea especially if that idea is in the consumer space.  If target customers are willing to pay through crowdsourcing to develop your product than later venture capitalist would be more likely to invest and give you a more favorable valuation.  For example, Interaxon, the company that created Muse, a brain sensing headband, raised $287,000 on Indiegogo platform.  For Marto Investment Partner’s market concept testing, we used iFunding, a real estate crowdfunding platform.

If you decide to try crowdfunding, you can start with the following sites: Indiegogo, Angel List, Gust,SeedInvest, and OurCrowd. Some angel investor networks also use technology platforms to source and assess companies.  For example, Harvard Business School Alumni Angels of New York uses Gust.

Look for funding for women and minority businesses

Women and minorities are underrepresented in the startup community.  However, there are funding sources that aim to help women and minorities raise money.  Golden Seeds and Astia are two women-focussed angel groups that support women-owned businesses.

The U.S. Department of Commerce’sMinority Business Development Agency (MBDA) helps minority firms with access to capital and consulting. According to INC Magazine, MBDA has helped minority owned businesses “gain access to more than $800 million in financial packages, including working capital, equity investments, and bonding.”

Consider government grants

Recently I had a conversation with Janet Levitt, who “shared that entrepreneurs do not adequately consider government funding as a source of capital for their ventures.”  Janet is the co-author of Public Venture Capital, an extensive guide for technology startups looking for government funding.

  • A major source of early stage funding for entrepreneurs is the Small Business Innovation Research (SBIR) program.  In fiscal year 2014, 2.8% and 2015, 2.9% of the budget of 11 federal agencies is available for contracts or grants to small businesses that are doing R&D that could lead to commercialization for government needs. Approximately $2.5 billion is awarded annually through this program.
  • Another important source is state funding.  Most states have their own programs on a smaller scale than the federal programs, targeted at local industries whether existing or future.  For example, in New York there is NYSTAR, New York Division of Science, Technology and Innovation.  These programs arise from interest in accessing advanced technologies to support government’s diverse functions and to promote local, regional and national economic development.

No matter what type of capital you raise, it is prudent to run a lean startup.  The dot.com boom days of sky high valuations and easy money are for gone. I compare the days of my first dot.com start up in Seattle in the 90s to the days of incubating Accordance in a tiny Manhatan office today and the difference is palpable. Investors today value entrepreneurs that run lean businesses and get to market quickly. Additionally, technology and communication innovations have dramatically decreased the cost of starting a business. In The Lean Startup, Eric Ries warns founders not to spend too much money early on and advises them to build a minimally viable product and quickly go to market.

 

This article was written by Katina Stefanova and Contributor from Forbes and was legally licensed through the NewsCred publisher network.