Becoming an entrepreneur is not easy. Besides the awesome amount of innovation and talent that is needed to break the competition, startups also need to face the biggest challenge of financial planning and funding for getting their chance at success. At different stages of development a startup must make investments. It can be in any form starting with the more traditional venture capital, angel funding to the now popular crowdfunding.
While venture capital has been the primary source of funding for many decades, the new phenomenon of crowdfunding seems to be gaining traction in the corporate finance world. Let us look into some of the characteristics and suitable scenarios where each of these financial sources seems to have the best results.
Crowdfunding is an innovative and fast growing investment model that has helped a lot of startups get a strong hold on the market. The relative growth of crowdfunding platforms like Kickstarter and Indiegogo stand as testimony to this fact. Crowdfunding essentially provides a way for startups to directly sell their idea to the consumers or to the general public. This model provides capital for companies at their startup and early stages.
It differs from the old models in the aspect that none of your investors are shareholders in your company. This lets you maintain equity while raising capital. Crowdfunding needs you to pre-sell or deliver something (a product or service) in return. When a company cannot secure the required financial investment, crowdfunding can be a boon for them. It lets them create a viable business that will attract further investments from Angels and VCs.
Some great benefits that have been witnessed with the help of crowdfunding are
i) A great way to get through the first run of the product and way to get a direct interaction with the consumer base.
ii) Quicker fund raising and elimination of gate keepers or middlemen.
iii) If successful, helps to gain trust from Angels, VCs and banks for further investments.
iv) Both general and niche platforms with access to a wide spectrum of entrepreneurs is made available.
v) Greater control is experienced by the entrepreneurs due to diluted equity.
vi) Support from a collaborative network of people with varying experience and skill levels.
Though the benefits of crowdfunding do seem attractive, using it as a long term funding option is not considered to be the wisest move. Crowdfunding could also give you false assumptions. This is because a success with a particular group of crowdfunders does not mean that your product will have a wider market. Moreover, this model is considered to be still immature in many aspects and its long term effects are yet to be explored.
While crowdfunding has undoubtedly raised eyes in the recent times, venture capital investing remains to the most well-known and favored capital for a startup. Venture capital is the funding provided by a well-established corporate to startups that are deemed to have a high potential for success. The history of venture capital dates long back to the 1940s. As an exchange for cash and strategic advice, a financial investor provides the capital required for a private startup. Hence, venture capitalists obviously look for those companies that will ensure high returns for their investment. They expect higher than market return values for the investment they make due to the high degree of risk involved. Venture Capital usually invests in the expansion stage or the early stages of the company.
The startups on the other hand have quite a few expectations like value added investors, access to experts, portfolio benefits, productive board members follow on capital, long term support and media exposure. While venture capital investing may not be able to provide all of these, they certainly have an edge over the crowdfunding model by providing an access to a larger pool of capital. VCs with their magic touch have been known for many success stories like Google and Facebook. Some advantages of VCs are
i) Additional capital for follow –on investment
ii) More focus on building the company rather than fundraising
iii) Access provided by VC to use Networks for employees or clients,
iv) Experience and expert knowledge
Having enumerated the best sides of VCs, it is time to alert you of the dangers of solely depending upon VC investments. Some cons of taking VC early are listed down.
i) Over estimation of company value leading to future problems.
ii) Stringent policies and timeframe
iii) Entrepreneurs getting pushed to backseats.
VCs demand the highest amount of equity and may become a part of the company’s management also.