External Funding – The good, the bad, and the otherwise

Starting a business can be a daunting task. It requires a significant amount of time, effort, and resources. One of the key challenges…

March 31, 2023

Starting a business can be a daunting task. It requires a significant amount of time, effort, and resources. One of the key challenges that entrepreneurs face is obtaining the necessary funding to get their venture off the ground. While some may opt to bootstrap their business and rely on personal savings or loans, others may choose to seek external funding. In this article, we will explore the ways in which external funding can affect a startup and the pros and cons of seeking investment from external sources.

External funding refers to money invested in a company by individuals, institutions, or organizations outside the business itself. These can include angel investors, venture capitalists, and crowdfunding platforms. The goal of seeking external funding is to obtain the capital necessary to launch or grow the business. This funding can be used to develop products or services, hire staff, expand marketing efforts, or purchase equipment.

The Pros – How External Funding can get you off the ground

There are several benefits to obtaining external funding for a startup. First and foremost, it can provide the necessary capital to get a business off the ground. Without funding, it may be challenging to secure resources or attract customers. Additionally, external funding can provide access to valuable resources such as mentorship, industry connections, and expertise. This can help a startup grow more quickly than it would on its own.

Another potential benefit of external funding for startups is the ability to access expertise and networks that may not be available otherwise. Investors who have experience in a particular industry or domain can provide valuable insights, guidance, and connections to help the startup navigate challenges and seize opportunities. They may also be able to introduce the company to potential customers, partners, or acquirers. In addition, having reputable investors on board can lend credibility and legitimacy to the startup, which can be important for attracting customers, employees, and future investors.

External funding can also provide a cushion of financial stability for startups that may otherwise struggle to stay afloat. Startups often face significant financial challenges in their early stages, such as high operating costs, low revenue, and a lack of predictable cash flow. External funding can help alleviate some of these pressures by providing the resources necessary to invest in product development, marketing, and hiring. This, in turn, can help the startup grow more quickly and efficiently.

Another significant advantage of external funding is that it can help a startup attract top talent. Hiring the right team is critical to the success of any business, but it can be challenging to attract high-quality candidates without the resources to offer competitive salaries or benefits. With external funding, a startup can offer more competitive compensation packages, making it easier to recruit and retain top talent.

Furthermore, external funding can provide a level of credibility and validation to a startup. When a company receives investment from reputable sources, it sends a signal to potential customers and partners that the business has potential and is worthy of investment. This can help to establish a reputation and build trust, making it easier to attract new customers and partners.

The Cons – The downsides of External Funding

There are, however, several drawbacks to seeking external funding. Perhaps the most significant disadvantage is that it often requires giving up a portion of ownership in the business. Investors typically receive equity in exchange for their investment, which means that they will have a say in how the company is run and may require a share of profits. This can be a difficult pill to swallow for some entrepreneurs who have poured their heart and soul into their business and may not want to share control.

Another potential drawback of external funding is that it can come with strings attached. Investors may require certain conditions or stipulations as part of their investment agreement, such as the right to veto certain decisions or the requirement to hit certain growth targets. These conditions can limit the flexibility and autonomy of a startup, making it challenging to pivot or adapt to less than ideal market conditions.

One other potential downside of external funding is the loss of control and autonomy that can come with giving up equity or taking on debt. Entrepreneurs who accept external funding may find themselves accountable to a board of directors or other stakeholders who have different priorities and perspectives than they do. They may also be required to meet certain milestones or targets, which can lead to pressure to prioritize short-term gains over long-term sustainability.

Another potential risk of external funding is the potential for conflicts or misalignments between investors and entrepreneurs. Investors may have different expectations around the pace of growth, the direction of the business, or the role of the founders. If these expectations are not properly aligned or communicated, it can lead to tension or even conflict between the parties.

External funding can also impact the hiring process and the types of employees that a startup attracts. When a startup has access to external funding, it can offer more competitive salaries and benefits, which can make it easier to attract top talent. However, this can also lead to a culture of entitlement or a lack of scrappiness, as mentioned earlier. It’s important for startups to maintain a strong culture and sense of mission, even as they grow and attract more employees.

In addition, external funding can also create a culture of entitlement or complacency within the startup. When entrepreneurs have access to a significant amount of external funding, they may become less motivated to hustle, innovate, or focus on the core mission of the business. They may also become less scrappy and resourceful, relying on external funding to solve problems rather than seeking creative solutions.

Finally, external funding can create a sense of pressure and urgency that may not be present when bootstrapping a business. Investors expect to see a return on their investment, and they may put pressure on a startup to hit aggressive growth targets or achieve profitability quickly. This pressure can be stressful for entrepreneurs and may cause them to make decisions that are not in the best long-term interest of the business.

Other Considerations 

Startups should consider the following aspects of external funding before making a decision:

  • Crowdfunding has also become an increasingly popular way for startups to raise capital. Crowdfunding platforms allow entrepreneurs to pitch their business ideas to a large pool of potential investors, who can then contribute small amounts of money in exchange for a reward or equity. Crowdfunding can be an effective way to validate a business idea, generate buzz, and raise capital without giving up too much equity. However, it requires a significant amount of marketing and promotion to be successful.
  • Another consideration when seeking external funding is the stage of the startup. Early-stage startups may find it more challenging to attract investment than more established companies. Investors are often looking for evidence of traction or validation before they invest, which can be difficult for a company that is just starting out. On the other hand, later-stage startups that have already demonstrated some level of growth may find it easier to attract investment but may also have to give up more equity to do so.
  • In addition to equity investment, startups may also seek debt financing in the form of loans or lines of credit. Debt financing can be an attractive option for startups that want to retain control over their business and do not want to dilute their ownership. However, it also comes with the risk of default and may require collateral or personal guarantees from the entrepreneurs.
  • Finally, it is important to consider the potential impact of external funding on the culture and values of a startup. When investors come on board, they often bring their own perspectives, priorities, and expectations. This can lead to conflicts or tension if their vision for the business does not align with that of the entrepreneurs. It’s important to choose investors who share your values and goals and who will be supportive of the company’s mission and vision.

Careful Assessment of Options the Key

The final decision to seek external funding should be based on a careful assessment of the startup’s needs, goals, and values. Entrepreneurs should consider the potential benefits and risks of external funding and choose the option that best aligns with their long-term vision for the business. This may involve a combination of external funding sources, such as angel investors, venture capitalists, or crowdfunding platforms, as well as alternative sources of capital, such as revenue-based financing, grants, or bootstrapping.

So, how can external funding affect a startup? The answer is that it can have both positive and negative impacts, depending on the specific circumstances of the business. For some startups, external funding may be critical to their success, providing the necessary resources and support to get off the ground and grow quickly. For others, it may not be necessary or desirable, and bootstrapping may be a better option.

Ultimately, the decision to seek external funding should be based on the needs of the business and the goals of the entrepreneurs. It’s important to carefully consider the pros and cons of external funding and to have a clear understanding of what investors expect in return for their investment.

EquityMatch.co’s Wheelhouse

Helping Startups find External Funding is one of the fundamental pillars of EquityMatch.co, and we have the experience and expertise in matching you with the optimum source of funding for you, whether you want to go with Venture Capital, Angel Investors, or if you choose to crowdfund. Make the leap and talk to us today about your startup and your ideas. We will get you the source of funding from our long list of potential investors.