startup-costs, funding, investmentSoftware startup that requires 2 phase investment. Phase 1 covers the cost of developing the product and making it ready for market. This will take roughly 1 year or less. Phase 2 involves investing into the infrastructure to operate the software (as it is SaaS). Phase 2 only takes place once the product is ready and clients express interest to purchase. If no one actually wants to purchase it, Phase 2 doesn’t take place - making things not as risky, as Phase 1 is relatively low investment in the grand scheme of things.
I’m not overly keen on giving up equity during phase 1, as this will limit the available equity during phase 2, where it is more critical. I’m also not overly keen on losing control of the company during the earlier months, as this time is rather critical.
I’m trying to find alternate ways of raising the required funds and I had an idea that I wanted to get an opinion on.
The current market competitor (of which there is only 1 significant player, who currently has a monopoly), charges for example £50k per year on this software solution. There is very little love to this developer and the product from the clients point of view - they will easily jump ship if something significantly better comes along (here is the market opening for us).
Would it be possible to approach a couple of these clients, asking them to fund phase 1, like a early bird sort of product purchase - much like Kickstarter, where you get a reward. We could then offer the product for free for a number of years, therefor giving them savings from licensing costs. We could also return their money once the product enters the market - perhaps even double their investment. Regardless of the actual rewards, all of this would be done without giving up equity.
Is this even a possibility?
I think it is a good idea to look after your equity share, however, I’d reconsider your thinking with regard to ‘giving up equity’ at phase 1.
Do not see it as ‘giving up equity’ but instead see it as bringing on board people with vested interests in your success - supporters with something reason to back you, to question you and make sure that choices being made are sound business practice.
Investment can be a solid marker of validation for your potential clients - that you have financial backing and that switching across to your product will be less of a risk as you stand a chance of being around longer so they wont have to switch back.
I am not actually advising you to take investment - (I’m currently avoiding investment myself in my current start up) I’m just hoping to give a different point of view on what is gained from investment to allow you to rethink.
With regard to asking clients to fund the building of phase 1 I would be surprised that any would be willing to go for it. If they are paying £50k per year, even for a service that they hate, getting them to pay for the creation of something without them having an equity stake in it will be a hard sell. But I’d be delighted to be proven wrong.
If you are pre-phase 1 then it may be worth you looking at an accelerator to help you fund and work through the building of phase 1. you used £ so I’ll assume you are in the UK? Look up Ignite accelerator. They are mentor driven. If accepted on, will give seed funding for a small equitable stake. They have programs in London and Manchester at the moment (previously Newcastle) and the idea will be thoroughly tested.
Full disclosure: I have previously gone through the ignite accelerator myself and although I know the programme directors have no stake in it. I have simply had extrenely positive expereinces going through it.
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As a StartUp you may not find it easy to attract investors towards your idea till you are able to show them value in their investments. This is where you may need to self-fund or bootstrap your business. Here you and your co-founders usually invest your own savings to fund the early stages of your business. This may go towards registering a website, getting a logo designed, having a working prototype or an MVP (Minimum Viable Product) and other legal and administrative costs required for registering your business and meeting industry specific compliances. You can also invite your friends and family to invest in your business. Many StartUps’ prefer this route as there is less of paperwork, compliance clauses and at the same time allows you to raise the funds faster at a later stage. Also there are less takers at this stage, so best route is to take it forward on your own shoulders.
While you would definitely like to knock your local bank or financial institution to raise capital for your business it isn’t always easy for young StartUps’ especially those that promise to offer virtual services with no serious physical asset or infrastructure to raise a large sum of loan. Banks and other financial institutions often value a business based on its financial track record rather than on the idea itself and hence for most StartUps’ traditional banks aren’t the most preferred option for funding. However a small loan can come handy in the initial days of a business, provided you have the collateral the conventional Banking institutes require you to fulfil.
This is another preferred route that entrepreneurs take in the initial days of their StartUp. Also referred to as seed money or seed capital it comes from an investor, often a friend or a person known to you, in exchange for equity stake in your business. Here your business would need to be incorporated and the investor would hold ownership over a percentage equity of your company. Seed funding also helps in determining initial valuation of the business. For instance if the investor buys 20% of your company for 600k the total valuation of your StartUp stands at 3 million. Seed funding usually goes into further development of product from an MVP to a regular product, marketing or Go-To market expenses, expanding the team and operational expenses of a StartUp. After Seed Funding round, the StartUp is expected to have a healthy traction and revenue flow.
After the StartUp idea is well accepted in the market and your business is showing a growth trajectory you would need to raise further capital to expand the user base as well as multiply your revenue to make it heathy. At this stage the StartUp many times isn’t making profits but promises a good returns in the future. The StartUp would undertake a bigger round of funding termed as Series Round of funding. Here you would sell stake in your company to either Angel Investors or Venture Capitalists aka VCs. Angel Investors are usually entrepreneurs who have made money with their idea and look for exciting ideas to harness better profits and make a good fortune with their investment. While VCs represent venture capital firms that raise funds from various sources to invest in StartUps’ for strong profits in the future. Angel Investors and VCs are also known as Private Equity firm and they have various investment strategies including leveraged buyout, venture capital investment, and growth capital depending on the StartUps’ growth strategy and fund requirements. Series Rounds of Funding
The Series Rounds comprise of multiple Funding Rounds but are clubbed together as at this stage the Fund raising is of higher amounts and which involves very mature StartUps’ those that have very high traction and/or already revenue positive. There are multiple Series Rounds categorized as A, B and C. The main differences between these rounds is the maturity levels of the StartUp. The Series rounds are the stepping stones for turning an idea into company that’s widespread, having positive net worth and very high traction. Post Series Rounds, the only option is to go for an IPO (Initial Public Offering). The various Series Funding Rounds are further explained as:
The Series A round, usually goes into expanding your business, running a comprehensive marketing campaigning and also being aggressive with the pricing. Here you need to keep in mind two important things – Pre-Money Valuation which is what your company is valued at which is 3 million (as per the Seed Funding example) and the Post Money valuation which is Pre-Money valuation plus what you raise from the investors. Let’s assume you are able to get a funding 1 million through Series A Funding your valuation would now stand at 4 million.
The stakes for the investors would be determined by dividing the pre-money valuation by the post-money valuation, thus converting the ownership of the new investors would be would be roughly 25% of your company (3 million / 4 million). So now you would own around 60% of the company while your seed investor holds 15% of the company. Here equity shares would have to be issued using dilution where you hold onto the same number of shares as previously with an increased value on every share you hold. For instance if you had 80,000 shares and your seed investor had 20,000 shares, which together would add up to 75% of the company. After the Series A round the total number of shares would stand at 133,333 and hence 33,333 shares would be issued to the new investors while the Investor and founder/co-founder or other original owners would still be holding 20,000 & 80,000 shares respectively. It is important for you to make sure that you strike gold with Series A as this will determine the success of your further investment rounds.
Now that your business has shown some steam and yet you need to raise further capital for furthering your plans you would have to go through the next round of capital raise which is known as Series B funding. This is often considered to be the toughest one as most likely your business is yet to show profits although you are fast expanding and have reached very very high traction. The ideal scenario for you would be to raise more money compared to the previous round. As we have seen above your share in the company along with all the other shareholders would be further diluted but financially it would improve your position. Ideally you are likely to own around 40% of stakes in the company and rest of the existing investors would see dilution of stakes on similar lines. But unlike Series A here stocks are usually split to accommodate new partners and hence you may hold 160,000 or 240,000 shares in place of 80,000 you had held earlier depending on the value of split.
This is usually the last round of funding that you would be generating from though there are some companies that would take their capital raising spree to a next round. Series C Funding is often easier than Series B as by now you would have been generating good revenue and your idea seems to have the potential to upset some established players in the market. But to fuel this you need lots of capital which would come from big investors. Like Series B stocks would further split of stocks and hence the number of stocks would further increase. In most cases your ownership of the company would also come down to about 30% to accommodate stakes for the new investors but yet you are expected to still remain the biggest stake holder in the company.
It’s possible you don’t need funding, what you might also like to consider is bringing on a co-founder with excellent software development skills.
Software development goes through cycles and it’s highly likely the first version will not solve all the customers problem, thus will need further development.
If you bring on a co-founder they can build the software essentially for free, yes you will have to give up equity but the product should be far better which means more of your contacts will convert, the equity loss will be regained by a more successful product and you should end up more successful overall.
As Kev mentioned it’s likely your clients will not want to pay for something that doesn’t exist yet, however if you do raise funds for development you then have to find a software company that wants the project, if that company doesn’t deliver everything required before the funds run dry you will have no funds, no product and clients that don’t trust you.
If the co-founder doesn’t deliver you start again with a different co-founder and you don’t have to rely on the client for funding.
I saw your other question and was thinking instead of giving up 70% for 150k give up 50% for a finished product.
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