As a founder of a brand new startup, you’ll be dealing with
various hurdles, from developing a business plan to building a
team, to attracting customers and so on. However, one major
challenge that stands out among the rest is raising funds.
From entrepreneurs who succeed in starting up their own
business to a financial institution, your choice of investor
has far-reaching consequences for the capital, guidance, and
direction you can expect from each funding round.
So in order to help you understand the pros and cons of
funding your first startup, it’s time to separate out the
incubators from the accelerator, and the VCs from the angels.
The right type of investor for your startup
Founders seeking to raise money mainly focus on the largest
and richest sources of funding. But there are actually various
kinds of seed investors, each with their own set of pros and
cons. While there are tons of different definitions out there,
we’ve distilled seed investors into basic categories.
Incubators/Accelerators
An incubator supports new venture while it’s still in its idea
stage, providing access to the infrastructure and environment
required for developing a Minimum Viable Product (MVP).
Without any offers of funding and no expectation of equity in
return, proven performance isn’t a prerequisite, with
incubators collaborating with their participants for anywhere
from a few months to years on end.
On the other hand, accelerators are a fast-track towards
further funding. They offer the chance for capital in exchange
for equity of your startup, and for a period of several
months, provide a crash-course growth and fundraising made to
accelerate your existing growth. Once you’ve graduated, an
accelerator’s alumni are expected to have honed their
performance metrics and pitch, and be prepared to raise a
complete seed round.
Pros of Incubators/Accelerators
Mentorship: The best incubators will normally
provide advice and guidance from some of the most experienced
startup minds around.
Access to investments: Accelerators will
offer a direct and reliable path to investment, with many
backed by either VCs, angels and experienced founders.
Credibility: Being accepted into Y Combinator
or 500 Startups latest batch is guaranteed to boost the
visibility of your startup.
Cons of Incubators/Accelerators
Immensely over-subscribed: The best
incubators and accelerators will be highly popular, both
TechStars and Y Combinator have been known to only accept 1 to
2% of applicants.
Quality: With the popular known incubators
and accelerators being oversubscribed, newer incubators and
accelerators will become available to join. While some of
these places do offer some pretty good value guidance and
support, others may offer a fast-track to startup death bed.
Expensive: Equity is a very expensive
commodity to hand over for a minimal amount of capital.
How much capital does the business need to reach the exit?
You can locate incubators and accelerators aimed at local
businesses in most cities. Accelerators and Incubators with
national recognition include the following:
One of the biggest accelerator programs in the business,
Techstars selects over 300 companies annually to join its
three-month, mentorship-driven program. TechStars invests up
to $120K in each startup and provides hands-on mentorship plus
access to the TechStars Network forever. TechStars hosts
dozens of accelerator programs all over different cities and
industries.
Y Combinator is a pioneer in the startup accelerator space.
Every year they fund a group of new startups with up to $120K.
A number that has been lowered over time due to friction among
founders. At the moment, the companies it has managed to help
have a combined valuation of over $100 Billion. Some of the
most notable startups include Airbnb, Dropbox, Reddit, Twitch,
Coinbase, and Weebly.
One of the most popular and well-known accelerators, 500
startups 4-month seed program helps your company get access to
mentorship, hands-on sessions with seasoned startup founders
and an office space where you’ll work with other talented
founders from all over the globe. They invest $150K in
exchange for 6% equity. They charge a $37.5K fee for
participation in the program and it takes place in both San
Francisco and Mexico City.
Headquartered in the United States with locations based in
Boston, Texas, Israel, Mexico, Switzerland, and the UK.
MassChallenge improves the global innovation of ecosystem by
accelerating high-potential startups across all industries
from anywhere in the world without taking any equity.
Angel Pad is a seed-stage accelerator program located in NYC
and San Francisco. Since 2010, they’ve managed to launch more
than 140 companies. Every six months, they choose a total of
15 teams from their massive pool of applications to work with.
Angelpad has recently managed to gain the rank of number one
accelerator in the US. AngelPad has been given the nickname of
the “Anti-Y Combinator” due to its strategy of working with
smaller teams on a yearly basis.
Angels
Angel investors are rich individuals that offer funds to
early-stage startups, in exchange for an equity share in the
startup. Given the relative volatility of angel investing,
many angels pair financial motives with a philanthropic twist,
usually related to their own personal entrepreneurial
background.
Just like any other investor, Angels will require an exit to
make their investment work: in order to free up the cash
they’ve spent on your startup, and unlock their profits,
they’ll need you to either sell the business or go public.
Pros of angel investors
They’ll take risks other investors won’t:
Angels will usually have a much higher tolerance when it comes
to risk compared to other investors. If your early-stage
startup is in need of someone to take a chance, angels will be
the most likely to supply the necessary funding.
Flexibility: Angels are not constricted by
limitations as most VCs and financial institutions (which is
one of the pros of investing your own money), and can often
flex investment terms for the benefit of all parties involved.
Experience: Plenty of famously known angels
are former founders themselves, and come along with their own
set of experience and network.
Quick Decisions: without need to need to
answer to other board members or investors, angels can make
investment decisions extremely quickly.
Cons of angel investors
Still expensive: Handing over early-stage
equity can be extremely costly, especially if you’re trying to
entice a popular angel investor with preferential investment
terms.
Not all angels are similar: Without other
investors to be accountable to, it’s very easy for an angel to
take advantage of a rookie founder. There’s also a huge
variance in the time, energy an expertise each angel will be
willing to invest in your startup.
Wallets are always deep enough: While
wealthy, angels will still have less capital available for
investment compared to VC funds or other financial
institutions. They’re going to be a time when you’ve finally
outgrown their support.
Big return: Early-stage angel investments
can be high risk, and future investments heavily dilute an
angels equity. One of the best ways to compensate this problem
is with a 10x return on their investment
Venture capital firms
Different from their angel counterparts, venture capital (VC)
firms invest using a fund, a pool of money provided by the
company’s own investors (which can be referred to as Limited
Partners) and the fund’s managers (General Partners).
The VC’s job is to invest that money into promising new
startups, often over the course of a decade, and generate a
return for both themselves and the investors. VCs offer their
funding in exchange for equity, and similar to angels, require
an eventual exit to generate a return on their money.
The amount of the VC’s fund will determine the amount of
return required, affecting both the capital they’ll invest and
the types of startups they’ll invest into.
Pros of venture capital firms
Advice and experience: VCs will have a vested
interest in the success of the startup, and that often means
they’ll guide and advise the founders more so that angels
would be willing to offer.
Access to a ton of capital: VCs have a much
larger and deeper cash flow than an average angel.
Network effect: Working alongside a well
established VC offers credibility, social proof, and most
importantly, access to their personal network of
professionals.
Transparent path to follow investment: Most
VCs are usually in it for the long-haul, and will lead to
subsequent rounds of funding.
Cons of venture capital firms
Massive return: Venture investments can be
risky business, and there are large amounts of capital at
stake, both of which translate into firm’s Limited Partners
expecting some serious returns. By looking into the maths of
how large VCs operate, it rapidly becomes quite clear that
successful investments won’t appease them, they need a huge
success just to survive.
They need control: With investors needing to
be appeased and investment to justify, VCs don’t simply want
more control over the direction of your business, they’ll need
it. This will usually occur through the form of board seats.
Conflict of interests: What you want to do as
a founder doesn’t necessarily line up with what the VC
investors want.
Conclusion
While it’s not easy to choose whether you should incubate or
raise your first round, it can be a game-changing moment for
your startup. Just make sure to stay positive, surround
yourself with the correct people and remember, it only takes a
change.
The decision is ultimately up to you, but we decided to put
together this blog post so that we can give you a better
insight on your options as you raise money for the first time.