Startups are constantly looking for funding to support their growth. Here is a brief explanation of the different types of investors that typically support entrepreneurs in their journeys.
Friends and Family
These are people you (obviously) know personally and who decide to help you in your endeavor. Think “rich uncle”. These investors usually have little or no knowledge of your business or industry and are investing in your company because they want to support you. They are “betting on jockey, not the horse”. They normally – hopefully! – do not get too involved in the business. To avoid problems in case the business fails, make sure you are completely clear about the risks of the venture and that you make them comfortable to turn down your investment offer.
Angel investors are high-net-worth individuals who provide capital to a startup, usually in exchange for convertible debt or equity (typically receiving anywhere between 10-30% ownership) and a sit at the Board. Angels usually give support to startups at the initial moments, when risks are very high and institutional investors are not willing to come in. Angels are often successful entrepreneurs or executives themselves, ideally in the relevant industry, who can provide mentorship and contacts on top of money. Although they understand risk, they invest professionally and expect a return on their dollar.
Venture Capital (VC)
A VC fund is a firm that provides equity financing to startups that have been deemed to have high growth potential and which have demonstrated initial traction (usually in terms of contracts or revenues). VC funds invest in a later stage than angels, but still take on substantial risk in the hopes that some of the startups they support will become successful. VC managers usually ask for a sit at the Board and are well connected in their industries.
Impact investment funds invest in companies with the objective of generating positive, measurable social or environmental impact alongside a financial return. They invest through debt, equity, convertibles and other instruments. Impact investors may accept below-market financial returns depending on the investors’ strategy and the companies’ abilities to meet impact targets. Typical sectors they support include sustainable agriculture, renewable energy, microfinance, and essential services such as housing, healthcare, and education.
Banks are financial institutions whose core business is to provide loans to companies. They are extremely risk averse and only loan to companies that can prove they have collateral (e.g.: property, inventory, and other assets) and the ability to pay back (e.g.: revenues, receivables etc.) Banks are more suitable to companies that have already broken even, with predictable cash flows, lower risks, and tangible assets – i.e., usually not a great option for early-stage startups.
Crowdfunding is a way to raise funds in a pulverized way, with small contributions from a large number of people, most of whom you don’t know. Contributions are made through online platforms to support a cause, or in exchange for perks/product, equity, or debt. Examples include global names such as Kickstarter and Kiva, and country or regional platforms such as PayPutt (Ghana), Lendahand (Netherlands), EqSeed (Brazil). It is a great way to fund product development because you get paid even before the product is ready for sale. Equity and debt crowdfunding options vary country to country depending on local laws and regulations.