Startup Capital: Everything You Need to Know
Startup capital is the money needed to start a new business.18 min read
2. Alternate Terms
3. Types of Startup Capital
4. Debt Capital Versus Equity Capital
5. Sources of Startup Capital
6. Online Sources for Startup Capital
7. Tips for Starting a New Business
8. Startup Capital Dictionary
9. Typical Terms on a Term Sheet
10. Factors Outside of the Term Sheet
11. Negotiating Your Business's Valuation
12. Instead of Raising Capital, Bootstrap
13. The Netherlands: The High-Tech Startup Capital of the World
14. Other Global Cities That Are Startup Capitals
What Is Startup Capital?
Startup capital is the money needed to start a new business. Startup capital might be needed to pay for office space, permits, licenses, inventory, product development, manufacturing, marketing, or any other expense that results from starting a new business.
Seed capital, startup funds, working capital, or seed money.
Types of Startup Capital
For each stage of its life, a company has different financial needs. Each level of funding plays a unique role in that stage of your business.
Seed capital is used for initial research and planning before starting the business.
Startup capital pays for rent and supplies during the first year or so of your business.
Mezzanine capital helps your company grow bigger, move to a better facility, or purchase higher-quality equipment. This is also known as expansion capital.
Bridge capital bridges the gap between your current level of funding and the next level.
Debt Capital Versus Equity Capital
Debt capital is when your business takes out a loan for its startup capital. The loan is given for a set amount of time and then it must be paid back with interest and possibly other fees.
The benefit of debt capital is that the owner retains full control of the company. The drawback is hefty repayment.
Equity capital is funding that's provided by people or companies who want to own a piece of your company. Those people fund your business in the initial stages in trade for ownership of a portion of your company. They benefit when your company is successful, goes public, or is bought by a larger company.
The benefit of equity capital is that there's no loan repayment. The drawback is that the owner loses control over a percentage of his company.
Sources of Startup Capital
A business can choose to obtain startup capital in any of these ways, but some may be more beneficial than others, depending on the type of business.
Friends and Family
It's very common that new businesses receive startup capital from their friends and family. This is a very easy way to receive funds, but there can be many drawbacks.
For example, if your company fails and you lose everything, you may lose your friends who loaned you money.
It's important when borrowing money from friends and family to have a contract that describes how startups work and all the risks that are involved. Be clear in your agreement with friends and family. For instance, if the company fails, do they still expect repayment?
This contract is also important when seeking funding later on. Future funders should be able to examine documents proving where your initial funding came from.
Many startups use personal funds as their startup capital. If your business doesn't need to produce a product, it's possible to keep costs low in the beginning by using only personal funds.
Personal funds may come from your savings account, taking out a second mortgage or home equity loan, a personal loan, or any other finances you have at hand.
Personal funds may also be obtained by borrowing money from a bank or taking on credit card debt.
Some government programs, including the U.S. Small Business Administration, offer loans of startup capital for new businesses.
An angel investor is a high net worth individual who will invest in your company in exchange for partial ownership. Angel investors typically give startup capital to businesses in ranges of $10,000 to $100,000. They participate in priced or debt rounds.
It's important to determine whether an angel investor is an active professional or merely an occasional investor. A professional is one who does at least six deals a year. You can also look them up on AngelList. A new business should be able to close a deal with a professional within the first three meetings. It's appropriate to ask their interest level at the end of the first meeting.
Target carefully when seeking out an angel investor. Make sure that your business or product is something that they're interested in.
This is a group of angel investors who pool their money to share deal flow. Angel groups can do priced rounds, and if a high enough percentage of the group is interested in your business, they can lead your deal.
A check from an angel group will range from $50,000 to $500,000. These angel groups aren't syndicates and therefore don't carry syndicate fees.
The angel group will meet regularly and likely has a pitch process that they prefer. Some angel groups do a lot of due diligence and others don't.
The most effective way to raise money on AngelList is through AngelList syndicates. The syndicates are formed by influential angel investors. The investment of an AngelList syndicate can range from a $200,000 to more than a million.
The best way to get a syndicate's interest is to spark the interest of one of the AngelList syndicate investors. If you can do that, then that angel investor will get the rest of the syndicate interested.
The micro VCs will commit or decline within three meetings. This type of investor may be comfortable with debt or equity capital.
A micro VC is very similar to the VC in that they're interested in ownership, but with a lesser stake. The micro VC will be interested in 8 or 10 percent ownership, while a VC would want 20 percent ownership of your company.
As you would with an angel investor, be sure to research micro VCs before targeting them. Research their portfolio and make sure that your business or product is something that they might be interested in. You should not only target a specific fund within the micro VC, but a specific partner.
A traditional VC will have available investment funds of between $100 million and $500 million.
For seed money, a VC might invest as little as $250,000 or up to $2 million. The sweet spot is typically between $500,000 and $1 million.
A VC is very interested in the percentage of ownership of the business. They might insist on doing a series A (preferred stock) round as well.
It's important to do a little research when meeting with a VC. The VC might still meet with you even if they are between funds and this would be a waste of your time. With larger firms, try to find out how many companies they typically manage and how many they're currently involved in. This could give you a good idea of their current funding level.
You should also try to determine the partner who is managing the deal. This isn't always obvious with larger VC firms.
Ask the VC firm what their pitch process is and how they would like for you to follow up. Make sure that the next steps are clear and ask the VC directly if they're interested.
A mega VC is a firm that has more than $1 billion under their management for investment.
Mega VCs include these companies:
Find out if the Mega VC has a seed program and try to determine who runs it. The seed capital process is compressed compared to the process of raising more capital. There's also likely one partner who is in charge of seed capital.
For some companies, it doesn't make sense to seek out a mega VC during the seed round as the mega VC must invest large amounts of money to make their return. Instead of trying to get the attention of a mega VC during the seed round, get their attention for a series A or series B round.
Online Sources for Startup Capital
There are many places online where business owners can request startup capital from investors. An online platform is sometimes the simplest and safest way to gain funding. It may be safest because these platforms are approved under the rules set out by the U.S. Securities and Exchange Commission.
Mentioned above, this minimalist website allows startups and investors to search for opportunities that are interesting or relevant to them.
Investors will pay five percent of their investment value to AngelList, while startups pay nothing to the website.
This website works in a similar way to Kickstarter. Investors can give money to a company in exchange for gifts and rewards or for stock in the company.
The option to solicit investors is new to the website, but some companies have been very successful at it.
Fundable charges startups $99 per month to be listed and a 3.5 percent processing fee for all credit card transactions.
This website focuses solely on matching entrepreneurs to vetted investors. The website was formerly known as AngelSoft.
Gust offers startups many tools to help them develop effective VC pitches. The website has the option to create both public and private business profiles, to search for investors, put together a video pitch, or to track investors' activity on the site.
The fee for investors isn't publicly disclosed, and the website is free for entrepreneurs. Gust has more than 1000 investment groups that have invested in over 1800 startups in the last year.
This is one of the largest websites where entrepreneurs can meet with investors. There are over 300,000 companies and 20,000 investors on the website.
The website focuses on entrepreneurs, offering tools and expert consultants to help a business create effective pitches and find investors.
Entrepreneurs pay $59 per month to access the network of investors and $300 or more for consulting services. There's an opportunity for large and small investments.
Tips for Starting a New Business
Starting a new business and securing startup capital isn't an easy task. These tips should help encourage you in founding your business the right way.
Get experience. Before starting your own company, work for someone else for a short period of time to learn the business that you're interested in before founding your own. This not only gives you more experience as a founder, but will make future investors more confident in your skills.
Make a business plan. There are many online forums and websites that offer help and resources for creating business plans. Those resources can be found on angel investor websites and also from SCORE, the Service Corps of Retired Executives.
Get sound advice. The first few stages of creating and starting a new business can the most difficult, and good professional advice is key. Advice will cost money, but it will pay off.
Build relationships with an attorney, a CPA, and a bank. These are the people who will protect you from mistakes and ensure a long business life. These professional advisors help you to get your business started in the right way.
Spend cash. Venture capital backing is very tempting to new companies, but it often means that owners lose their ownership rights and future profits. Venture capital funding is quick money but it may not be worth it long term.
Take your time. There's no need to rush the founding of your business. Take your time and work hard. Things will eventually start happening.
Stay focused. When starting a new business, it's all about hard work and persistence.
Study your loan options. As with the founding of your business, there's no hurry in taking loans or funding. The Small Business Administration can be a great resource when looking for loans and making decisions for the best of your business.
Startup Capital Dictionary
You need to know many terms when you're seeking startup capital.
Pre-money vs. Post-money Valuation
Valuation is the value of your company. This number is often agreed upon by the company shareholders, but when you're a startup looking for capital, your valuation is whatever you can convince investors it is.
A company's valuation is important because it determines the equity stake that is given up to the investors.
Convertible debt, also known as convertible notes, is a way for a new company to raise funding while avoiding valuation until the company is more mature.
Because valuation allows an investor to own a portion of the company, a young company that needs funding can quickly lose too high a percentage of their stake in the company to investors.
Convertible debt often converts from debt into equity during a series A round of funding.
Investors who invest in convertible debt often are rewarded with a discount for investing during the earliest and riskiest stage of business.
Capped Notes vs. Uncapped Notes
A capped round of funding means that there is a ceiling on the valuation that an investor's notes can convert to equity. In an uncapped round of funding, the investor has no guarantee as to how much equity their investment in convertible debt will purchase.
An uncapped note is better for the entrepreneur. An uncapped note helps the entrepreneur maintain more ownership of the company.
This is part of the investment proposal that an entrepreneur would receive from a venture capital fund. A term sheet is the summary of the terms and desires under which the venture capital fund wants to invest in the entrepreneur's business.
There are some important terms to look for on the term sheet: valuation, option pool size, liquidation preferences, founder revesting, veto rights, preferred type of stock, and the number of board seats.
The terms set out by the venture capital fund are very important to help the entrepreneur decide whether to accept the deal.
Many entrepreneurs consider the valuation to be the most important number on the term sheet. They believe that the higher the valuation, the better the deal. This isn't always the case and shouldn't be the only factor in the decision.
Typical Terms on a Term Sheet
This is the price at which the venture capital firm is going to invest in your company. How much they invest in comparison to the post-money valuation determines the percentage that the investors own of an entrepreneur's company.
Option Pool Size
This is the amount of additional stock that the venture fund wants the entrepreneur to create in order to provide incentive structures to future employees. This percentage will be higher for newer companies that are in earlier stages of seeking investment.
The liquidation preferences answer this question: "If the company goes bankrupt and the remaining assets must be turned into cash, who gets what assets first?"
A capitalization chart or table lists who has put money, whether it's equity or debt, into a company and who owns what shares. In most companies, the debt providers have been around longer than the equity providers, meaning they get their money out first.
Investors want to be as high as possible on the capitalization chart. To do this, investors will want to make their investments "preferred" investments.
A founder often earns his equity in the company over a number of years. This is known as vesting. Some term sheets will require founder revesting. To revest, the founder starts his vesting clock over again. This can seem very unfair to founders who have worked with the company since the beginning.
Veto rights give the investor a certain amount of power to say no in certain situations. Common investor veto rights are the ability to veto the sale of the company or the issuance of a major amount of new debt.
It's important to pay attention to who has veto rights and what they can veto.
There are two types of preferred stock: straight preferred and participating preferred. Participating preferred can heavily benefit the investor to the detriment of the entrepreneur. Straight preferred is most often the better choice for entrepreneurs.
Depending upon the amount of money they're investing, investors may want to hold one or more seats on the board. If you don't hold the majority of the board seats in your company, you can't control the decisions that are made for your company.
Something else to consider is not only who holds those seats, but who has the power to appoint people to those seats if they're vacated. If investors hold a majority of board seats, they can even remove the founder from the position of CEO.
Factors Outside of the Term Sheet
It's important that you get along well with the people you're founding the company with and those who are investing in your company. The people who invest in your company will sit on your board and will likely serve as your business mentors. These people will be with you for the next three to ten years, so it's important that you like working with them.
Partner's Operation Experience
Investors have valuable experience, but that's often not the same experience and knowledge that's gained from actually running a company. The best type of investor is one that is also an entrepreneur, business owner, or former c-level executive.
A fund's investments are known as its portfolio. Be sure to look at a firm's portfolio to find out if there are other businesses there that you could possibly partner with or sell to one day.
You want to also look at an investment firm's successful exits. These are considered companies that leave the firm with more than $100 million. If the firm doesn't have many of these, it may be new or not very good at what it does.
The network of the investment firm is important to assess because its network becomes your network. The firm may have a network of c-level executives who they can bring in to advise and help your company grow.
Negotiating Your Business's Valuation
A company's valuation is extremely important when seeking startup capital and funding. The valuation is based on numerous factors:
CEO's past experience
Size of the user base or market
Location of the company
Build a Pipeline of Investors
By creating a competitive environment, you have better control over your fundraising process.
Try to schedule as many investor meetings within a few weeks as possible. Your initial meetings might be as long as six to nine months before you're ready to start your business. Then have those meetings again when you're ready. You want to receive all of the term sheets within the same week.
Term sheets are typically only good for a few days. This means that to get a good deal, you need multiple offers in the same period of time, and that time can be short.
Know Your Customer Unit Economics
Your customer unit economics is the cost to acquire one additional customer. You must know this number before acquiring venture financing.
Customer acquisition cost can be found by dividing your total spending on advertising by the total number of new customers per month.
Instead of Raising Capital, Bootstrap
For companies that aren't ready to take on the risk of raising startup capital, there's the option to bootstrap, or simply supporting yourself. This often takes longer than raising capital and can be more difficult, but there's less financial risk.
Before looking for funding, try these tactics.
Convince friends and other people to work for you for minimal salary in exchange for equity in the company or a deferred salary
Create a product or service to sell
Start selling that product or service
Use the revenue from sales to improve the product and development
Once your revenue is $20,000 a month or you have 50,000 users, you're ready for seed funding
Getting to this point can take time, and that's OK. Generating revenue with minimal capital is tough.
The bootstrapping process sifts through the talkers and identifies the doers. Investors want to invest in someone who has figured out how to do. That's much more interesting to investors than someone who needs money to get started with their great idea.
The Netherlands: The High-Tech Startup Capital of the World
The Dutch startup scene is already considered one of the most prominent in Europe. The Netherlands is approaching a turning point where the hard work of the past is giving way to future success.
The volume of activity in the Netherlands is enough to prove its status as a startup capital. There were 75 major deals in 2014 that resulted in $560 million in investment. Ten of those companies raised over $9 million.
The Dutch are highly regarded for their educational system. They have some of the highest scores in math and science across the world and speak better English than any non-native population. Strong economic foundations in industry and commerce also create a dependable framework for growth and innovation.
Global innovation and the startup scene in the Netherlands are moving toward improvement in financial tech, digital health, sharing technology, 3D printing, and many other industries.
If you still need proof, just look at the companies moving there to work. Uber and Netflix located their European headquarters in Amsterdam.
This moment took years to get to, and there doesn't seem to be an end in sight.
Two of the most successful Dutch startups are Booking.com and TomTom, founded in 1991 and 1996, respectively. These two names are mentioned by almost everyone when asked how the startup scene began.
There's a strong tradition of entrepreneurship in the Netherlands, but still, the beginning of the startup scene was plodding and non-linear. It took years before the success stories emerged.
As with any new industry, there were struggles for the startup industry in the Netherlands. The financial crisis of 2008 was especially difficult because the startup scene was truly starting to take shape then.
Then a shift began to retaining tech talent locally at universities. Instead of moving off to traditional industries, talent remained.
One of the major selling points of the Dutch capital is that it's a great place to live. Amsterdam is a beautiful city where people can ride bikes, enjoy parks, visit museums, eat at great restaurants, and view architecture. Amsterdam is a culturally rich city. On top of everything else, Amsterdam remains affordable.
One of the centers of Amsterdam startup culture is B.Amsterdam. The 6,000 square-foot office space is home to 67 companies. It also houses a design academy, gym, post office, and events space. The rooftop view is the envy of all other businesses.
Along the canals and nestled in with other businesses are dozens of other startups, including Rockstart, Startupbootcamp, and ACE Venture Lab. Amsterdam gives off a buzz, a vibe that this is an important place to be and that there are new things happening.
The startup scene is of course supported and encouraged by the Dutch venture capital. Prime Ventures, Van den Ende & Deitmers Venture Capital Partners, and henQ are the city's leading firms. The Dutch Venture Initiative distributes $167 million in European Union funds.
As the capital, Amsterdam will likely always be the center of the Netherlands success in startup, but it's not the only city making a foray into the startup world.
Delft is the forefront of where the startup scene is going and how it's changing in the Netherlands. Delft is a small, nerdy city with just 100,000 residents. Ten to 15 percent of those residents are students.
The city has a medical school, Delft University of Technology, and the largest number of student societies. Delft is all about high-tech innovation, engineering, and hardware. As the students became interested in entrepreneurship, so did the universities, and so did the city of Delft.
In 2013, Eindhoven was declared by Forbes to be the "hands-down most inventive city in the world." The density and output of invention in the city isn't matched anywhere else in the world.
Eindhoven produces 22.6 patents per 100,000 residents. The U.S. city of San Diego, the runner-up, produces only 8.9 patents per 100,000 residents. The city of Eindhoven lives and breathes tech.
This high-tech town has been transformed from small to the fifth-largest city in the country in part by the Dutch company Philips. The company has gone from light bulb manufacturer to technology giant. Part of that growth was creating the High Tech Campus in Eindhoven.
The major limiting factor in the Netherlands growth as a startup capital is their access to capital. This isn't unique to the Netherlands. Access to capital is the biggest barrier to growth all over the world.
Other than a lack of access to capital, it's difficult to find a weakness the Netherlands framework for encouraging startup culture.
The Netherlands is a small country, but it's wealthy. Locally-based startups can get a good gauge on the developed world by trying products in the Netherlands, and the permanent industries there provide a stable foundation for the unstable experiment of startups.
In the future, the Netherlands might face the problem of retaining their talent. Movement throughout Europe is easy, meaning it's easy for people to come, but also for people to go. Companies may come there to grow and once mature, may leave for larger markets, better weather, or higher valuations.
Other Global Cities That Are Startup Capitals
The Netherlands isn't the only place in the world earning the title as a startup capital. In 2012, the worldwide venture-capital investment came to a total of $42 billion.
The major points for startups are the East and West Coasts of the U.S., Western Europe, and the major cities in China and India. The U.S. is a dominant center, accounting for almost 70 percent of the total global venture capital funds.
The top six metropolitan areas for venture capital funding are in the U.S., and 12 of the top 20 are located there. The top six cities are:
Those six cities account for nearly 45 percent of the total global venture capitalist investment.
Other major cities worldwide are:
To control for sheer size, such as in the case of New York, London, and Beijing, you can look at the venture capital that's invested per capita. Even on a per capita basis, California's Bay Area dominates. With these constraints, a few new cities appear on the list, such as:
Durham, North Carolina
Greensboro, North Carolina
New Haven, Connecticut
When controlling for venture capital funds per capita, the only metropolitan area to appear in the top 20 outside the U.S. is Toronto. London drops from 7 to 39, Beijing from 9 to 55, and Mumbai from 15 to 70.
Venture capital funding has begun to spread out across the globe by moving to China and India, but the major hubs still remain in the U.S. Large U.S. cities and universities still provide the dynamism and open-mindedness that is required to attract great talent and venture capital funding.
What is startup capital?
Startup capital is the initial money needed to begin a business. This money is often used for supplies or materials needed by the business.
Do I need startup capital to start my business?
Many entrepreneurs actually like to start off by self-funding their business or by raising money from customers, supporters, or friends. Startup capital isn't required for new businesses.
What's the benefit of startup capital?
Startup capital can make starting your business easier and faster. Having capital to invest in your company makes it easier to produce products or hire employees.
What's a negative effect of startup capital?
Most investors who give startup capital to businesses want something in return. This can range from equity in the business, repayment of the loan, or a seat on the startup's board of directors. It's important to weigh the benefits of receiving startup capital funds with what is asked for in return.
UpCounsel offers help in creating a business plan or seeking out startup capital for your business. You can also post your legal needs on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site.