WHERE TO FIND MONEY

Raising funds is an important milestone in a start-up’s life and often ends up being a great concern for the founders as money doesn’t grow on trees. Who to ask for funding, under what form and when are important questions to meditate. In this section, we will have a look at the different potential investments sources as well as the different forms fund raising can have.

INVESTORS

The financing needs of the start-up will change over time and the investors to talk to will also vary over time. Here we will present your different possibilities:

Self-funding and bootstrapping: There are high chances that you might have to invest some of your own funds to start your idea’s development and bring it to a stage where other investors might get interested. Remember that bootstrapping is always possible and it’s also a good occasion to learn some new skills.

Friends, Family and Fools (FFF): For small initial investments, it is very common to rely on FFF believing in your project. Nevertheless, keep in mind that start-ups are a risky investment and only few of them manage to grow old. As is might be touchy to mix family and friendship with business, make sure you are very open about the risk that investment represents at that stage.

Crowdfunding: this option has become more and more popular in our connected society. On advantage of this option is that if successful, it allows you to create a community and eventually a first customer basis before the launch of your product or service. Also, the reward to those early investors is often based on a discount or a free products. This means you don’t have to give up equity while raising funds.

Incubators and accelerators: there are numerous structures in Switzerland offering incubation programs. Incubation can take different forms such as coaching, offices, grants or funding. Some incubators are state hold and work pretty much as non-profit organisations but some are privately own and have a for-profit activity. That means that they will probably ask for something in return like a commission on your first equity round.

Business Angels: these are private investors willing to directly invest in start-ups. Sometimes they are former entrepreneurs willing to live the start-up’s exciting adventure again and sometimes it is just a diversification from traditional markets. There are numerous groups of business angles in Switzerland where you can submit your idea for a potential match up.

Venture capital funds: they are the big guys with the big wallet. VC funds have only one goal, make a lot of money. For this reason, their approach is very standardized in terms of selection and risk scanning. VC funds know that out of 10 start-ups, around 8 will fail and have to make sure that the two remaining ones compensate for the other’s losses. These investors won’t hesitate to squeeze you to make their investment as profitable as possible for them and their stakeholders. Nevertheless, as they have deep pockets, it might be inevitable at some point to reach out to them to raise large amounts.

Loans: it is very rare to finance a seed project with loans. When asking banks for a loan, they want to make sure you will have the resources to pay it back someday. They will ask for customer lists, pre-orders, financials, etc. Chances are high that at a seed stage you don’t have enough certainty about your business’ future cash flow to convince a bank to loan you money. This might be an option at later stage once your product is sold on the market and profitability can be assessed with less risk.

Partnership: if your product or service could be integrated by another big player, they might find an interest in funding your project. This option though might tie your hands for the future.

INVESTMENT TYPES

Equity deal: this is the most common form used to raise funds. The investor provides funds and gets a certain percentage of ownership over the company in return based on the post-money valuation you agreed on (see Valuation Methods). Especially when dealing with educated investors trying to maximize their investment’s return, you might be confronted with more exotic equity deal structures including options, preferred shares, dilution clauses or stock option plans. Those clauses can have very impactful consequences on the owner’s ownership as they could highly dilute the owner to a point where he loses almost all ownership over his own company. For this reason, I highly recommend you review an equity deal with a lawyer who will be able to to inform and protect you from bad deals.

Convertible loans: Convertible loans are half-way between a loan and an equity deal. They are debt that can the converted to equity based on certain elements and triggers that can vary. First, the convertible loan needs a trigger, an event that will define when the debt is converted into equity. The conversion trigger can be a fixed date or an event such as the first financing round. The value of the company at conversion can also be defined in advance in the contract or left to be determined at conversion (for example during the first financing round). To compensate for the risk taken, the investors often get rewarded with a discount rate at conversion. For example, if the discount rate is 20% and your loan was 1m, you will convert it into 1.2m in equity. This discount incentivises the inverstor to account for the risk of not converting. If the trigger event never happens and if the loan was based on a one-year period, the owners will pay back the loan with the defined interest rate.

This method has multiple advantages in favour of the owners. First, it offers them a chance of raising funds with an option of not having to concede equity if the conversion never happens or if they manage to pay their loan back before. Also, it allows them to postpone the company’s valuation and hopefully convert at a time where the company’s valuation is higher and therefore their dilution is reduced (or at least compensates for the discount they offer). Finally, when multiple investors are onboarded at different times, it allows to convert them all at the time and at the same valuation reducing the burden of going through individual negotiation creating multiple valuations that might be challenged by the other investors.

Let’s see an example of how a convertible loan works:

The owner is looking for 1.5m in funding. He finds investor A ready to put 500k in his start-up. Three month later he finds another investor ready to put 500k and same again three months later.

If the owner had done an equity deal with each of them, investor 1 might ask for a 4m post money valuation. The deal is signed but investor 2 wants a 3m valuation considering the risk. As the owner needs cash, he accepts but that makes investor 1 unhappy because a 3m valuation dilutes him more and makes his initial investment negative at this stage. Investor 3 would have been keen to accept a 4m valuation for as the latest pricing is 3m, he of course wants that valuation too. Quite a mess!!

In this scenario, convertible debt would have been an easier way to raise funds. The owner knows he will need around a year to find 1m. Therefore, he issues a convertible debt with the following clauses:

• Debt: 3% interest rate on debt
• Trigger: 1 year from now
• Discount factor: 25% within 6 months and 20% afterwards
• Valuation: Fixed valuation in 1 year at 3m post-money

Based on this contract, the owner can now onboard all the investors with a clearly defined pricing and timeline. One year from now, all investors convert their debt into equity with the additional discount factor.

If the owner knows he needs a small bridge financing before Series A start, he could also decide to raise the bridge amount as convertible debt and define the trigger as the Series A equity deal signature with a valuation equal to the amount negociated during Series A. The structure would look like this:

• Debt: 3% interest rate on debt
• Debt time limit: 1 year
• Trigger: Series A funding
• Discount factor: 25%
• Valuation: According to Series A post-money valuation

This option allows the founder to avoid a time and resource consuming valuation process for a small amount of money. Of course, the investor might prefer to convert immediately into equity at a better pricing but if Series A never happens, the start-up might not grow and it might be more interesting for him to get his loan with interests back.

In summary, convertible loans are interesting tools as they offer a lot of flexibility in their application.

Grants: A grant is an award, usually financial, given by one entity (typically a company, foundation, or government) to start-up to facilitate a goal or incentivize performance. Grants are essentially gifts that do not have to be paid back, under most conditions. There are a lot of different start-up contests and kickstarters in Switzerland who offer grants. As they all require lots of documentation, they are time consuming but on the other hand they are a easy way to raise a couple of grants to start your idea’s development.