After you incorporated your start-up business, the next major question you will face is how your business will be financed. While you might already have great ideas and the people to make these happen, you will also need funds to materialize these ideas into reality. Depending on your business plan and cash needs, you will search for funds from different sources and types of investors. For founders, it is important to understand that each type of investor comes with both advantages and stumbling blocks. Therefore it is important to have a clear understanding of what you are looking for in an investor. Please note that the following overview includes generalities, yet each individual relationship will differ, depending on the specific start-up and investor.
Investor types – focus and limitations
Friends and family
Those closest to you might often be the quickest way to generate some cash for your company. With a "friends and family" financing, you can raise initial funds to get you off the ground, however soon thereafter you will have to reach out to additional investors, such as accelerator programs (governmental, semi-public or private support programs) or business angels (focused small investors) as well as high net-worth individuals / family offices. Depending on your business plan, you will then either remain with the private funding of individuals or go big.
For companies with a low need for cash, a "friends and family" round can be an attractive starting point to keep the investor base small and close to your heart while at the same time avoid strong dilution which allows you to keep the reins in hand as long as possible. However, for cash intensive businesses, such as biotech or medtech, "friends and family" will most likely not suffice to get the business going.
Accelerator Programs
Depending on your line of business, it can be interesting to reach out to private or government funded accelerator programs such as Venture Leaders or Innosuisse. These programs often include not only funding, but also access to coaching programs where you can refine your skills as a business person. If you do not have access to certain business knowledge like management, financing or business development, accelerator programs can be a great way to receive both cash and knowledge, sometimes also combined with networking opportunities to connect with further investors. Depending on the program, it is even possible that such financing will be granted on a non-dilutive basis, meaning you will receive the cash without having to give away equity in your company in return.
Business Angels / High Net-Worth Individuals / Family Offices
Smaller private investors include among others business angels that are specifically searching for interesting businesses to grow, or high net-worth individuals and family offices that wish to diversify their investment. Private investors are often interested in seeing you succeed, while at the same time not interfering too much on the business side. This materializes e.g. through small or even no due diligence prior to the investment and only limited involvement on board level. While you might also get funds from friends and family, keep in mind that professional private investors as presented in this section will have extensive knowledge in the area of investment growth and market development, therefore even though they might not perform an extensive due diligence on your company, they will have assessed whether or not it is worth investing in your company. Also, do not be mistaken, there are certain private investors which can provide extensive funding to start-up companies in comparable sizes to amounts from venture capital funds.
Strategic Investors
Apart from your ideas and your man power, you might also need certain industry specific support to grow your company. A strategic partner will provide you funds either through an investment or a business collaboration to help you develop your business and products. Further, compared to a venture capital fund a strategic investor is either itself an operational company or directly linked to one in your field of expertise. The strategic investor sees your product as a potential future addition to its own range and can provide you both with funds but also knowledge and connections in the industry. A strategic partner that comes in as an investor is also very often the first point of contact if you are moving your company towards a successful exit.
Venture Capital Funds
If you are looking into financing by a venture capital fund, please be aware that the main purpose of a VC fund is to create a positive return on investment. While of course each of your investors hopes to create more money from your company than what they invested initially, the VC fund will work on potentially shorter timeframes in which they want to see such return be realized. An area specialized VC fund can also be a great source of knowledge and connections, however they might be more eager to go towards a quick exit than other investors that see the potential of a more profound development of the start-up. In addition thereto, please be also aware that a professional fund that is solely set up to give money and make return on it, the VC fund often has the most extensive requests in regard to due diligence and your future business planning and management.
Forms of Investment
After you found an investor who is interested in your company, you need to decide how that investor shall bring money into your company.
Cash Investment
In case of a cash investment, the investor will pay a certain amount of cash as a subscription price to a blocked escrow account at a Swiss bank, which will only be released to the start-up upon successful registration of the formal documentation of the capital increase in the commercial register. Cash investments against equity shares are a classic and straight forward way to get funds into your company. If you deal with foreign investors, it is important to inform them that their investment will first go to a specific blocked escrow account and will only be released upon registration of the capital increase for their equity in the commercial register.
Loan Conversion
An alternative to a cash commitment is the convertible loan, whereby an investor directly disburses a certain cash amount to the company's regular business account and at a later point in time, instead of repaying the loan amount, the company will later issue equity for a certain subscription amount against which the loan amount is set-off. For a company, convertible loans are an interesting instrument because cash goes directly to the company account and is accessible from day one. For the investor, a convertible loan can be interesting if the commercial terms include an interest accrual on the loan amount or a discount on the price upon which the loan amount will be converted or a combination of the two. Additionally, there is no need for a company valuation when agreeing on a convertible loan, which makes the convertible loan faster and less complicated in comparison to a cash commitment transaction.
Collaboration
Apart from becoming a shareholder in your company, certain investors might also be interested in funding your company by entering into a business development relationship, be this in form of a license agreement or collaboration agreement, where your company will closely work with the investor on a development project to create growth opportunities not just through cash but also through directly applied knowledge.
Lifecycle and Exit
While there are several options on how your start-up can develop, the "successful Exit", meaning the sale of all shares by founders and investors to a third party is often portrayed as the ultimate success. However, to get to an exit or, alternatively, to a self-sustaining business, you might undergo several financing rounds to grow your business, which can start with family and friends rounds to then work yourself to wherever you and your professional investors want to go.
Whether you are looking for the big bucks and early exit with the help of a venture capitalist or are working on a long term strategy to satisfy your private investors, there is neither right nor wrong. However, before approaching an investor, make an effort to research their portfolio and check whether the specific investor knows your industry and will provide you with the support you are looking for, both cash and knowledge wise. In doing this research prior to approaching certain investors, you might realize that e.g. the private investor is more interesting for your business than the big venture capital fund, which can save you a lot of time and effort. Also, be sure that you have clarity on whether you are looking for a cash commitment in a few months or a convertible loan which shall be disbursed rather sooner than later, to make every contact as successful as possible.
Author: Pauline Pfirter
More blogs from the series:
- From Concept to Reality: A Practical Guide for Start-up Founders on In-corporating a Swiss Legal Entity (Nr. 1)
- Successfully growing a Start-up: Stages of Funding (Nr. 2)
- The shareholders' agreement in the Start-up (Nr. 3)
