BUSINESS CAPITAL BASICS: FUNDRAISING SOURCES FOR STARTUPS AND SMALL BUSINESSES, PART 2
June 11, 2014
By Jeff Wolfe
I enjoy working with Forrest Firm clients as they explore the world of raising capital for their startup and new growth-phase businesses. Recently, I had the pleasure of appearing with our friend, Lea Strickland, on her Focus on Business radio show to discuss this subject.
To further educate our clients, prospects, and friends of the firm, I launched a blog series last month. We began the series talking about types of funding, ranging from equity financing and debt financing to the brave new world of crowdfunding. This week, let’s talk about some different sources of funding that make themselves available to startups and companies entering new periods of growth.
Friends and Family
Perhaps it should go without saying, but in the spirit of thoroughness, we should first mention the primary source of investment for many startup businesses, the network of friends and families of the owners involved. While many business owners find it difficult to mix business transactions with their personal relationships, others find it easier to reach out to people they know and love to help them fund a new idea or help with a needed injection for growth. Investments from friends and family are often informal, with simple agreements outlining repayment terms or equity stakes.
While many investments from friends and family can be quite small, ranging in hundreds or thousands of dollars, many of these people fall into a wealthy class of investor called angel investors, which are discussed below.
Angel investors are typically affluent individuals—sometimes family members, friends, or acquaintances of the owners—who typically enjoy investing in their belief in the owners. They typically offer more favorable terms that other types of investors, like venture capitalists, since they are sympathetic to the business and its owners. Angel investors often provide a capital injection and later seek to convert their investment into future debt or equity offerings.
A more recent phenomenon we’ve observed is the formation of angel groups. In angel groups, these wealthy investors share their research and educate their peers on investment opportunities with startups and growing companies they know well. Another hallmark of angel investors is that they typically draw on their own business success to offer key management advice to the companies where they invest.
Venture capital firms pool money from a variety of sources—institutional investors, rosters of wealthy individuals, and investment banks—and then fund high-risk startups with high reward potential Funding a business through venture capital can be particularly necessary when a company has larger funding needs coupled with a limited operating history. Venture capital firms play a key role in funding many of the technology and life sciences startups here in the Triangle area—companies with big ideas where capital investment is much needed for building technology infrastructure, high-cost labs, and often long-term research and development prior to launching products into the market.
While venture capitalists play a critical role in the formation and sustainability of companies in multiple sectors, they often demand a large equity stake and also install their own managers within the funded company’s leadership structure. Due to the high-risk nature of their investments, often in hundreds of thousands, if not millions of dollars, many venture capital firms want some greater control over the operation of the company and execution of its business plan.
As we continue to explore raising capital for startups and small businesses in the coming months, we will next take a look at some of the legal considerations companies must entertain as they contemplate fundraising.