Friends and Family – When a company and its founder have exhausted the usual means of generating early financing (that is, maxing out the founder’s credit card and living on a ramen-heavy diet), the company may reach out to the founder’s friends and family. Friends and family have a close personal relationship with the founder and will be motivated by their respect for the founder and his or her passion for the business. Financing via friends and family is usually accomplished through the sale of common stock.
Crowdfunding – Kickstarter, Indiegogo, and similar online platforms allow entrepreneurs to communicate their vision to the public in an effort to solicit monetary contributions to the company. Typical crowdfunding campaigns involve a perk to the donors and raise approximately $7,000, although there are noteworthy instances of companies raising many thousands or even millions of dollars. Certain types of business that resonate with the public (or a committed market niche) are more likely to raise meaningful capital through crowdfunding.
Angel Networks – Angel networks are confederations of well-heeled individuals who come together to consider making syndicated investments in companies. These networks can be as informal as social circles of interconnected rolodexes, or as formal as organizations with branded websites and formal evaluation and investment processes.
Scientific Research Grants – The federal government and some states have grant programs that provide non-dilutive capital to finance private company research. Two popular federal programs are the Small Business Innovation Research (SBIR) Program and Small Business Technology Transfer (SBTT) Program. These competitive programs operate through numerous federal agencies to allow the federal government to fund its technology research and development priorities through grants to small businesses.
Economic Development Programs – Some state and municipal governments sponsor economic development-oriented programs that invest in businesses domiciled within their jurisdiction. Because the primary goal of these programs is economic development and job creation, program investors focus on different aspects of a company’s business as compared to angel networks, venture capital funds, and strategic investors. Governmental economic development programs will typically avoid setting a valuation for a company and will therefore tend to invest in convertible notes or in equity as non-lead participants in a syndicate of investors.
Venture Capital Funds – Venture capital funds are sophisticated institutional investors with the ability to make multi-million dollar investments and with the resources to provide support for follow-on investment rounds. Often the lead venture capital fund will seek to syndicate the investment with other venture capital funds. Many venture funds have industry expertise and can bring value to a company’s board. Venture funds typically invest in preferred stock and usually insist on a corporate structure so as to avoid complications resulting from the pass-through tax treatment of limited liability companies.
Strategic Investors – Strategic investors are companies that operate in the same market as, or an adjacent market to, your company. In order for a strategic investor to invest, there must usually be a champion within the operational side of that company’s business. Frequently, a strategic investor will expect to establish a commercial relationship with your company at the same time as it makes its investment. Most strategic investors will not want a seat on the board due to complications arising from a director’s fiduciary duties, but they will be interested in information rights.
Venture Debt – Venture debt is a form of debt financing provided to venture equity-backed companies that lack the assets or cash flow for traditional debt financing, or that desire greater flexibility. Typical venture debt is structured as a term loan that amortizes (pays-down) over time and that includes warrants (purchase rights) for company stock. This debt is generally senior debt (repaid first in an exit or bankruptcy) and is collateralized by a company’s assets and/or intellectual property, or by specific equipment. Venture debt is a complement to equity financing; it is “risk capital” that is less costly than equity when structured appropriately.
Commercial Banks – Commercial banks may offer working capital lines, or revolving lines of credit secured by working capital, to start-ups satisfying certain requirements. Principal repayment of working capital lines may increase or decrease over the life of the loan based on the value of secured assets. Further, companies entering into these types of loans are often bound to expansive default clauses (generally, any “material adverse change”) and financial covenants (including an established minimum of cash, accounts receivable, performance v. plan, etc.) which serve to mitigate risk to the bank.