Sources of Capital

By J. Gerry Purdy  |  Posted 2010-11-18 Print this article Print

Sources of capital

Here are the sources of capital that you need to consider to get your new business funded and off the ground:

Personal funds: Many entrepreneurs often don't realize that they have to invest some of their own funds. If the approach is that the entrepreneur will only consider other people's money, then the other people will own most-if not all-of the business. This stage is typically focused on producing a demonstration or prototype and doing some market research that demonstrates that there's demand for the product or service.

Friends and family: The most important stage of a young company is get someone else beside yourself to believe enough in what you're doing and provide additional capital. This stage is often used to build the product so it can be put into the market.

Angels: Angels are investors outside of your circle of friends and family that operate on an individual basis to provide capital to "pre-revenue" ventures. The purpose of angel investors is, typically, to get a company operational and generating revenue. Often, this isn't to make a profit but, rather, to demonstrate that revenue can be generated and to learn and refine the sales process. Most angel investors want to buy an early stake in the new company so they can see their investment grow in paper value via a subsequent round at a higher price.

Institutional VCs: In the old dot-com days, you could get funding for an idea on the back of an envelope over lunch. But today, institutional investors typically want to see that a business has already generated some revenue or, if it is still pre-revenue, that there's enough information to believe that revenue growth can occur very quickly. Institutional investors typically purchase preferred stock in the company, giving them preferred rights on acquisition or liquidation. When a business succeeds and either goes initial public offering (IPO) or is acquired, the kind of stock may not make any difference.

A typical rule of thumb for institutional rounds is that they will buy 40 to 50 percent of the company in return for their putting up sizable funds. Some successful ventures do much better (for example, in October 2007, Facebook sold 1.6 percent to Microsoft for $240 million, which valued the company at $15 billion).

Also, don't get too caught up on trying to get a high pre-money valuation. The higher the valuation, the greater the demands that the VCs expect. They always want to achieve a goal of 10 times their investment in five to 10 years.

Strategic investors: These are typically your partners that are helping you gain success in the market. Often, a partner will see the benefit of the future value of your business and will offer to either invest alongside the institutional investor or will make a separate investment. Strategic investors will typically not be as sensitive to the price of the investment as institutional investors, but it can take longer to settle.

J. Gerry Purdy, Ph.D., is Principal Analyst of Mobile & Wireless at MobileTrax LLC.
Dr. Purdy has been covering mobile, wireless, cloud & enterprise for the past 20+ years. He writes analysis and recommendations each week in an easy-to-read manner that helps people better understand important technology issues and assist them in making better technology purchasing decisions.

Disclosure Statement: From time to time, I may have a direct or indirect equity position in a company that is mentioned in a column. If that situation happens, then IÔÇÖll disclose it at that time.

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