One of the most important questions that start- ups have to ask themselves when setting up a company is that of financing . Because in order to realize the business idea, founders must first invest. There are several options for financing the start-up of a company. One of the best-known is the financing of business start- ups with your own capital (bootstrapping) and venture capital from investors. But not every form of financing is equally suitable for every start-up. In the following article we explain the two forms of financing.
Financing of the business idea by means of bootstrapping
One way to finance the business idea is through bootstrapping. This term is used to describe a type of financing for founding a company that does not require external financing – such as financial injections in the context of venture capital.
Founders who want to “bootstrap” their business idea usually have a very tight budget, a tight schedule and scarce resources at their disposal. Financing with bootstrapping makes sense, especially when founding a company according to the so-called low-budget model.
The aim of bootstrapping is to finance the start-up out of your own pocket. The aim is to reduce expenditure while maximizing income. The bootstrapping model has the following advantages and disadvantages:
Advantages of bootstrapping:
- no transfer of company shares to e.g. B. Business Angels as in financing with venture capital
- no financial dependence on investors and banks
- Entrepreneurs learn to budget, to work cost-efficiently and customer-oriented
Disadvantages of bootstrapping:
- scarce time and capital resources
- high performance pressure
- difficulties in recruiting employees
- Lack of higher test budgets
- limited development potential
When start-ups should rely on bootstrapping
Bootstrapping is not equally suitable as a financing model for the business idea for all entrepreneurs . Before founders decide on a financing method, the business model must be analyzed thoroughly. Bootstrapping works well when the following points are true:
- The business model also works on a small scale.
- There are no competitors who can massively take away market shares in the short term.
- Business growth cannot be accelerated with money.
- There is no great risk associated with the business idea.
What start-ups should consider when bootstrapping their business idea
On the one hand, start-ups that rely on bootstrapping as a form of financing should note that due to the small budget, they can get into the operative business as quickly as possible in order to reach the break-even point as early as possible and generate a positive cash flow.
It also makes sense for founders to place their product on the market as early as possible, for example in order to take important feedback from users into account early enough during product development.
Financing the business idea with venture capital
Founders who are looking for capital can also have their business idea financed with venture capital. Venture capital, which is also known as risk capital or venture capital , is usually provided by venture capital companies that invest in young companies mainly through a venture capital fund. Through the invested capital, the respective investors automatically become co-shareholders in the venture-funded company.
However, the primary goal of venture capital investors is not to acquire a majority stake in a company. Because the venture capitalists plan first and foremost the so-called exit, i.e. the profitable sale of company shares.
Benefits of venture capital
- no interest and principal payments
- Securing the existence and growth of the business start-up
- provides planning security and crisis resilience
- will be made available on a long-term basis
- Improvement of the company’s equity base
Disadvantages of venture capital
- Selling company shares to investors so that investors have control and say rights.
- Founders often lose the incentive to work hard for the company.
- Different ideas and decisions of investors and founders
When start-ups should rely on venture capital
Not every company is equally interesting for investors. After all, the venture capitalists hope for high profits from the respective start-up. In order to attract investors, start-ups that opt for venture capital financing must meet certain criteria:
- innovative business idea
- high market volume with constant growth
- Immediately recognizable customer benefit or USP
- Founding team with expertise
The more of these factors are fulfilled, the better the chances for an investment with venture capital.
How venture capital investments work
Once founders and investors have found each other, a so-called confidentiality agreement is first signed. This is intended to prevent information on VC financing from being passed on. Venture capital financing then proceeds as follows:
- Investors examine the business plan and business model of the start-up.
- The start-up’s management team is scrutinized more closely.
- Signing the Term Sheets (external link)
- Creation of a participation agreement
- Cooperation between founders and investors begins
What start-ups should consider when financing venture capital
For founders who decide to finance their business idea with venture capital, it is advisable to consult an experienced advisor. This person should be familiar with investors and venture capital contracts (e.g. participation agreement and articles of association). Because the legal consequences resulting from the contracts are often difficult for company founders to understand. Important points that should be examined more closely are:
- Collateral: Here it is necessary to check which liability and warranty provisions are contained in the contract and which control rights the investor can exercise.
- Possibilities of influence: Here it must be determined how the regulations on the majorities are designed.
- Exit: At this point, it should be checked when and under what conditions the respective investor can exit and what consequences this has for the shareholders.
Business start -up advice can therefore be worthwhile in order to secure yourself as part of a venture capital investment. A consultant can also help with the creation of a business plan.
Whether bootstrapping or venture capital: every form of financing has advantages and disadvantages. Ultimately, the decision depends on which business idea the founders want to implement and how much capital is required. For example, while smaller start-ups can also be financed with bootstrapping, innovative business ideas can be realized with venture capital from investors. However, founders should also keep an eye out for other financial opportunities to advance the business idea.