Start-Up Funding: The Basics
Funding can seem like a daunting task to an early-stage food business. Where do you start? What resources can you turn to? Why is investment even necessary? This guide breaks down funding to its very basics, helping you turn an infant idea into a fully-blown company.
Why Funding?
Start-ups often find themselves with an awesome idea, but no time or money to pursue it. Funding in its simplest form provides the start-up with the resources it needs to get on its feet and running. Before a business can launch a food product into the market and start generating income, it needs to buy everything upfront from packaging and ingredients to design and branding work. All of this takes capital. On average, most Union Kitchen Accelerator Members spend around $15,000 before hitting any grocery shelves.
Let’s take a look at how a hypothetical start-up receives funding.
Pursuing an Idea
An idea. That’s all it takes to start your new food venture. At first, you are skeptical that your idea will even be successful. But as you start working on it, you find yourself falling in love with the product that was once just a small idea. The more work you put into your food venture, the more value you create. That value will eventually turn into something referred to as equity. Equity is the ownership in an asset and at this moment, you own 100% of it.
To propel your product to the next phase, you decide that you are ready to bring on a co-founder to help split up the work and obligations in hope of boosting your productivity. Choosing a co-founder is a big decision. You need to find a partner that is equally dedicated to your food venture and passionate about creating a product that is built to last. Once you take the step of adding a co-founder, the equity that was once 100% yours is now split 50-50.
With double the work power, your start-up is making major progress. Ideas are flowing and the chemistry with your partner is great. You quickly realize that to take your food start-up to the next level, you are going to need outside funding. These investments will help you buy packaging and order larger quantities of ingredients. Running to and from Safeway is no longer viable as you receive more and more orders for your food product.
Seeking Investment
Round 1: Friends and Family
Before you can take on any investments, you need to legally set up your company and receive a license to sell your food product. There are two main steps: Company Formation and Food Business Licensing.
Once that is squared away, your food business can start accepting outside investment. The biggest challenge? You believe strongly in the viability of your business but you do not have sales yet to support your assertions. Because of this, you decide to tap into your personal network of friends and family. They know you on a personal level and are willing to take a risk to help you pursue your dream!
When you bring in outside funding, you create and issue new shares. You set up your company with 100 total shares to start. This meant you had 100% (100 of 100 shares) ownership in your business. With a co-founder, you created 100 new shares. The total shares in your business went from 100 to 200. Your co-founder received 100 shares (or 50% of the total 200 shares) and you maintained your initial 100. Your percentage ownership changed from 100 of 100 shares to 100 of 200 shares. Similarly, when you bring on more funding, you will create more shares. Your original 100 shares do not change. The total number of shares changes. Every investor you take on essentially becomes a co-owner of your start-up, exchanging funding for equity.
An easy way to think of it is the splitting of a pie. When you first had an idea, the pie was 100% yours. As you bring on new investors, you have to dish out more slices of the pie, making your once giant slice, smaller, but also a lot more valuable because people really, really want your pie. Think about it this way, would you prefer 100% of a company worth $100 or 10% of a company worth $100,000,000.
Round 2: Angel Investors
After your initial round of investment from your friends and family, your start-up is hitting its stride and you begin to see some real growth. You are now in a handful of local stores and orders for your packaged product are coming in steadily. You get really wonderful news. Several large grocery chains want to pick up your product. The problem? They want to pick up a lot of product and you do not have enough cash on hand to cover the upfront expenses of purchasing packaging and ingredients at that volume. You need to bring in outside financing so that you can take advantage of this huge opportunity.
This is no longer something your friends and family can cover alone. You turn to Angel Investors, or individuals that invest in early-stage businesses, like yours. It’s time to give out another slice of your pie. You create new shares for your new investors. After meeting with Angel investors, you decide on a few individuals that really believe in your vision of manufacturing packaged food. Again, while your slice of pie decreases, the value of the pie continues to grow larger and larger. Your 100 shares are now worth a lot more than when you first started.
Round 3: Venture Capitalists
As your brand expands throughout the Mid-Atlantic and begins taking on more market share, you continue searching for more investors to drive the growth and development of your brand. All of a sudden, you are now talking about filling purchase orders worth a million dollars. That’s a huge amount of upfront labor, ingredient, and packaging costs. But you are confident and ready to go. You approach a venture capitalist, a private equity investor that provides funding in exchange for equity. After a lot of back and forth discussions, the venture fund values your brand at $2 million and is willing to invest 1 million into the business.
You think back to your pie and how these new investments impact the size of your slice. It’s important to use a post-money valuation when determining the percent split of equity. Post-money valuation refers to the estimated market value of a company after a round of financing from venture capitalists or angel investors has been completed. While the pre-money valuation was $2 million, the post-money valuation includes the VCs investment and is $3 million. This leaves the VC with a 33.33% stake of your company (1 million investment out of a 3 million total valuation). To make this possible, you issue new shares. This decreases your total percentage ownership but makes your shares much, much more valuable than when you first started!
You look back on your experience. While your slice of pie is smaller, it is now worth significantly more! And you are very excited to continue expanding your food business.
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