Early-stage financing options: it pays to do your homework

18 Jul Early-stage financing options: it pays to do your homework

Whether your new business venture is technology oriented or not, there are lots of options available to an early stage company looking for money to fund its operations. Often, the early stage company is gearing up for more significant financing down the road, but it needs money now. Early stage funding can come from banks and institutions, but also is likely to come from friends, family and angel investors.
This article is a summary of the basics of each type of financing, including some specifically geared toward technology startups, a comparison of the various options, and some pluses and minuses for each alternative. Much information is included in the helpful Early Stage Financing FAQ, so don’t forget to read that for a complete comparison. Keep in mind that the terms of the financing options and other circumstances affecting your company and your market significantly affect the type of financing that is appropriate for your venture. Moreover, there is significant difference of opinion over what financing alternative is the “best” option for an early stage company, so keep an open mind! Don’t be afraid to seek counsel from professionals and trusted, experienced friends. In the end, however, the final decision must be yours, based on what is best for your business at the time.
So, what forms might early stage financing take?
EQUITY: This is the classic type of investment in a company: an investor puts money in and gets stock (or another form of equity, such as membership interests in an LLC) back. This is what most venture capital firms will want. Also might be called: stock investments.
DEBT: This one is relatively easy, too. The company simply borrows money and pays it back over time. Loans can be from banks, but a company can also borrow from anyone (including for example, friends and family). Also might be called: loans, debt financing.
CONVERTIBLE DEBT: This is a hybrid version of the first two. This looks like a loan at first, with payment terms over time and interest accruing. The difference is that at some point in the future, it can (or must) be converted into equity. So, for example, an investor could loan $100,000 to an early stage company, but convert the loan into stock in the company six months later. The conversion often is at a discount from the market value of the stock to reflect the inherent risk in loaning money to a start-up.
ALTERNATIVE FINANCING: Companies should not overlook the other options available to them. These include Small Business Innovative Research (SBIR) and Small Business Technology Transfer (STTR) grants. These grants can be worth up to $100,000 in the first phase, and up to $750,000 in the second phase, with no dilution or financial responsibility for the company. Also, be on the lookout for business plan competitions; the Wisconsin Governor’s Business Plan Contest is worth $50,000 in cash and services each year.
Not one of these options is inherently better than the others in every situation. The analysis depends on the economics of the situation, together with the other terms of each option (for example, will you lose control of your board of directors?). Check the Early Stage Financing FAQ table for common questions and brief answers regarding each form of financing.