Globally, investors are an essential source of funding for startup companies. In fact, they are crucial to the growth of startup businesses, as their level of investment may help influence the success or failure of a company. According to the Africa Investment Report 2021, startup companies in Africa received over $4 billion from investors in 2021.
This reflected a surge of investor interest in the continent’s startup ecosystem and indicated that startup companies are on the increase. Consequently, startups must take time to learn and understand the types of investors available and the options that best suit their business needs. This will not only guarantee an efficient fundraising campaign but also ensure that startup companies target the right investor at each stage of investment.
How to Pick a Suitable Entity for your Start-up
Types of Investors
There are different types of investors for funding startups. While some are general investors, others are very specific in the stages and funding rounds they invest in. Accordingly, the following are the types of investors for startups;
VENTURE CAPITALIST
A venture capitalist provides capital to companies exhibiting high growth potential in exchange for an equity stake. Investors of this finance model are usually large institutions such as pension funds and insurance companies that prefer putting their funds towards high-risk investments.
Africa’s venture capitalist scene is fast growing. Venture capital (VC) firms injected a record $5.2 billion into African startup firms in 2021, a nearly fivefold increase from 2020 levels. Some examples of VC firms include Future Africa, Greentree Investment Africa, Ventures Platform, Oui Capital, Microtraction, and Tiger Global.
One of the reasons startups love venture capital as a source of finance is the large capital accessible to them. Unlike other models, this is arguably the most prominent channel for fundraising. Another advantage is the increased exposure and reputation it gives the startups. This could potentially lead to competitive investment negotiations with future investors. Besides the large pool of money, startups get access to industry experts and mentorship, which help make the startups successful.
The major drawback against venture capital as a source of finance model for startups is the dilution of ownership due to equity stakes given by startup founders in return for capital. Hence, unsophisticated founders may unknowingly give out major ownership in their startups for capital. This is very detrimental for founders as they may lose their rights to own and manage the startupANGEL INVESTORSAngel investors are wealthy private individuals who offer promising startup companies funding in exchange for a piece of the business as convertible debt or ownership equity. Angel investors are willing to invest in small companies and are more flexible with their agreement terms than venture capital firms.
Most times, startup companies approach angel investors when it comes to the seed round and beyond. Sometimes, a group of angel investors invest online through equity crowdfunding or organize themselves into angel groups or angel nets. The provided capital could either be a one-time investment or a continuous injection of funds to aid the business through its strenuous initial stages.
There are generally two types of angel investors, and they are; affiliated and unaffiliated. The former refers to investors who have a relationship with the entrepreneur or the startup or are acquainted with them in some way. In contrast, the latter refers to investors who have no connection to the entrepreneur or the startup.
Angel investors are different from venture capitalists because they use their funds to finance companies, unlike venture capitalists that use funds from other investors to finance startups. Aside from financing the startups from their own pockets, angel investors sometimes band together and contribute to form a group fund for potential investments.
CROWDFUNDING (EQUITY, DEBT AND DONATION-BASED)
Crowdfunding involves raising funds for a project or cause through a large group of people online. Usually, it is a form of financing used in the early stages of startups where some potential individual investors are offered company securities in exchange for funds in an entity.
Each investor invests in the company through a digital platform that acts as an intermediary. Examples of online platforms for crowdfunding include Kickstarter, Indiegogo, Patreon, and Gofundme, among others.
Debt crowdfunding collects funds from a large pool of investors in return for the payment of the principal sum and interests. Equity crowdfunding occurs when a startup publicly offers its equities in the form of securities to investors in exchange for financing.
Donation-based crowdfunding involves selling ideas to people who believe such ideas and are willing to donate to see such ideas launch and become profitable. Interestingly, this type of financing does not give ownership or interest to the investor. The investor does not get any financial benefit, and in return, the startup owes the investors nothing.
One of the advantages of the crowdfunding model is that it makes investment more accessible to founders when compared to other types of financial models. However, in the effort to build trust and transparency to the public, startups may show too much to the public. They may be susceptible to being hijacked by competitors who have better financial leverage and resources to be better at what the startup does.
BUSINESS INCUBATORS
A business incubator is a company that enables the development of other companies in their early stages through mentorship, networking, education, and financing for some time, usually three months. Monetarily, funding could range from $10,000 to $120,000.
Business incubators provide a variety of services to startups which include but are not limited to; advisory services, business management training and helping the startups with some of their core operations.
The most apparent advantage of adopting a business incubator as a source of finance for startups is the indirect capital available to startups for working expenditures like office spaces, equipment and tools, which are all given to these startups in incubation.
Another benefit of a business incubator for startups is easy access to investors. Most startup incubator platforms are collaborations or partnerships with investment firms or organizations interested in funding startups. Thus, startups have the opportunity to meet investors and build relationships with them not just for the incubation period but for future fundraising.
The major disadvantage of business incubation is that a startup in incubation can almost not avoid having to disclose its business model, business process and every information that should be kept secret. This is because an incubation program usually requires that cohorts (startups) share their ideas and information to be adequately trained before launching into the market. As beneficial as this is for startups, they must protect every potential intangible property that needs to be protected for its intellectual property rights.
BANK LOAN
A bank loan is a sum of money that an individual or a company gets from the bank to be paid back with an interest fee. Technically, banks are not investors but sources of capital for startup companies. However, banks can invest in businesses, but they need to ensure safe investment.
One attractive feature of bank loans for startups is access to large capital without giving up ownership, unlike Venture Capital, which provides significant capital for some ownership in a startup. Furthermore, bank loans provide a wide range of financing options, making it flexible for startups to choose the perfect product loan for their needs.
Sometimes, startups could choose different bank loan products at the same time. However, these startups should work with experienced attorneys that can help choose the right loan product without overwhelming the startup in the long run.
The disadvantage of bank loans is their non-inclusive nature. Large capital cannot be sourced from banks as loans where the startup has no assets and is not sustainably profitable. Hence, bank loans may only be ideal for startups in the growth phase. Another disadvantage is the complicated process involved in accessing these funds.
GOVERNMENT GRANTS AND SUBSIDIES
A government grant is an award given by either the federal, state or the local government for beneficial projects. The most appealing thing about government grants is that, unlike loans, the person receiving the funds or the grantee does not have to repay the money given out to them.
The biggest disadvantage of business grants lies in how difficult it can sometimes be to receive them. Twiga Foods is an example of a startup that received a $2M grant from the U.S. Agency for International Development (USAID) in 2017. Twiga Foods, founded in 2013, is a Nairobi based startup mobile-based supply platform that connects farmers and vendors to markets.
In conclusion, most startups depend on investors to run their business irrespective of the stage. Hence, efficient fundraising for a start-up requires understanding the different types of investors available so as to know the most suitable one to approach based on the startup needs and the stage of the startup, and how to approach them.
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