6 Options for Financing Your Startup

THE INSTITUTEAfter reading IEEE Fellow Chenyang Xu’s suggestions for the four actions engineers can take to help their startup succeed, several readers asked him for guidance on pathways to get seed financing for starting a venture. Xu has been working with and advising entrepreneurs and investors since 2002.

“Raising funding is one of the biggest challenges an entrepreneur can face,” Xu says. “When engineering founders start to build a company, they often do not realize there are multiple pathways for seed funding. Knowing all the available funding sources can help them choose the right approach.”

Before you start asking for money, Xu suggests, make sure your idea is worthy of building a company around. Get feedback about the viability of your planned venture from contacts who have commercial and investing experience in the targeted technology and market spaces, he says.

“Many engineers think they can launch a startup based on an expansion of a product’s features or functions they’re working on, but these ideas are too narrow,” Xu says. “You need a game-changing technology or product combined with an innovative business model that addresses unmet market pain points.”

Once you have a solid business plan and a working prototype, check out the following six sources of funding to get your venture off the ground.

SELF-FINANCING, FAMILY, AND FRIENDS

Before seeking outside funding, founders with financial means often bootstrap their venture with their own money. Even a modest amount of cash could get the company started and take it to a point where an early prototype could be built. If there are multiple co-founders, each might contribute to the seed funding to increase the amount of working capital.

Beyond yourself, the most obvious people to ask for money are relatives and friends. But you should tread carefully, Xu cautions. “Because money is a touchy subject,” he says, “proceed with care, because you can put these relationships at risk.”

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ANGEL INVESTORS AND EARLY-STAGE VENTURE CAPITALISTS

Angel investors are wealthy individuals who invest in startups in exchange for equity. In addition to individual investors, there are angel investment clubs. You can find investors and investment clubs through acquaintances and referrals, or by conducting an Internet search, Xu points out.

An angel investor, though often the first source of outside seed funding, likely will need more convincing than family and friends, so you must be prepared with a solid business plan and answers to possible questions on all aspects of the business, such as profiles of your team members, the marketing plan, market opportunities, and financials. If a working prototype exists, demonstrating how it works is always more convincing than just presenting your plan, Xu says.

Angel investors are likely to be located where there is plenty of entrepreneurial activity, such as Silicon Valley, Boston, and Tel Aviv. But, Xu says, it’s getting easier to find such investors all around the world, especially in Asia.

Early-stage venture capitalists are another source of seed funding. Unlike angel investors, VCs are employees of firms who invest from a fund financed by other wealthy people or organizations. Early-stage VCs often focus on certain investment areas or industries. Founders seeking VC funding should check the firm’s investment criteria before reaching out. Compared with angel investments, the VCs’ process tends to be more rigorous, and their decisions typically need approval by other partners.

Founders need to allocate enough time for meetings with angel investors or VCs, Xu says.

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ACCELERATORS AND INCUBATORS

There are tens of thousands of accelerators and incubators for startups globally, Xu says.

Incubators provide shared office space and other services such as mentors, investors, and even prospective customers for free or at little cost in exchange for a small amount of equity.

Instead of offering office space, accelerators provide training programs in exchange for a small amount of equity. They offer mostly three- to six-month programs that can help a startup refine its idea and develop its business plan. At the end of the program, accelerators help to convene investors to participate in funding pitches, which substantially increases the startups’ odds of raising initial funding.

Although not common, some incubators and accelerators also provide early-stage companies with a small seed investment.

Plug and Play is one of the best-known incubators. Y Combinator was one of the first accelerator models. Xu says some incubators and accelerators are focused on a specific theme such as materials science, robotics, or agriculture technology. Commercial business-to-business accelerator programs include Alchemist Accelerator and TechStars.

Engineering universities around the world have incubator and accelerator programs to help their students and recent graduates, Xu notes. Some well-known ones he cites are SkyDeck at the University of California, Berkeley, and Delta V at MIT. [READ MORE]