Written by: Gal Shefer & Allon Sasson
“I have a great startup plan, where can I raise money?”
This simple question brought to us by a student taking part in a young entrepreneur’s program, expecting a simple and short answer.
Having realized that there are several options, and the choice in between is “depended on…”, we’ve decided to look at the list of sources from which entrepreneurs can raise capital according to two discussed criteria that were particularly important: the first is how much money can one usually receives from this type of investor, and the second is to what extent the funders influence the growth of the startup.
TL;DR— There is a great correlation between the amount of money that can be obtained from an investor and the degree of plan’s impact and control that is expected in return of the taking the investor position (this usually also correlated to the startup development stage), but this is not a complete match.
Beyond that, looking at the potential investors’ map is a good starting point for an entrepreneur, but he/she should answer few more questions prior proceeding and choosing an investor. The first question is, of course, what’s the use of the funding round? Is it for completing a technology proof of concept, to raise additional manpower, to break into new markets?
in the last section of this article it is shown that for each of the investment options there are advantages and disadvantages, based on the purpose of the investment.
How did we structure the investment types map?
There are a huge variety of possible sources for funding startups — from self-financing (bootstrapping), through raising from a venture capital fund (VC) to IPO — these are very different from one another.
Naturally — we have mapped all common and well-known sources of investment, such as banks and venture capital funds. In addition, we did not want to ignore other entities that can help fund the startup even though their focus is not necessarily on funding but on helping startups in the growth process, where money is just one component. In this group we included incubators / accelerators and strategic partners.
We also included the once desired ‘exit’ (acquisition) on the entrepreneur’s roadmap of raising capital for the startup, but in practice, it should be noticed that for some entrepreneurs this is the stage of separation from the startup and the transition to their next startup as they no longer have the right to make decisions in the company.
At this stage we did not include unique or less common investment options such as credit loans and hedge funds. If you think we missed any option — write us in the comments!
It’s possible to present all investment sources according to more parameters, such as the purpose of the investment, or the startup stage. However, we preferred to keep the basic analysis based on the two questions that concern the entrepreneur (and ourselves), because it offers to explore a broader picture, relatively easily, on one graph. We kept the super important highlights as supplemental information, which is important for any entrepreneur to consider before choosing the specific route that suits them.
What have we learned from mapping the investment types?
It’s possible to spend hours discussing each of the capital raising options available to the entrepreneur and their similarities or differences. We chose to focus on just three highlights that came to mind while done adding all on the graph.
First, there are many options for raising capital! It’s not at all trivial when you think about it, which means that there are many funds looking to conduct smart investments, and if you as an entrepreneurs believe in your product and its uniqueness — don’t rush to raise money from the first place you came to or the first investor you’ve met— look carefully at all your options and try to make the most of your equity, as you may add on board another entity who wants to know what your plans are and even influence it.
Another thing that can be seen from the graph is that there is a relatively high correlation between the amount of investment that can be raised in each of the sources and the degree of involvement and impact the investor expects — the higher you scale up on the impact scale, the more right you go on the axis scale that goes between those who want to learn and succeed, those who want to earn to those who want to influence and those who want to decide.
The third point to emphasize when comparing different investment options is that each of the different entities has a certain range of impact, and the actual impact on your startup depends on many factors. A significant point that will determine, for example, the extent to which an investor intervenes, is whether he/she sees your startup as merely a financial opportunity or has its own vision or plan for your startup involvement in their other business activities. If the answer is close to the second option — he/she probably has a lot to say for every dime invested in your startup.
And the last point to keep in mind when looking at the list is that despite the large number of options — no one guarantees that one of the investors will eventually want to invest in your startup… Professional investors meet a lot of entrepreneurs, all of them are passionate and motivated, and they have to make an informed decision where to spend their money in order to later see It returns with high profits. In addition, every professional investor also has an investment policy — areas he believes in, preference for investing in early or late stages of startup life, desired founders’ team, strategic fit to broader activity and more. It may just be that you are not meant for each other.
A brief explanation of each of the investment types
What does it mean? Self-financing, funding from the entrepreneur own pocket. If you don’t believe enough in your venture to invest in it — why would others believe in it?
Can elaborate? For most entrepreneurs, this is a temporary step on the way to raising external capital, but if that is the case — no one can interfere with their plans. Some people attribute the origin of the name ‘Bootstrap’’ to Baron Munchausen, who managed to get himself out of the egg by pulling on the shoe strap without no-one’s assistance, but there is no real evidence of this version of the story…
Is there an example? There are some companies out there that remain as a ‘bootstrap company’ and avoid external fund raisings, one of which is ‘Natural-Intelligence’ which employs more than 400 employees and gains annual revenues of more than $ 300 million!
What does it mean? ‘Friends, Families and Fools’, sounds like a joke, but in practice it is an early-stage round of investment from family, friends and other innocents.
Can elaborate? Most people who are categorized as FFF understand that their chances of seeing investment returns are low, but this is the first circle of support for most entrepreneurs. Without this funding round, many of the startups that later became large companies would have never reached a later major stage of capital raising.
Is there an example? In fact, whenever you asked Dad or Mom for some money to buy equipment or materials for a new hobby — you used the FFF funding source (meant Family, not to cause misunderstandings). In any case, it is always good to have your request for funding accompanied by a good story.
What does it mean? Like any other business, a startup can also request a cash loan from the bank. The difference will probably be the percentage of interest on the loan, since it is a high risk loan.
Can elaborate? The advantage of bank credit — the bank does not ask for a percentage of the company’s equity and does not want to interfere in its management decisions. The downside — a loan must be returned, and delaying schedules can put the company in real trouble when yet to show significant revenues.
Is there an example? Even if you are an entrepreneur who develops a tech product designed for banks in the field of fintech — you will probably have to go through the bank to take out a loan…
What does it mean? Incubator / startup accelerator supports young startups in starting a new business initiative and build primary product through sharing knowledge, offices, relationships and financing.
Can elaborate? The various acceleration programs are mostly time limited, with the aim of enabling the startup to build strategic partnerships and reach the next funding rounds. In addition, some programs ask for a small percentage of ownership in the startup.
Is there an example? It is estimated that there are over 5,000 incubators and tech accelerators in the world, of which over 120 are in Israel, alone.
What does it mean? State grants are given to startups as part of a government strategy to encourage the economy and the high-tech sector, from a systemic plan to support the industry and not necessarily from a business perspective.
Can elaborate? Most of the state grants in Israel are provided through the Innovation Authority, according to state-defined criteria.
Is there an example? As part of the response to the Covid19 crisis, the Israel Innovation Authority allocated NIS 1.3 billion of fast grants to startups, of which NIS 500 million are for growth stage startups.
What does it mean? ‘Angels’ are private investors who invest their private money, seeking high returns and to diverse their portfolio.
Can elaborate? Angels invest as individuals or in groups (syndicates), usually in the early stages of startup life cycle. In return for the investment, the angels ask for a company share, and most often offering their ‘know-how’ to consult the company in engaging with potential partners and perform businesses development. The ‘Angel’s Law’ in Israel provides tax relief to the Angels in favor of encouraging investment.
Is there an example? In the ‘Shark Tank’ TV show, entrepreneurs are seeking funding for their startups from angels. Jamie Siminoff, founder and CEO of Ring who found himself without funding for his venture, presented on the Shark Tank TV program and requested $ 700,000 to develop a smart doorbell. He was rejected by the Angels on the show and it became his startup low point, but it forced him to succeed. Later he had received funding from investors among Sir Richard Branson; five years later Amazon bought Ring for $ 1 billion.
What does it mean? Crowd funding is an act of raising investments or donations from broad public groups, which are not necessarily professional investors.
Can elaborate? Crowd funding existed even prior the Internet era but has expanded dramatically with the advent of digital platforms such as ‘Indiegogo’ and ‘Kickstarter’, and with supportive legislation around the world. There are different models of crowd funding — some models that are more akin to public’s contribution and some like venture capital investment, spread among masses of small/medium angel investors.
Is there an example? OurCrowd is the largest crowd sourcing fintech firm to be founded in Israel. OurCrowd community consists of approximately 30,000+ accredited investors from over 183 countries. OurCrowd has raised over $1B and invested in 173 portfolio companies and funds, with 29 exits to date. As of 2020, it is considered to be the most active investor in Israel. Israelis also founded other crowd funding platforms such as Pipelbiz and Exit Valley.
What does it mean? A venture capital fund is a private equity fund that raises funds from various accredited investors (‘Limited Partners’) and invests it in startups in anticipation of high returns.
Can elaborate? There is a wide range of venture capital funds with different characteristics — corporate or private, international or local, etc. Each has a different investment strategy and policy (preference for early / later rounds, focus on specific technologies, etc.). In return for the risk taken, the fund usually seeks for a major percentage of equity in the startup.
Is there an example? Throughout 2019, 308 VC deals were closed in Israel with a total value of $ 6.4 billion.
What does it mean? A strategic partner is a firm that has the capability to add value or leverage startup capabilities in a way that serves both parties.
Can elaborate? An investor who is a strategic partner will usually make a significant investment in the startup, but more importantly — contributes additional assets other than funds, which the startup will find difficult to obtain in other ways. Such a partner could be, for example, a giant company with existing customer base that the startup products can fit into, or a company with complementary technology that sees the partnership as a way to significantly shorten the development processes.
Is there an example? A recent example of such a strategic partnership is the investment of several millions dollars (exact scope has not been revealed …) of Visa Inc. in the Israeli startup ChargeAfter which offers businesses a financing online platform for its customers from a variety of sources at time of making an online purchase.
What does it mean? The Private Investments Fund (PE) is typically a partnership between a number of businessmen who raise capital from various entities, such as pension funds, banks, or accredited private investors (‘family office’), and invest in companies that usually are ‘cash-flow positive’ already, for a predefined period of time.
Can elaborate? Private funds will most often look for their investment opportunities in for-profit companies that are expected to continue to earn in the next 5–10 years. The fund will strive for a deal that allows it to invest and even take control in the invested company, and in return will work to improve it and increase its value dramatically. By the end of the fund’s fixed term, a new fund can be raised to continue its former. Venture capital funds are private case of PE, where the risk is particularly high (a method that has not yet been proven as a win-win case).
Is there an example? One of the most noticeable examples of PE in Israel is the acquisition of major share in ‘ARMIS’ by the American ‘Insight Fund’ for $ 1B in early 2020. At the same time, Google’s Alphabet fund also remained as a shareholder in the company and even expanded its investment.
What does it mean? An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. A company that wants to raise money from the public can issue stock, bonds, options, other securities or a combination of these on the stock exchanges. An initial public offering makes a private company become a public company.
Can elaborate? In issuance of shares, capital is raised through a public sale of some of the ownership (equity) of the company. In contrast, in the issuance of debentures (bonds), capital is raised for a commitment to repay interest. The act allows investors in the company to sell (return) part of their holdings (investments) and is therefore somewhat like ‘Exit’ (acquisition) despite there’s no specific company acquiring control.
Is there an example? ZoomInfo raised $ 935 million on NASDAQ exchange at $ 8 billion valuation — above the expected value. Founded by an Israeli Jonathan Stern in 2000, the company maintains its R&D center in Israel that employs about 150 employees and part of its senior management resides in Israel.
What does it mean? An exit strategy is a contingency plan that is executed by an investor, trader, venture capitalist, or startup/business owner to liquidate a position in a financial asset or dispose of tangible business assets once predetermined criteria for either has been met or exceeded. A successful exit will not only return the initial investment, but also a very high profits (usually measured by a multiplier of the investment).
Can elaborate? In Israel, the media likes to elaborate on the larger exit deals (M&A) which pour in a lot of money to the country, and is a growth engine for innovation and for a new startup generation that attracts many international companies to set up scouting offices and development centers in the country. On the other hand, there are also some who claim that larger number of exits of early stage startups makes it difficult for building Israeli owned tech giants and makes it difficult for senior managers to gain international business management experience.
Is there an example? Most of us have heard of the largest exit deal ever to be completed in Israel — the M&A of Mobileye by Intel in 2017 ($ 15 B). but what was the second largest tech exit in the country? In 2019, the acquisition of Melanox by Nvidia completed for $ 6.9 B, effectively establishing a new Nvidia R&D center in Israel.
Thank you to Lihi for the challenging question.
So far for this time…