Startup Capital: Everything You Need to Know
Startup capital is the money needed to start a new business.18 min read
What Is Startup Capital?
Startup capital is the money needed to start a new business. Startup capital might be needed to pay for office space, permits, licenses, inventory, product development, manufacturing, marketing, or any other expense that results from starting a new business.
Seed capital, startup funds, working capital, or seed money.
Types of Startup Capital
For each stage of its life, a company has different financial needs. Each level of funding plays a unique role in that stage of your business.
- Seed capital is used for initial research and planning before starting the business.
- Startup capital pays for rent and supplies during the first year or so of your business.
- Mezzanine capital helps your company grow bigger, move to a better facility, or purchase higher-quality equipment. This is also known as expansion capital.
- Bridge capital bridges the gap between your current level of funding and the next level.
Debt Capital Versus Equity Capital
Debt capital is when your business takes out a loan for its startup capital. The loan is given for a set amount of time and then it must be paid back with interest and possibly other fees.
The benefit of debt capital is that the owner retains full control of the company. The drawback is hefty repayment.
Equity capital is funding that's provided by people or companies who want to own a piece of your company. Those people fund your business in the initial stages in trade for ownership of a portion of your company. They benefit when your company is successful, goes public, or is bought by a larger company.
The benefit of equity capital is that there's no loan repayment. The drawback is that the owner loses control over a percentage of his company.
Sources of Startup Capital
A business can choose to obtain startup capital in any of these ways, but some may be more beneficial than others, depending on the type of business.
Friends and Family
It's very common that new businesses receive startup capital from their friends and family. This is a very easy way to receive funds, but there can be many drawbacks.
For example, if your company fails and you lose everything, you may lose your friends who loaned you money.
It's important when borrowing money from friends and family to have a contract that describes how startups work and all the risks that are involved. Be clear in your agreement with friends and family. For instance, if the company fails, do they still expect repayment?
This contract is also important when seeking funding later on. Future funders should be able to examine documents proving where your initial funding came from.
Many startups use personal funds as their startup capital. If your business doesn't need to produce a product, it's possible to keep costs low in the beginning by using only personal funds.
Personal funds may come from your savings account, taking out a second mortgage or home equity loan, a personal loan, or any other finances you have at hand.
Personal funds may also be obtained by borrowing money from a bank or taking on credit card debt.
Some government programs, including the U.S. Small Business Administration, offer loans of startup capital for new businesses.
An angel investor is a high net worth individual who will invest in your company in exchange for partial ownership. Angel investors typically give startup capital to businesses in ranges of $10,000 to $100,000. They participate in priced or debt rounds.
It's important to determine whether an angel investor is an active professional or merely an occasional investor. A professional is one who does at least six deals a year. You can also look them up on AngelList. A new business should be able to close a deal with a professional within the first three meetings. It's appropriate to ask their interest level at the end of the first meeting.
Target carefully when seeking out an angel investor. Make sure that your business or product is something that they're interested in.
This is a group of angel investors who pool their money to share deal flow. Angel groups can do priced rounds, and if a high enough percentage of the group is interested in your business, they can lead your deal.
A check from an angel group will range from $50,000 to $500,000. These angel groups aren't syndicates and therefore don't carry syndicate fees.
The angel group will meet regularly and likely has a pitch process that they prefer. Some angel groups do a lot of due diligence and others don't.
The most effective way to raise money on AngelList is through AngelList syndicates. The syndicates are formed by influential angel investors. The investment of an AngelList syndicate can range from a $200,000 to more than a million.
The best way to get a syndicate's interest is to spark the interest of one of the AngelList syndicate investors. If you can do that, then that angel investor will get the rest of the syndicate interested.
Think of a micro venture capitalist (VC) as an angel investor with more money to invest. It might be an individual investing $100,000 or a firm that has $10 to $50 million to invest.
The micro VCs will commit or decline within three meetings. This type of investor may be comfortable with debt or equity capital.
A micro VC is very similar to the VC in that they're interested in ownership, but with a lesser stake. The micro VC will be interested in 8 or 10 percent ownership, while a VC would want 20 percent ownership of your company.
As you would with an angel investor, be sure to research micro VCs before targeting them. Research their portfolio and make sure that your business or product is something that they might be interested in. You should not only target a specific fund within the micro VC, but a specific partner.
A traditional VC will have available investment funds of between $100 million and $500 million.
For seed money, a VC might invest as little as $250,000 or up to $2 million. The sweet spot is typically between $500,000 and $1 million.
A VC is very interested in the percentage of ownership of the business. They might insist on doing a series A (preferred stock) round as well.
It's important to do a little research when meeting with a VC. The VC might still meet with you even if they are between funds and this would be a waste of your time. With larger firms, try to find out how many companies they typically manage and how many they're currently involved in. This could give you a good idea of their current funding level.
You should also try to determine the partner who is managing the deal. This isn't always obvious with larger VC firms.
Ask the VC firm what their pitch process is and how they would like for you to follow up. Make sure that the next steps are clear and ask the VC directly if they're interested.
A mega VC is a firm that has more than $1 billion under their management for investment.
Mega VCs include these companies:
- Kleiner Perkins
Find out if the Mega VC has a seed program and try to determine who runs it. The seed capital process is compressed compared to the process of raising more capital. There's also likely one partner who is in charge of seed capital.
For some companies, it doesn't make sense to seek out a mega VC during the seed round as the mega VC must invest large amounts of money to make their return. Instead of trying to get the attention of a mega VC during the seed round, get their attention for a series A or series B round.
Online Sources for Startup Capital
There are many places online where business owners can request startup capital from investors. An online platform is sometimes the simplest and safest way to gain funding. It may be safest because these platforms are approved under the rules set out by the U.S. Securities and Exchange Commission.
Mentioned above, this minimalist website allows startups and investors to search for opportunities that are interesting or relevant to them.
Investors will pay five percent of their investment value to AngelList, while startups pay nothing to the website.
This website works in a similar way to Kickstarter. Investors can give money to a company in exchange for gifts and rewards or for stock in the company.
The option to solicit investors is new to the website, but some companies have been very successful at it.
Fundable charges startups $99 per month to be listed and a 3.5 percent processing fee for all credit card transactions.
This website focuses solely on matching entrepreneurs to vetted investors. The website was formerly known as AngelSoft.
Gust offers startups many tools to help them develop effective VC pitches. The website has the option to create both public and private business profiles, to search for investors, put together a video pitch, or to track investors' activity on the site.
The fee for investors isn't publicly disclosed, and the website is free for entrepreneurs. Gust has more than 1000 investment groups that have invested in over 1800 startups in the last year.
This is one of the largest websites where entrepreneurs can meet with investors. There are over 300,000 companies and 20,000 investors on the website.
The website focuses on entrepreneurs, offering tools and expert consultants to help a business create effective pitches and find investors.
Entrepreneurs pay $59 per month to access the network of investors and $300 or more for consulting services. There's an opportunity for large and small investments.
Tips for Starting a New Business
Starting a new business and securing startup capital isn't an easy task. These tips should help encourage you in founding your business the right way.
- Get experience. Before starting your own company, work for someone else for a short period of time to learn the business that you're interested in before founding your own. This not only gives you more experience as a founder, but will make future investors more confident in your skills.
- Make a business plan. There are many online forums and websites that offer help and resources for creating business plans. Those resources can be found on angel investor websites and also from SCORE, the Service Corps of Retired Executives.
- Get sound advice. The first few stages of creating and starting a new business can the most difficult, and good professional advice is key. Advice will cost money, but it will pay off.
- Build relationships with an attorney, a CPA, and a bank. These are the people who will protect you from mistakes and ensure a long business life. These professional advisors help you to get your business started in the right way.
- Spend cash. Venture capital backing is very tempting to new companies, but it often means that owners lose their ownership rights and future profits. Venture capital funding is quick money but it may not be worth it long term.
- Take your time. There's no need to rush the founding of your business. Take your time and work hard. Things will eventually start happening.
- Stay focused. When starting a new business, it's all about hard work and persistence.
- Study your loan options. As with the founding of your business, there's no hurry in taking loans or funding. The Small Business Administration can be a great resource when looking for loans and making decisions for the best of your business.