What is start-up capital?
The term startup capital refers to the money a new company raises to meet its initial costs. Entrepreneurs looking to raise startup capital must develop a solid business plan or build a prototype in order to sell the idea. Start-up capital, which may be provided by venture capitalists, angel investors, banks or other financial institutions, is usually a large sum of money to cover any or all of the company’s major initial costs, such as inventory, licenses, office space, and product development.
- Start-up capital is money raised by an entrepreneur to cover the costs of a venture capital investment until it becomes profitable.
- Venture capitalists, angel investors and traditional banks are sources of startup capital.
- Many entrepreneurs prefer venture capital because its investors do not expect a return until the company is profitable.
How Startup Capital Works
Young companies that are just at the development stage are called startups. These companies are founded by one or more people who typically want to develop a product or service and bring it to market. Raising capital is the first thing a startup needs to do. This financing is what most people call start-up capital.
Start-up capital is the money an entrepreneur uses to pay for any or all of the required expenses involved in creating a new business. This includes paying for initial hire, obtaining office space, permits, licenses, inventory, research and market testing, product manufacturing, marketing or any other operating expenses. In many cases, more than one round of start-up capital investment is required to start a new business.
Most start-up capital is provided to young companies by professional investors such as venture capitalists and/or angel investors. Other sources of start-up capital include banks and other financial institutions. Because investing in young companies carries a lot of risk, these investors often need a solid business plan in exchange for their capital. They usually get equity in the company to invest in.
Start-up capital is often sought repeatedly in different funding rounds as the business grows and takes it to market.
The final funding round could be an initial public offering (IPO) in which the company sells its shares on a public exchange. By doing so, it raised enough cash to reward its investors and invest in the further growth of the company.
Types of Startup Funds
Banks provide start-up capital in the form of business loans – the traditional way of funding new businesses. Its biggest disadvantage is that the entrepreneur has to start paying debt and interest at a time when the business may not be profitable.
Venture capital from a single investor or a group of investors is an option. Successful applicants typically hand over a portion of the company’s shares in exchange for funds. The agreement between the venture capital provider and the entrepreneur outlines some possible scenarios, such as an initial public offering or acquisition by a large company, and defines how investors will benefit from it.
Angel investors are venture capitalists who serve as advisors to new businesses in a hands-on way. They are often successful entrepreneurs themselves, using a portion of their profits to get involved in emerging companies and serve as mentors to their management teams.
Start-up capital and seed capital
The term startup capital is often used interchangeably with seed capital. Although they look the same, there are some subtle differences between the two. As mentioned above, start-up capital usually comes from professional investors. Seed funding, on the other hand, is often provided by the startup founder’s close personal connections, such as friends, family, and other acquaintances. Therefore, seed capital (sometimes also called seed money) is usually a moderate amount of money. This type of financing is often enough for founders to create a business plan or prototype that will spark the interest of startup capital investors.
Pros and cons of start-up capital
Venture capitalists have secured the success of many of today’s largest internet companies. Google, Yuan (former Facebook), Both DropBox and DropBox started out with venture capital and are now famous. Other venture-backed ventures were acquired by major corporations — Microsoft bought GitHub, Cisco acquires AppDynamics, Meta acquired Instagram and WhatsApp.
But providing startup capital for young companies can be a risky business. Backers hope that the proposal will develop into a profitable business and are generously rewarded for their support. Many don’t, and the venture capitalist’s entire stake is lost. According to a 2011 Harvard Business School study, about 30 to 40 percent of high-potential startups end in liquidation. A few enduring and growing companies may go public, or they may sell their operations to larger companies. These are exit scenarios for venture capitalists that are expected to provide a healthy return on investment (ROI).
This is not always the case. For example, a company might get a buyout offer below the cost of venture capital, or the stock might drop at an IPO and never recover its expected value. In these cases, the return on the investor’s capital is low.
To find the most notorious losers in venture capital, you have to go back to the dot-com bust at the turn of the 21st century. These names exist only as memories: TheGlobe.com, Pets.com, and eToys.com, to name a few. Notably, many of the companies that underwrote these ventures also went out of business.