An insightful article on "startups on a shoestring" in the New York Times covers the rise of companies running on angel investors, loans, or even credit cards. It's a switch from the more famous method of raising piles of venture capital from a firm. But what does that mean? It means startup founders get to keep more of their money and power.
Startups raise money in rounds, often taking on multiple investors per round. Here's how the major types of funding work:
- A VC firm raises funds from investors, then invests it in startups, usually at upwards of $1 million per company (and sometimes as high as $12 million or more).
- A VC firm is buying a share of the company — anywhere from a tenth to a third, depending on how much the firm decides the company is worth before the investment.
- If the company needs more money a few months later, the firm may invest again, or a different firm might invest. Companies often raise funds from multiple firms in one round.
- VCs want at least three times their money back, though they expect most deals to fall through
- Many companies only take VC funding after they've used up the funding from their...
- These are often the first investors in a company, most always used before venture capitalists.
- Angels invest a few thousand dollars. As with VCs, several angels may invest in a startup at once, for a total round of anywhere up to about $1 million.
- They have less of a business interest but more emotional involvement.
- Angels can be friends and family of the investee, but some startups raise a preliminary friends-and-family round.
- Or they may go even smaller and rely on...
- When is it healthy to run up a 20%-interest-rate debt on plastic? When it's cheaper than running up a 200%-interest-rate debt on VCs.
- Of course, you could also rely on your own cash reserves, as many startuppers do with their second companies — Evan Williams, for example, who used his windfall from selling Blogger to Google to buy out the investors in his new company, Odeo.
- Ironically, credit card funding is a far cry from other way to borrow from banks...
- The 90s bubble was partly blown up by VCs, but the big money came from hedge funds — an adventurous form of private investment fund.
- They're not as involved this time — the money's too small, at least for now — but they powered many a startup in the 90s, when more tech-savvy VC firms hadn't dominated the Silicon Valley funding industry.
So why are startups avoiding VCs? Because they're finding that angels, friends and family, and personal credit are less demanding funding sources, with lower expected returns, giving founders the freedom to take it slow and stay in control. Of course, VC money is hard to resist after a year of bootstrapping and dining at McDonald's.