When it comes to raising funds for startup environment, you need to keep in mind that you have many options. You've probably heard about equities, loans, convertible debts, but do you know the exact differences? Apart from these classic types of fundraising, new options keep appearing - such as private token sale, also known as ICO.
Classic types of fundraising
Loan
A loan is undoubtedly the simplest way to raise funds. You ask for money and then pay it back with interest.
A loan is the best way to get money when you need a small amount of cash (usually not more than 100.000 $).
The loan is usually secured - you have to put up collateral for a loan for investors to be safe if you won't be able to repay the sum.
Loan is also the option when you need money quickly or are reluctant to offer somebody a stake in your company.
Example: you need $ 800.000 to hire more people and enter new markets. You take a 3-year-loan, APR (annual percentage rate) is 10%. You’ll have to pay back $ 800.000 + $80.000 * 3 (yrs) = $1.040.000.
2. Equity
Equity is a form of fundraising that is specifically attractive for founders with grand plans and a clear vision of their company development but, unfortunately, lacks collateral. In exchange for money put into, investors receive a stake in your company. If you resort to equity fundraising, you are to value your company correctly - investors will get a stake based on your valuation. You can use our valuation calculator not to get in trouble.
For example, you've calculated that your company is now worth $ 1.500.000. An investor that's ready to give you $ 600.000 will receive 40% equity. As soon as your company sells or goes public, the investor gets proportional (in our case, 40%) compensation.
Equity is your option when
Your business is up-and-coming, but it needs time to develop. Equity investors are ready to wait if they see prospects.
You don't have anything to secure a loan.
You can't bootstrap - you need an impressive amount of money from the outset.
You do have a great plan and believe in yourself - investors won't risk if you're not self-confident.
The advantage of equity - it has nothing to do with repayments at the exact time. However, remember about the points below:
It takes time to find an equity investor. There are a lot of entrepreneurs eager to raise funds - and there are much fewer investors. Be ready that your business will be examined from every angle. (check our due diligence checklist)
There is almost no way back - once an investor got a share of your company, they are likely not to give it back. Find an investor that you'll be able to work with comfortably.
The new type of fundraising - Initial Coin Offering (ICO)
Initial Coin Offering can also be considered as quite an easy form of fundraising. Initial Coin Offerings (ICOs) create digital tokens by small companies to investors in exchange for fiat currency (euros, dollars) or another dominant cryptocurrency. ICOs are enabled using Distributed Ledger Technologies (DLTs), such as the Blockchain, which facilitates the exchange of value without the need for a trusted central authority or intermediary, allowing for essential efficiency gains driven by such disintermediation.
ICOs enable value creation through the potential development of network effects, and efficiency gains were driven using the Blockchain. In addition, it is favorable among startups because they do not have to give up any equity, and any retail investor can participate in the fundraising, which makes it a much more accessible form of fundraising.
There are different types of ICO's like IDO or IEO
Initial Dex Offering or IDO is when a project launches a token through a decentralized liquidity exchange.
Initial Exchange Offering or IEO is when crypto projects launch their tickets and raise funds via a centralized sale.
There are some pros and cons in both types of fundraising, and it's upon startups which one is preferable to them.
Example: One of the first and successful ICOs is Ethereum, a smart contracts platform with a crypto token named Ether. In 2014, the Ethereum project was announced, and its ICO raised $18 million in Bitcoins or $0.40 per Ether. The project went live in 2015. About 30% of the total supply of tokens was given away for ICO. Today, the Value of one Ethereum Token is around $2,400.
It might seem that ICO is a way to go, but it is crucial to note that there are many factors why you should not go with ICO: It's essential to see whether your product needs a crypto token or not; if not, it's better to avoid ICO. Many projects, just for the sake of fundraising, introduce an unnecessary crypto token. It takes down the credibility of a startup and creates a mismatch among the project and investors, which is not efficient for a startup in the long term.
Whereas, Raising money via equity from traditional investors gives you a strong trust score because of their long due diligence process, which helps in PR and further expansion. Also, conventional equity investors bring a lot of experience and network with them, which allows business guidelines and builds valuable connections.