Chapter 1: Where can Startups find money?
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It’s no secret that fundraising is a daunting challenge. In a study of over 110 failed startups, funding-related issues were the number one reason (38% of failures) startups failed (Source: CB insights). Many entrepreneurs are mystified by the fundraising process, asking themselves, for example, How much should we raise?, Where do we look for money?, or What is our valuation?
In this blog series for entrepreneurs, we go back to the basics to demystify the fundraising process.
We start with the first question entrepreneurs often have when they want to raise capital: what sort of funding is there for startups?
Types of funding
We’ve identified 5 main types of funding for startups, and their respective advantages and disadvantages.
Table 1: Types of funding
Grants/Subsidies |
Bootstrapping |
Financial Debt |
Convertible Loan |
Equity |
|
|---|---|---|---|---|---|
Definition |
Funding given by a state-backed entity or other organisations to help young companies grow. |
Cash flow generated by the company, through core or non-core activities (e.g. consultancy) to finance its own development. |
Borrowing from a financial institution. |
A short-term debt potentially (can be optional) converted into equity depending on valuation achieved (usually at a discount vs future valuation). |
Money invested by an external investor in exchange for shares or ownership of the company. |
Advantages |
No need to reimburse. Limited risk. Founders keep full ownership and control of the company (non-dilutive). |
Encourages rigorous resource control. Founders keep full ownership and control of the company (non-dilutive). |
Founders keep full ownership and control of the company (non-dilutive). |
Shorter process, no extensive discussion on valuation yet. Usually from existing investors/state-backed funds Usually provided as bridge financing in the run up to a next funding round. Considered as quasi-equity instead of debt before converting. |
No need to reimburse. New investors can bring in advice, expertise and network. |
Disadvantages |
Time-consuming process. Very rigid eligibility and application requirements. Availability often depends heavily on the political and economic climate. |
Usually not sufficient to support fast growth. In case cash flow is coming from non-core activities, the company might lack focus. Risk of being overtaken by competitors in speed. |
Debt–capital ratio is a metric that can be used in procurement processes, subsidies, etc. Banks are usually reluctant to loan money to startups to fund the overall business (specific assets such as machinery or buildings are easier to finance with debt). High interest rates to balance the high risk taken. |
Dilutive instrument when converted to equity. If terms of convertible are too favourable, this can become a deal-breaker for a new investor. |
Relatively long process. It can be difficult to attract the right investors. Founders do not keep full ownership and control of the company (dilutive). |
Examples |
Regional, national or European subsidies supporting employment, innovation, etc. |
Providing consultancy services to reinvest incoming cash flows in the development of a new software. |
A bank loan for a building or car, a straight loan for working capital financing. |
PMV convertible loans granted during Covid-19 crisis. |
Series A, B or C venture capital investment in a tech company. |
As described above, there are pros and cons to each type of funding. The big question is, how do you know which type of funding is right for you? There’s no right or wrong choice, because most successful entrepreneurs determine the optimal source of funding taking into account a variety of factors such as their growth stage, environment, company goals, etc. For example, it’s not unusual for medical device startups to rely significantly on grants/subsidies earlier in their life cycle because of large investments in product development. On the other hand, a lot of SaaS companies look at equity investors quite early on to fund their growth. As from a certain stage, the main funding source for startups usually tends to be equity (Figure 1).
Figure 1: Distribution of startup investment in Europe
Let’s zoom in on equity financing.
Different types of equity investors
We’ve identified 7 types of investors that can provide startups with the equity financing they need.
Figure 2: Types of investor
While different types of investors are available to startups, this article focuses on the main ones — business angels (BA), venture capital funds (VC) (i.e. seed, early and late stage) and corporate venture capital funds (CVC) — because they make up a significant portion (98%) of the entire range of venture capital investments in Europe (Figure 3).
Figure 3: Distribution of venture capital investment in Europe
Business angels are individuals with a high net worth, willing to invest their own money in startups. Often, they are themselves successful entrepreneurs and want to help young companies by investing in early-stage startups.
In addition to their investments, they bring relevant network, strategy and experience, especially when they have successfully created companies in the same industry as yours. However, it’s important to choose your business angel carefully in order to stay in the driver’s seat. A business angel should always be there for advice rather than decision making.
Gut feeling and fit are usually key investment considerations for a business angel. They usually require a 10%–20% stake when investing in your business.
Click on the other tabs to read more about venture capital and corporate venture capital.
VC funds are usually the main source of capital for startup investments (Figure 3). They can have a specific focus (e.g. geography, industry, etc.) and usually have a specific investment ticket size (e.g. series A, B, C, etc.). VCs invest funds received from their investors (also known as limited partners), and therefore have a structured and more thorough investment process than business angels.
Having a VC fund invest in your company can be a game changer, as they typically invest sufficient funds in a round to keep you going for another 12–18 months, help you raise money in the future, and bring additional industry experience to your company. You can also leverage their other portfolio companies and broader network to find commercial opportunities. As a business owner, however, it’s important to keep in mind that most VC funds have a limited investment horizon (7–10 years max.) and have a strong focus on financial metrics and growth.
From a VC fund perspective, management, market, competitive advantage and product are usually key investment considerations. They usually require a 15–30% stake when investing in your business. However, keep in mind that companies go through several VC funding rounds, which will further impact dilution: according to Crunchbase the median and average level of VC ownership at exit is 50% (Source: Crunchbase).
VC funds usually invest together with other funds to reduce their risk. When investing together with other VCs, usually one fund takes the lead (i.e. the lead investor) in negotiations and due diligence.
Distinctions between BAs, VCs and CVCs are summarised in the table below.
Large corporations have realised they need to innovate if they want to stay competitive, but they are often constrained by the complexities of their organisational structures or the cost of developing innovation. However, they can invest directly in startups or via a dedicated investment vehicle known as a corporate venture capital fund. CVCs usually have a much longer investment horizon in mind, and can focus on both strategic (i.e. acquiring a technology that they believe will change the future) and financial returns. Their investment process can be relatively long, depending on the decision-making process for startup investments.
Investments from a CVC can help a startup accelerate its growth, as they bring significant operational and market knowledge, as well as a network of partners across the world.
If you intend to choose a CVC as an investor, there are some key questions to consider, such as: what happens to co-created IP if there’s a break-up? What are the implications if you try to sell your product to their competitors? These and similar issues should be addressed at the start of the relationship, usually with the help of good lawyers. CVCs usually require a 15–50% stake when investing in your company.
Distinctions between BAs, VCs and CVCs are summarised in the table below.
Table 2: Comparison BA / VC / CVC
Business angle |
VC |
CVC |
|
|---|---|---|---|
Fundraising process |
Short (1–3 months) |
Long (4–9 months) |
Long (4–9 months) |
Due diligence |
Minimal |
Extensive |
Extensive |
Money invested |
Own money |
Limited partners’ money |
Corporate money |
Stage of investment |
Pre-seed, seed |
Seed, series A, B, C, D |
Seed, series A, B, C, D |
Reason to invest |
Financial return and being part of a growth journey |
Financial return |
Financial and strategic return |
Investment capacity |
€10k–€1m |
€500k–€50m+ |
€500k–€50m+ |
Involvement |
High involvement in daily operations |
High involvement in strategic decisions. Can open up a network. |
Involvement can range from none to co-developing, joint selling, … |
PwC Pro Tip
- Don’t raise too much (as your valuation will be higher in the future, and thus equity money less expensive), but make sure to foresee a buffer to get through at least 12–18 months without worrying about financing again.
- Make cash efficiency and frugality part of your company culture.
- Try to get all the subsidies possible to save cash.
Want to know more about subsidies for your company? At PwC Belgium, we’ve developed a tool that allows you to find and manage government incentives in a few clicks. Follow the link to learn more.
In our next post, we’ll discuss how VC funds are structured.
For more information on how PwC can support you in your fundraising, and how we support startups and scaleups, visit our website.
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How are VC funds organised
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