Blog

How to Fund a Startup: Is it a $20,000 – or $20 million – question?

By October 18, 2016 No Comments

401k-2012-2-on-flickrThe New Yorker recently published a fascinating profile of Sam Altman, a Silicon Valley wunderkind who is both the new president and an alumni of startup “accelerator” Y Combinator. A startup accelerator promises to take a tech company from a pile of code to a viable company by providing the founders of the fledgling company with funds to keep it afloat for a short time, introductions to mentors, advice, and access to long-term funding. Some companies which have gone through the Y Combinator accelerator, including Airbnb and Reddit, have been crazy successful, while others have vanished. The article is not without its flaws — I’ll buy coffee for anyone who finds reference to any women in the article other than Altman’s mother and Y Combinator co-founder Jessica Livingston – though that may say more about Silicon Valley than the article. Nonetheless, it provides a peek into the characteristics to cultivate to try to mimic the success of a small fraction of startups – as well as a sobering reality check that the vast majority of startups don’t make it.

The “classic” Silicon Valley model of forming a corporation, seeking investors, and spending investors’ money in pursuit of the next funding round is not the only way to start a company, whether that company builds an app or makes cupcakes. The vast number of ways to start a business are almost on par with the number of new businesses started each year. In this blog post, I will discuss a common approach to funding a new business. In a follow up blog post, I will explore two additional ways that startup businesses might obtain capital.

Many startups obtain initial funding by cultivating investors: This is the “traditional” approach of the tech startups. These companies seek acceptance into Y Combinator or similar accelerator programs, and then pursue venture capital funding. Successful startups following this model can infuse their companies with a lot of investor money fast, but they are also tied to keeping the investors happy. Many founders are frustrated in pursuing this model, because they find that in order to obtain needed funds, they must forfeit a certain degree of control in the company to the investors.

A startup with starry-eyed visions of this type of success is likely to form a C-corporation, and then be prepared to issue preferred shares to the many investors they hope will want a piece of their pie. The preferred stockholders receive an additional bundle of rights as compared with the common stockholders. These rights vary, but they generally include a liquidation preference. Meaning, if the startup bites the dust, the preferred stockholders will be reimbursed for their investment prior to the common stockholders receiving any payment – even if that means that the common stockholders end up receiving nothing.

Photo credit: 401(k) 2012 on Flickr

This post is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting with an attorney.

(206) 784-5305