How you raise funds for a venture is critical to success. In recent years new options have become available for early stage ventures which have no cash, family, friends or local means to raise money.
Fundraising slim pickings
A generation ago, early stage venture funding involved a smaller range of options such as using personal savings, cash flow, personal loans, leasing, deferred payments, sweat equity and selling equity.
Then, as now, ventures often began with founders relying on cash flow (eg fees for their services), while applying their profits to the speculative start-up venture.
Back then, before you got to money, the usual expectation was to put in place planning documents (often dumbed down into just a “business plan”), a PowerPoint pitch, a team of advisers in suits and probably a product prototype. Most of those still apply, but not always and often later down the establishment track.
Increased funding options today
Then from roughly 2006 onwards in Australia and years earlier in Silicon Valley, significant new funding innovations emerged. We are only just beginning to understand the way they are changing the venture establishment and funding landscape. The availability of early stage venture funding has certainly increased in recent years, at least in the United States (see graphic below).
Focusing on tech start-ups, opening opportunity on the supply side was open source software and Web 2.0 technologies which from about 2002 evolved in Silicon Valley. With them there were parallel developments that have been given snappy names subsequently (eg cloud computing, social networks, open innovation, telecommuting, lean or agile development and big data).
On the demand side the addressable market grew as traditional media were demonetised by digital media, the population online vastly increased, Wi-Fi became an addiction and mobile devices became sought after fashion accessories.
Collectively these supply and demand developments made it vastly less expensive to set up the venture’s technology and web hosting needs and put qualified personnel to work.
For tech start-ups there remains an excessive fixation on advertising as a source of funding, trying to copy giants in net advertising such as Google, Yahoo! and Facebook.
That’s understandable but narrow thinking. Sure, between 2009 and 2012 in Australia revenue from online advertising continued to grow faster than from ads for print media, radio, TV, outdoors or cinema ads. And the 2013 revenue online giants generated from four main sources is jaw-dropping:
- search engine advertising – (eg Google snared over US$16 billion including from YouTube in the fourth quarter of 2013, most from ads);
- social network advertising – (eg Facebook earned US$2.34 billion in the fourth quarter of 2013);
- online video advertising – (YouTube got an estimated US$5.6 billion in 2013); and
- in-game advertising.
Trying to channel ad dollars also encourages many to seek affiliate marketing arrangements, in which typically sites which feature ads for your offering receive a cut of the revenue, so there’s no up-front cash outlay by you. These ads might be dressed up as “sponsorship”.
Entering the funding scene for digital and non-digital ventures are newish or revived mechanisms such as crowdfunding, incubators, tech start-up accelerators, in-app product sales, trade of anonymous and aggregated user data and other experimental approaches that incorporate novel technology. Here’s an overview.
1. Crowdfunding – Crowdfunding supports the collective efforts of individuals who network and pool their money to support new initiatives. Crowdfunding sites differ, see here, here and here. Examples include:
2. Business incubators – In return for a cut or a deal business incubators seek to facilitate the development of new ventures by providing office space; technical, design and business support, and additional resources and services. An informed estimate indicates that 5 per cent of incubated ventures get to Series A funding. Australian examples include:
3. Tech start-up accelerators – Provide a short window anywhere from a day, weekend or several months of mentoring and support including hackathons and similar events. Examples include those below, there are more Australian examples listed here state by state. Some accelerators are prepared to also invest in a start-up. Startmate for example will invest $50,000 for a 7.5% equity holding. There’s been a surge of corporations setting up accelerators. Long-standing ones include Google Ventures and Intel Capital. In Australia there’s telco-supported facilities such as Muru D from Telstra and Innov8 Seed from Optus.
4. In-app purchases – The purchase process is completed directly from within the app and is seamless to the user in most cases.
5. Aggregated data – Major online sites (eg LinkedIn and Twitter) serve their advertisers by providing user data, segmented in many ways, to target specific ads at specific user categories. Such interactive media have been very competitive against traditional media which less reliably captures and segments user information – see Disruptive innovation in Oz job, car, and property advertising. Aided by machine learning, trade in data may have the greatest potential for funding future ventures. Indeed, Netflix and Google don’t merely trade data intelligence to raise revenue, they use it to build and extend their empire.
6. Product pre-ordering or crowdsourced invention – These have been used by gizmo inventors, eg kitchen aid products, who gather pre-orders from site visitors as a means of validation of consumer interest and even as a means for producing development and funding. Some are online community tool sheds used for open innovation involving collaborative brainstorming and co-operation between product designers, funders, investors and consumers.
7. Non-cash exchange systems – Here we might group use of crypto-currency (eg Bitcoin) and peer-to-peer sharing.
Funding selection criteria
To select the funding mechanism most suited to your circumstance, there are numerous variables to consider. They include the level of clarity of your vision; the long-term plan; the size, nature and market targeted by your venture; and the sufficiency of resources, experience, skill and knowledge base of your existing collaborators.
The level of required funds at each stage of a venture also shapes the choice of funding options; hence in very rough numbers incubators and angels can contribute up to say $100,000, seed funders sums above that, and venture capital sums starting from say $2 million (in Australia).
For a range of reasons fundraising is staged, common labels being bootstrap, seed, angel, Series A, Series B, Series C, Series D and initial public offering. Stating fundraising is an entire subject on its own.
How to prepare for fundraising
Relevant to venture funding, there are legal implications for a range of potential transactions and venture documents, eg at a minimum a website or app terms of service.
Here are three things to do to identify those implications to help your legal and other advisers and team members work on your venture.
- Map your business process – Create a one-pager which maps the business process or workflow of the venture. This might include how it will get customers, what it provides them, and when and how it charges them. If you can also do a graphic illustrating all this, even better.
- Define your business model – Next, create a one pager to help the adviser understand your business model. Do this before you drill down on the venture’s financial model. This is because that work should come last, after the practical process and arrangements are defined or known.
- Supply your documents and plans – Finally, if you have them, supply any forms, business plan, budget spreadsheet, templates, style guides, glossary, mock-ups and wireframes; everything to indicate and illustrate your thinking. The legal work and documentation you require needs to be made consistent with that thinking.
Plenty of people use the term business model as if it is self-explanatory. Prof. Henry Chesbrough in his book, “Open Innovation” provides a useful definition, setting out six elements.
- To articulate the value proposition, that is, the value created for users by the offering based on the technology.
- To identify a market segment, that is, the users to whom the technology is useful and the purpose for which it will be used.
- To define the structure of the firm’s value chain, which is required to create and distribute the offering, and to determine the complementary assets needed to support the firm’s position in this chain.
- To specify the revenue generation mechanism(s) for the firm, and estimate the cost structure and target margins of producing the offering, given the value proposition and value chain structure chosen.
- To describe the position of the firm within the value network linking suppliers and customers, including identification of potential complementary firms and competitors.
- To formulate the competitive strategy by which the innovating firm will gain and hold advantage over rivals.”
Go back and read again point 4, the revenue generation mechanisms. Think of them as the financial model or as mechanisms for monetisation. As we’ve seen, these mechanisms are in a state of constant innovation, especially for digital products and services such as websites and apps.
Why is getting funding right so important?
Designing a successful monetisation mechanism for your web, app or non-digital start-up venture is a crucial part of business strategy. Designing the best monetisation mechanism for a venture can be complex. The pay-off is worth it as a crafted mechanism can itself become the competitive strategy that distinguishes an innovative venture from its rivals.
Another pay-off is that a properly documented arrangement for payment or receipt of rewards, benefits, value or remuneration, when packaged within a contract (and other legal documentation if needed), forms a sophisticated blueprint for running a business.
If you have the one-pagers ready as discussed above then your team can address a range of critical financial modelling issues or topics to finalise the blueprint. To illustrate, across a range of financial models these can include working out:
- incentives for customers who buy more (eg volume purchases and loyalty rewards);
- invoicing and terms and conditions for customer relationship management;
- using open source software or applying digital rights management;
- refund or credit arrangements if goods or services are unsatisfactory; and
- application of standards to define goods or services.
Got an idea? Got the one-pagers ready? We welcome your call for a free initial conversation or email to discuss your unique needs as a start-up or investor.
Photo: Steve Jobs in 1977 is holding an investment cheque for US$250,000 from Mike Markkula. It comprised $80,000 as an equity investment and $170,000 as a loan, making Markkula a one-third owner of Apple and employee number 3.
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