Overview Of Entrepreneurial Funding
Everybody agrees that creating a strong entrepreneurial environment can be an important driver for a community’s economic prosperity. Entrepreneurs can start their businesses up virtually anywhere with today’s communication technology. But, if accessing funding becomes a major challenge, it is unlikely any start-up business will survive let alone thrive. Communities need to objectively assess if startup and growth funding is reasonably available to entrepreneurs. If not, then any identified gaps needs to be addressed. Failure to do so will make it unrealistic for a community to rely on entrepreneurial startups as a strategy for local economic development.
But, what type of funding do entrepreneurs need?
While we can all agree access to funding is important, I am not sure we necessarily understand what that looks like. When I first started studying this area, I found terms like “Angels” and “Incubators” and “Venture Capital” confusing. When does a business qualify for the different funding sources? Where do they even apply for the funding? Who is in a position to help a community establish a missing funding stream? All these questions (and more) made the idea of building a strong entrepreneurial environment a real challenge.
I found a Forbes Magazine article that provided a nice overview of typical ways to fund a startup business entitled “The Non-Entrepreneur’s Guide To Startup Funding”. It was a starting point for me to better understand just how an entrepreneur gets access to the money needed to bring their product/service to life.
The Forbes article was a good start, but additional research suggests it just scratched the surface. Another article I read was the ABCs of Small Business Funding. It gave me additional perspective, and the puzzle became a little clearer.
Four Major Funding Sources
Based on what I have learned to date, I believe there are four major funding sources you need to make certain are available (or accessible) in your community if you want to nurture entrepreneurial success.
Angel and Seed Stage Funding
This funding helps startups with early market research, product development and building a management team. The typical investment is between $500,000 and $2 million. Investors make their decision whether to fund a project based on the perceived strength of the idea and the capabilities, skills and history of the founders. Angels typically invest their own funds. Angel investors are often retired entrepreneurs or executives, who may be interested in angel investing for reasons that go beyond pure monetary return. These include wanting to keep abreast of current developments in a particular business arena, mentoring another generation of entrepreneurs, and making use of their experience and networks on a less than full-time basis. Thus, in addition to funds, angel investors can often provide valuable management advice and important contacts. Angel capital fills the gap in start-up financing between “friends and family who provide seed funding—and formal venture capital.
This funding helps startups keep moving toward early-stage funding. The typical investment is between $2 million and $5 million. This is the proof of concept phase for many startups and it is critical to securing later stage funding. For angel investors, seed-plus means there is a good business plan and maybe a prototype, but not necessarily customer revenue. For Venture Capitalists, seed-plus means customer revenue is less than $10M.
Early Stage Funding
This funding helps startups build teams, accelerate sales and marketing after entering the market. The typical investment is between $3 million and $6 million. It may also include mezzanine funding to expand operations. This is sometimes called Series A funding. Series A rounds are a critical stage in the funding of new companies. A typical Series A round purchases 20% to 40% of the company, and is intended to capitalize the company for 6 months to 2 years as it futher develops its products, performs initial marketing and branding, hires its initial employees, and otherwise undertakes early stage business operations.
Later Stage Venture Capital
This funding helps startups that are generating sales and revenue become profitable. The typical investment can be more than $5 million. This is sometimes called Series B funding. Its time for Series B when the product is successful and the market demand is evident. Series B is about taking something that works and scaling it as fast as possible.
Obviously, very few communities are going to have investors from each stage available locally. But, it is important local entrepreneurs have access to the funding they need. That means understanding where the money is and what is required to access it. The more transparent this network is, the more nurturing an entrepreneurial environment your community will have.
I think the strategic objective is to first create the required network and transparency, and then facilitate efforts of local entrepreneurs to leverage that network. Based on my observations, most economic development professionals do not have a deep enough understanding of what the network looks like let alone what the gaps in that network might be. Without such knowledge, it is extremely difficult to create a competitive advantage with entrepreneurism as a local “How To Win” economic growth strategy.
How well do you feel your community leadership understands what entrepreneurs need to be successful? Does your community know what the current gaps are in entrepreneurial funding sources, and is there an action plan in place to close them? Or, do you feel local leadership talks about the importance of having a strong entrepreneurial environment, but have no real plan to create one? What do you think the biggest barriers to having an effective plan are?
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