Why entrepreneurs are asking for funds earlier than ever before
Recent years have given way to the popularity of fundraising. Think Shark Tank. Demo Days. Seed, Pre-Seed, Stage A-Z Rounds.
The widespread amount of capital flowing to startups, media attention of reality TV shows like Shark Tank, and proliferation of accelerator models has created a greater sense of urgency for new entrepreneurs to ask, “So now that I have this idea, how do I get funded?"
With a $72B Venture Capital Market (Statista, 2017), raising funds seems trending towards the metric of success and forgetting that the capital should be used as a mechanism to achieve success.
The latest academic research seeks to examine how the role of fundraising is changing the entrepreneurial landscape. Here’s a quick overview of the latest findings:
Two dominant reasons why funding has become part of the mainstream conversation is because of the decreasing cost to start a business and the rise of types of funders (Drover et al., 2017). First, the rise of Internet and tools like Amazon Web Services estimates the cost to start an Internet-based business has decreased from $5M in 2000 to $5K in 2011 (Suster, 2012). The significant drop in costs allows more businesses to hit the ground running and ask for very little compared to pre-Internet days. Second, there has been a significant rise in sources and structures of financing. Gone are the days of debt from banks and equity from venture capital as angel groups, crowdfunding platforms, and accelerators have entered the sector with a variety of unique ways to fund startups.
What funding is available now
Venture capital firms are typically small, geographically concentrated entities that mainly participate in deals mistake to late stage (Gompers & Lerner, 2000; Sorenson, 2007) and continue to drift to larger and later-stage investments. Crunchbase recently noted the largest amount of $100M venture capital deals in Q2 of 2018. The trend towards larger and later stage investments is because of the demand to provide return to their limited partners within a fixed time frame, mostly between 7-10 years (Hellman & Thiele, 2015). As venture capital trends to fund older startups with larger sums, new sources of financing have become available for smaller startups.
While venture capital has also served as a signal to potential follow on investors quality and likelihood of success, stories of fraud such as Theranos have given investors a reason to pause and take less risk on earlier stage investments. Earlier stage investors have risen in importance for new businesses. Angel investors, and more specifically, angel groups provide platforms for angels to evaluate and invest in earlier stages (Kerr, Lerner & Scholar, 2014). Crowdfunding and accelerators have experienced rapid growth to provide capital at earliest stages in exchange for equity in the company (Hathaway, 2016).
The modern entrepreneurial funding landscape includes a variety of sources and structures of funding. Entrepreneurs must consider the important implications that come with these newer types of funding. Crowdfunders, for example, may provide less ownership expectations than angel investors, but also may not provide as much feedback for entrepreneurs as they may need ( Agrawal, Catalini, & Goldfarb, 2016, Drover et al., 2017). Conversely, accelerators may provide intense ownership but less market-feedback than crowdfunders who may also be important consumers of the startup (Hathaway, 2016).
What entrepreneurs should consider
Academics and practitioners are continuing to explore and understand the modern startup funding landscape with a cautionary eye. As one prolific venture capitalists notes, “You’re either spending time fundraising or spending time on your business. it’s impossible to do both,”. While fundraising may be important, entrepreneurs should consider not just how much funding to raise, but when, if and how they are ready to raise funds. Research points to such cautions as there are serious ownership considerations (Cochrane, 2005), quick milestones (Allen & Hevert, 2007), and strategic choices (Hellman & Thiele, 2015) an entrepreneur must make. While these are all part of the trajectory of a startup as it grows, pushing those goals earlier in the lifecycle of a startup may lead to spending more time on the presentation than the operations.