Most financial institutions don’t work with early stage startups, which is why founders are turning to angel investors and venture capitalists for funding. Today, fewer deals and larger raises make early stage financing more elusive than ever.
Despite an impressive year of venture capital funding in 2017, investors are investing in fewer seed and pre-seed rounds, according to the “4Q 2017 PitchBook-NVCA Venture Monitor” (email required). The average entrepreneur is expected to self-fund for at least two years before raising outside capital.
In managing startup accelerator programs and through my work with entrepreneurs, I understand the impact that failure in fundraising can have on the founder. This initial runway, where founders strive to prove viability and gain traction, is where most entrepreneurs run out of money, motivation and, ultimately, fail.
How can you bridge that gap? How can you produce your first products and hire your first employees?
One well-known example of bootstrapping success comes from the founders of Airbnb, Brian Chesky and Joe Gebbia, who took advantage of the political fervor that was sweeping the country and sold more than $20,000 worth of Obama O’s cereal to raise financing for their house rental platform. That entrepreneurial move was enough to secure them a place in Y Combinator’s seed accelerator program.
We can all learn from this innovation. Below are a few best practices that can help startups secure financing, circumvent funding bias and overcome a lack of personal financing.
Pricing And Purchasing Structure
Using a subscription model allows businesses to charge up front for increased access to a product or service. By employing a subscription model, you can require customers to pay up front, and then use the sales to finance the creation of a new product or service, while able to cover your initial costs. Subscription models usually range from monthly to quarterly to biannually and annually.
Alternatively, think of a nightclub. If you see a line wrapped around the building, it seems like the establishment must be great and worth waiting for. Products and services function similarly. By taking preorders and accepting deposits, you are eliminating your risk by having customers pay up front and are also able to prove demand. This is helpful when seeking to bridge an initial funding gap or when you are seeking to raise equity financing.
Trade And Barter
If your initial products or services require funding to establish and grow your company, then this method might be for you.
If you are a nonprofit, many times trading and bartering can come in the form of in-kind donations. If you are a for-profit, sometimes it is easier to get $30,000 worth of items or services you need, compared to raising $30,000 in cash. Negotiate and be flexible in how you achieve outcomes. Look for ways to promote resource providers and the services they offer in exchange for discounts.
Search for the opportunity to create mutual value through sponsorships. As an example, many brands are incentivized to associate with a social cause. When engaging with these companies, it may be cheaper to host sponsored events and create sponsored materials, as opposed to spending cash on resources. Many companies have corporate social responsibility (CSR) departments, banks have Community Reinvestment Act (CRA) funding, and local governments often offer opportunities for free resources and technical assistance.
For example, if you are seeking to raise $30,000 for a web-based application, work with a local coding school to supplement the workload and trim down your cost on the project. Or, if you need $10,000 to purchase initial equipment and infrastructure, first reach out to any larger organizations that may be able to donate old or recently replaced equipment. Think about spaces you can rent, borrow or share, and propose temporary profit-sharing agreements that allow you pay individuals at a later time.
Purchase Order Financing (Debt)
Leveraging contracts, memorandums of understanding (MOUs) and purchase orders can enable you to access debt financing at a cheaper rate.
For example, if you have a current contract with the government to build 300 units and need money to manufacture the initial inventory, you can share your purchase order with the financier to access debt financing at low rates.
This might be a fit for your startup if you are able to secure purchase orders or legally binding agreements to pay for products or services rendered — and require money to deliver the product or service to the customer.
You can work with local Community Development Financial Institutions (CDFIs) — an organization our portfolio companies engage with — foundations and local economic support programs to access this funding at lower interest rates than traditional loans. And organizations, like our own, offer financing programs created to increase access to capital.
Accelerator Programs And Fellowships
Accelerator programs and fellowships support entrepreneurs in growing their businesses and increase the likelihood of success. Many times, these programs come with a form of mentorship and access to capital.
A couple of the top nationally recognized programs include Y Combinator and Techstars, which generally invest for a small percentage of equity. Fellowships such as Kellogg Fellows Leadership Alliance, Kauffman Fellows Program and Echoing Green, and organizations like the Urban League, generally award grants and mentorships after assessing potential impact. Other organizations like NewSchools Venture Fund, Backstage Capital and Richelieu Dennis’ New Voices Fund invest in early-stage companies through an impact or racial lens. (Full disclosure, Kellogg and Kauffman provide funding for some of Propeller’s efforts.)
Additional opportunities include pitch competitions, which can be phenomenal sources of free money. I recently spoke with a group of early-stage entrepreneurs who had raised more than $250,000 from pitch competition winnings.
If you want a better deal and a higher valuation, show as much traction as possible and wait to take on financing. The disadvantage of seeking equity financing early on is that the valuation of your company will be relatively low and the ask from an investor who is seeking to cover risk will be relatively high.
Before working with investors, try out the strategies above and exhaust your free local resources.