[This is a guest article written by entrepreneur Zack Shapiro of the University of Colorado, Boulder]
I live in Boulder, Colorado, home of TechStars, a slew of bloggers and start-ups galore. Everyone seems to have their own great idea for the next big thing. Start-ups come in all shapes and sizes; they aren’t all websites either. A start-up can be anything from a new city service to a catering company to an iPhone app.
When someone has a great idea they usually need money to make their idea a reality. But how do they get the money they need to take their dream from a prototype or a piece of paper, to a product that others can use, buy or otherwise interact with?
There are three major types of funding that entrepreneurs often seek out. Those three types are available in the forms of Friends and Family (commonly called F&F), Angel Investors and Venture Capital. Each require those interested to present or pitch their ideas in hopes that the particular investor will be interested in funding a project that aims, down the road, to be a self-sustaining business. Investors exist to make dreams come true for those that would otherwise not be able to fund, say, a 20 person staff over four years as their product evolves and matures.
Friends and Family
The first type of funding comes from Friends and Family (F&F). F&F is also sometimes called FFF for Friends, Family and Fools. This type of funding is generally the first round of funding that start-ups receive before they begin to pitch to Angel Investors or Venture Capital firms.
The funds that come from F&F are called Seed Funding, necessary funds that allow for a business to begin and sustain itself for a short period of time. F&F comes in the lowest amounts of the three types of funding and is usually in the area of $10,000. These funds, as the name suggests, comes from the savings of the friends and families of the parties involved in the start-up. Those involved invest their own savings as part of the F&F round of funding as well.
F&F is a risky venture for those with the money because the project that they are funding may not be anything more than drawings on pieces of papers or a fancy pitch. It’s easy to see where the foolish aspect enters into the F&F round of funding as some will invest in companies without much of a background in what those companies may be doing. Remember, many small businesses and start-ups fail within the first year.
But what if you get lucky with some F&F funding, a great idea and an early and worthwhile product? The next step is to approach Angel Investors.
Angel Investors are individuals who invest their own personal funds in an idea or a company that they feel strongly about. The term “angel” originally comes from the investors that used to put up money to fund Broadway productions. Angel Investors are sometimes retired entrepreneurs or executives for companies that want to be involved and on the pulse of new developments.
Angel Investors have significantly more funding at their disposal yet still less than Venture Capital firms. Angel Investors usually lend in the $100,000-$450,000 range.
Similar to F&F, a large majority of Angel Investors’ money is lost in the early stages of a company as the company struggles to gain footing. Investors require a high return on their investment and therefore will only invest in companies that they feel have a product and a business model that can yield a sufficient return within four or five years. In order to make Angel Investors feel that their money is in a safe place, new companies’ business models sometimes contain plans for offering an initial public offering (IPO) or plans to be bought by a bigger company in the same field or niche.
While their money is caught up in a company, Angel Investors will usually ask to be board members or have some type of high office so they can be sure that their money is spent wisely and in the best interests of the new venture.
The companies that dig in their feet and secure a temporary place for themselves then go to Venture Capital firms to ask for still larger sums of money in the sums of millions of dollars. Venture Capitalists are generally small teams of investors with sufficient backgrounds in the fields in which they are investing.
Venture Capital (VC) funds come from pools of money gathered by investors. Firms trade shares of the new venture for funding and VCs often invest in multiple companies at a time. New ventures will seek to raise funds in rounds of funding called “series.” Often times when researching companies you will see that Company X received $4M in Series A funding and $5M in Series B funding. Generally, the more series of investments, the more promise VCs, Angels or other investors see in the company. The more promise they see, the longer they are willing to sustain a company on their own dime.
Like F&F and Angel Investors, VC funding is still risky though it is often associated with companies that have some sort of incoming revenue. VCs distribute their funding throughout a variety of endeavors to ensure that if one or more of the ventures goes under, not all is lost.
Funding your startup
Most of the technologies that you’re probably familiar with are either still involved with or were formerly involved with at least one of the three types of funding. Facebook ($716M), Twitter ($155M) and Tumblr ($5.25M) are all supported by VC funding.
Flickr, a photo-sharing website, was supported by funding before being bought by Yahoo! in 2005 for $35 million. YouTube was supported by $11.5M in Venture Capital funding during 2005 and 2006 before being bought by Google for $1.65B in stock. Google is well known for having its hands in a variety of start-ups and technologies. They currently have investments in 23andme.com (a human genome research website), Tesla Motors (electric cars) and AOL, to name a few.
If you’ve got a great idea write it down, draw some sketches and find some talented people who can help begin to make your dream a reality. More importantly, find someone who can fund your idea. Maybe this article was a start for you but most importantly, good luck!