Nikhil Arora and Alejandro Velez needed a van and some buckets.
Unlike software entrepreneurs, who might be able to get going with nothing more than a laptop and enough coffee money to use Starbucks wi-fi all day, the UC Berkeley students had an idea involving a physical product: homegrown mushrooms.
They got the growing medium — used coffee grounds — for free. But they still needed some money for space to grow their product and a vehicle to deliver it to grocery stores.
Fortunately, they won a couple of grants, which, supplemented by the savings from their summer internships, got them through until revenue began mushrooming.
How will you pay your business’s expenses before it turns a profit?
Even tech startups will eventually need computers, employees and and office space, so all startup founders have to figure out where to get funding at some point. Each funding source has its advantages and drawbacks:
Self-funding, aka Bootstrapping
Whether it’s by tapping savings, maxing out credit cards or by earning a side income as a consultant, most entrepreneurs self-fund their ventures at first.
Plus: As startup adviser Martin Zwilling puts it, bootstrapping is simply “more fun,” because you have total freedom and don’t have to give up a stake in your company.
Minus: You’re limited by your own bank account or credit limit, which could stop you from growing as fast as you need to. One way around that limitation, Zwilling suggests, is paying early employees with equity stakes.
Family And Friends
Turning to family and friends for cash is part of many a company’s early days. John Mackey and partner Renee Lawson (Hardy) borrowed $45,000 from family and friends to open his first natural foods store, according to Whole Foods Market’s official corporate history.
Plus: It can be easier to sell your mom on your idea than a jaded venture capitalist.
Minus: A lost investment could strain family ties. The Small Business Administration recommends that you minimize the opportunity for hurt feelings and misunderstandings by putting clear terms in writing.
Fundraising sites such as Indiegogo and Kickstarter, where anyone with a computer and idea can set up a campaign to fund a product idea, have rocked the startup scene like a hurricane. And now that it’s legal to solicit true investments through crowdfunding, giving participants an equity stake instead of just a product or perk, crowd-investing may be about go to the next level.
Plus: A good crowdfunding campaign is also a public relations strategy. With luck, participants will share your campaign on social media, raising your startup’s profile. You can also use the crowdfunding process to get feedback from consumers on what they would like to see in a product.
Minus: There’s a low bar for setting up a crowdfunding campaign, which means that there are already zillions of them for donors or investors to choose from. How will your startup stand out from that one dude’s campaign to make potato salad or the quest to produce an all-pug version of Hamlet?
You’re also committing to a very public process when you set up a campaign for an early company. What update will you post when your prototype bursts into flames or your co-founder gets arrested for solicitation? Just as today’s teens can suffer from broadcasting their youthful mistakes on social media, there are disadvantages to letting your startup grows up in public on a crowdfunding site.
Especially if your new business will benefit your community, the environment or society as a whole, or if you fit into an underrepresented demographic, you may be able to apply for a grant from the government, a non-profit agency or another organization.
Plus: Winning a grant is a feather in your cap that may include promotional opportunities such as press releases and events. For Arora and Velez, the first $5,000 they won in a entrepreneurship competition put them on the path to turning their company, now called Back to the Roots, into an ever-expanding brand with mushroom growing kits, aquaponics sets and packaged food.
“That grant was about more than the cash — it was validation that there was something in this idea, and it was the start of building a community that could help us bring this to life,” Arora said.
Minus: Filling in applications or entering business plan competitions is arduous — by design: If it were easy to apply, the organizers would have to wade through millions of applications from people who aren’t serious about starting a business.
You could hire a grant writer or grant broker to help you, but keep in mind that if you aren’t awarded the grant, you still have to pay them.
You can approach the Small Business Administration, a local development agency or your bank or credit union for a loan. You’ll need a business plan, financial statements and other detailed information about your business, and a clear vision for how you’ll use the money.
Plus: You don’t have to give up control or a stake to investors.
Minus: Finding a willing lender with terms you can deal with may be time-consuming; it’s not uncommon for small businesses to approach 10 or more banks. And you’ll be adding interest payments to your new company’s other expenses.
Plus: Because anyone who makes $200,000 a year or has $1 million in assets can qualify to become an angel, you may have an easier time finding one than getting an appointment with a venture capital firm. And your angel may encourage their friends to join them; web sites such as Ravikant’s AngelList formalize this effect.
Minus: The same quality that makes angels attractive — the fact that anyone can be one — is also a disadvantage. It’s up to you to determine whether your angel is qualified to hand out the guidance he may feel entitled to dispense. On the other hand, with only a small investment on the line, an angel with operational experience might not want to commit the time to give you the guidance you’d like.
Accelerators go beyond funding to nurture early-stage companies with resources such as office space, classes and a network of contacts. Startups usually stay in an accelerator for a set time period before “graduating.”
Plus: Like the kids in your freshman dorm, your accelerator classmates will be your peers for the life of your business. Make School cofounder Ashu Desai lauds the benefits of being able to turn to his Y Combinator classmates years after he and cofounder Jeremy Rossmann completed the accelerator program, for everything from partnerships to finding new office space.
Minus: “[N]ot all accelerators are created equal. Just like with a college, your personal and professional brand will always be associated with that particular accelerator, so choose wisely,” warns former entrepreneur and Flybridge Capital general partner Jeff Bussgang in a blog post.
Despite the public perception that pitching a VC firm happens right after you dream up your big idea, VC money is increasingly going to more mature companies. Of the $128.6 billion venture capitalists invested in 2015, less than a third went to early-stage companies, according CB Insights.
Plus: In addition to cash, a good venture capital firm will provide advice, guidance and introductions to other powerful people in your industry.
Minus: It’s really hard to get — in fact, venture capital makes up less than 1 percent of startup funding, according to the Kauffman Foundation. And those pitch sessions can be ego-crushing.
Plus, your VC may not deliver everything you expect. Kauffman senior fellow Diane Mulcahy, a former VC herself, points to the idea that all VCs will be there for you as one of the great myths of venture capital.
“Founders who want more than capital from their investors should conduct a thorough due diligence on a VC firm,” Kauffman offered in the Harvard Business Review.
For instance, you’ll need to know if the investors have strong operational experience, or if they can they connect you with those who do. Feedback from other founders who were funded by the firm would be valuable.