Oftentimes, people confuse startups with small businesses. However, there is one important aspect to remember when differentiating the two: startups aim to bring significant change to the world we live in. They are constructed with one main idea in mind: to become big and impactful.
For our startup to get there, there are a few challenges we need to overcome. The first, and maybe the most important, is understanding how funding works. Following that, we need to understand what type of investors are there and what’s the difference between them, especially between angel investors and venture capital funds (VCs), since these two are the main sources of funding for accelerated growth.
With that said, before getting into the specifics of funding, we must focus our attention on a few facts worth knowing prior to diving into that topic.
Helping investors help us
As the old saying goes, “the best way to get what we want is to help others get what they want”. Angel investors and VCs are in it for the money they make, when the value of the startup grows and they sell their shares.
Statistics show around 80% of investments in startups end in loss, regardless of how experienced the investors and the startup founders may be. In order to mitigate the risks, investors do a few things:
- They only fund startups that look capable of generating 10x the return on investment.
Four out of five startups would generate zero returns, so the successful ones need to cover these losses. Aiming just for 5x would mean the investors would still lose money on their total portfolio.
Therefore, investors aim for startups that look capable of generating 10x the returns. We should apply for funding only after developing our business model to make such returns possible.
- Funding happens in stages or rounds.
We get to the next round of funding only after we have reached certain milestones. It is important to realize that these milestones have more to do with increasing the value of the startup than with achieving some technical results.
Investors are there to witness the growth in value. Technology is only relevant in so much as it helps achieve that. Improving the technical quality of the solution must result in the growth of sales, the number of users, or the lifetime value of a customer, just to name some of the more important metrics to keep track of.
- VCs tend to specialize in certain stages, meaning they know how to best help startups at certain levels of maturity.
As the need for financing grows, new VCs must be brought in. Being able to successfully convince them to invest depends a lot on the quality of assistance received from the existing investors. Therefore, it is crucial for a startup to choose the first investors wisely, to help keep the startup on track to achieving those 10x returns.
Most entrepreneurs are tech-savvy. That means that from their perspectives, superior technology would make customers come knocking at their doors. If we want funds from investors, we need to come up with a plan to reach the 10x return threshold other than by relying on popularity. Obviously, it’s always an advantage to pursue projects that are in the social limelight, for all the right reasons. However, simply going for a popular project, without much to back it up, won’t get you very far in an entrepreneur’s eyes.
That is where a good accelerator comes into play – to help guide you through all the hoops that you have to jump, in order to make the cut.
While the startup is accelerated, a major part of the mentoring process focuses on improving the business model and tweaking the technical solution to support the business plan.
A good acceleration program has mentors that boast a significant amount of business experience in the sectors that the startup is targeting. They know what it takes for a solution to be successful & popular, and they know what kind of sales effort it takes to get things going with your customers.
Once you’ve taken into account all of these pre-funding aspects, we can focus on the financial part of the process, which will be covered in our next article.