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The relationship between venture capitalists and startups is well-known throughout society. In fact, it is the source of much debate, controversy and comedy, from the battle between politicians and venture capitalists when Silicon Valley Bank collapsed to the satirical representation of the relationship on the hit TV show Silicon Valley.
Many first-time startup founders and people outside the startup ecosystem don’t recognize that venture capitalists aren’t the primary source of funding at the early stages of a startup. Today, we will explore the alternative funding sources that most early-stage startups turn to and discuss the pros, cons and risks of seeking capital from each source.
Related: You Can’t Get VC Funding for Your Startup. Now, What?
1. Accelerators and incubators
Accelerators and incubators are organizations that provide a mix of resources and cash in exchange for equity in a startup.
Pro: For first-time founders, mentorship and advice from accelerators and incubators can help avoid many common pitfalls. These organizations work with dozens to thousands of startups per year, so they are experts at helping early-stage companies. Another significant benefit for all founders is the network effects of an accelerator or incubator. YCombinator is the most famous accelerator; its network allows participants access to many of Silicon Valley’s most influential companies, people and investors.
Con: Accelerators and Incubators often provide lower valuations for a startup than other investors. This means you receive less money and give away more equity than if you pursue other investors.
Risk: The most significant risk with an accelerator is failing to properly value the non-monetary benefits of mentorship, advice and networking. If you undervalue these benefits, you might turn away an accelerator that could have propelled your growth. If you overvalue them, then you’ll accept a deal that undervalued your company.
Related: How To Choose the Right Funding Model for Your Startup
2. Angel investors
Angel investors are individuals who provide capital to startups.
Pro: Many angel investors have expertise in some area, whether design, product development, law, accounting, etc. This means they can provide crucial advice and insights that you might otherwise have needed to pay significant amounts for in addition to capital.
Con: Angel investors often write small checks; if you raise a significant amount of money and angel investors fill the round, you may end up with dozens of individual investors in your company. Each investor will require your attention as you grow the company, potentially distracting you from your day-to-day obligations.
Risk: There are two primary risks with angel investors. First is an angel investor who promises to provide expertise but fails to do so. Second is an angel investor who is too hands-on and consistently interferes with your management team.
3. Syndicates
Syndicates are groups of angel investors who invest together in a group.
Pro: Syndicates can provide significant network effects. The investors in these groups are generally successful in their fields and can provide unique and specialized insights.
Con: Syndicates can be slow to invest. Once a syndicate lead decides they want to invest in you, they need to present the deal to their syndicate, determine how much they want to invest, create a special purpose vehicle, collect the funds, and then invest. This depends on the syndicate, but I’ve seen these deals take so long that founders give up after 6-9 months and look for alternative funding.
Risk: Syndicate leads tend to be people with high social capital. This gives them a level of authority and power within your company that can become counterproductive if your vision doesn’t align with theirs.
4. Family and friends
People with whom you have a personal connection.
Pro: They will invest in you and not your idea. That means you can get capital before you’ve proven that the business works.
Con: They are investing in you. You have a personal relationship with these investors. You are putting your own personal relationships at risk based on the performance of the business.
Risk: Many family and friend’s investments are not properly documented. This can create issues around ownership when you go to raise further rounds.
5. Crowdfunding
Raising from the general public online.
Pro: You can raise directly from your customers. Crowdfunding works best when your future customers are willing to invest in your company to help you build the solution to their problem.
Con: Before you can raise a crowdfunding round, you’ll need to go through the process of being accepted by a crowdfunding platform and registering your raise with the SEC. These legal and financial filings can be expensive, and most platforms charge a fee of around 7% of the total funds raised.
Risk: The most obvious risk is failing to hit your target. In this circumstance, not only will you lose the money invested to begin the crowdfunding process, but you’ll also have an online record of the company’s past failure, potentially impacting your future ability to grow or raise funds for the company.
6. VC Scouts
VC Scouts are individuals given funds by venture capitalists to invest in early-stage companies.
Pro: You will receive investment from someone well-connected to funds that could provide funding in future rounds.
Con: The person providing you funding is not investing their own money. This means their thesis and risk/reward proposition will likely differ from most other investors. They are potentially misleading you as to the viability of your idea.
Risk: If you don’t receive follow-on funding from the VC associated with the VC Scout, this will be a major red flag for all other investors and make raising any future funds very difficult.