There are two main types of financing instrument:
- Equity (shares, stock):
- Typically the only form of financing in the early years because no commercial bank wants to finance your business (risk to him for them)!
- Ownership of the business
- Entitled to dividend (if any…)
- Company by share, either private (i.e. not listed on stock market) or listed (NASDAQ, TecDax etc)
- If not listed, then selling might not be easy (selling internally to other shareholder in the company, trade sale to a larger firm)
- Have the largest risk: you can loose everything
- If no success, shares might be worth next to nothing; but if success, shares might be worth a lot
- Borrow money from someone else (friend, bank, other company etc)
- Principle (amount borrowed) has to be reimbursed at some stage down the road (in phases or in one shot, as stipulated by the debt contract)
- Also interest rates
- Can also be risky (that’s why bank want collateral. E.g. buy a house -> Mortgage)
- Debt can be callable; convertible into equity.
The following pictures shows how a typical start-up gets financed in multiple rounds. As additional shareholders (venture capitalists) come on board, the initial ownership gets diluted. Source: Equity Fingerprints 2011. Thank you to Philip Baddeley for allowing us to reproduce this material here.
When you start a technology start-up, this is what you want to achieve, right?
So how do you do it? This is what you need to finance
At each step, you share of equity gets diluted. You might even lose control. But do you want to own a large share of a small cake, or a smaller share of a big cake?