No VC funding? Seven alternative ways to fund your startup in Australia

I was at a startup event last month which included a panel session involving a number of Australia’s leading Venture Capital firms. The room featured a range of startups and scale-ups who were keen for insights on how they could attract VC interest. Instead through a mix of a platform that allowed for anonymous questions and upvotes from the crowd, the session turned into a pile-on with the VCs at the bottom. Questions such as “Why don’t you fund women founders” and “How can we trust VCs?” showed the room felt the VC community was at least partly to blame for the difficulty startups are having raising at the moment.

There are plenty of stats out there from Cut Through Ventures and others that shows how startup investment has dropped off dramatically in the last 12-18 months. And from speaking with a lot of founders, they are all nervous and trying to figure out the secret sauce on how they can land some funding.

But is this really VCs’ fault?

Many of the conversations I have with founders are around how they can crack VC investment, however in many cases it will likely never happen. Don’t get me wrong, VCs are not perfect, however, they cop a lot of flack when I feel there is often a drastic misunderstanding of the business model of VCs and what they invest in.

Part of the reason why I feel like there is such animosity towards VCs is that they are often seen as gatekeepers to success — if you can’t raise VC money your startup dream is over. However, VCs are not the only options to fund a startup. While some may not be suited to every startup, there are definitely a variety of options when VCs say no.

Why do VCs say no?

Let’s start with why VCs say no.

Does it mean you have a bad company, product or idea? Absolutely not! (although in some cases you may, which means you have far bigger problems, but let’s work on the assumption you don’t).

There are a range of reasons why VCs choose not to invest in companies, but at a macro level, it often comes down to fund economics and what type of companies they fund.

Generally speaking, early-stage VCs operate on something called the Power Law, which essentially means that VCs know the majority of their investments are likely to fail, however, a small number of these investments will deliver outsized returns, making those losses palatable. It’s a relatively simple concept, but it does have huge implications for the types of startups in which VCs invest. VCs must have confidence that your company has the potential to make such a high return that it covers all the other companies in their fund failing, and still deliver 30%+ returns to investors who have put into their fund.

While it’s hard to translate this into exact metrics for startups, essentially the VC will need to have confidence that if everything goes right they will make at least a 10x return. If they’re investing in seed-stage companies, however, the additional risk means the return needs to be much higher — closer to 100x. If you’re a startup trying to raise at a $5 – $10 million valuation, this essentially means you need to have the characteristics of a $1 billion company for a VC to say yes.

Does this mean they often miss out on investing in good companies that make good returns for investors and founders but never end up being a $1 billion company? Yes, all the time.

So what do you do if you are one of those companies? Below are a few other ways you can fund your quality startup when you’re not in the VC wheelhouse.

Accelerators and incubators

Many of you would be familiar with the accelerator and incubator model, where companies join in with other startups as part of a cohort, accessing resources and networks to build their business. While the terms are often used interchangeably, incubators are generally much earlier stage, helping turn an idea into a business, whereas an accelerator is taking a slightly more mature business and helping it scale.

Typically founders are giving up equity in return for some cash, but in reality, it’s the access to networks that can often bring the biggest return for founders — both through new investors and also business capability. With a bit of Googling, you can typically find the terms that founders take in order to participate.

There are a number of quality accelerators in Australia that have a great track record in developing quality startups. Startmate is part of the Blackbird family and has been around for years, taking on a range of startups at different stages. It would be the closest thing Australia has to Y Combinator, which many would say is the world’s leading accelerator based out of San Francisco.

Techstars is another huge global accelerator with locations all around the world. It recently launched in Sydney in partnership with the NSW Government and I have signed up as a mentor. I can attest to the quality of the program and the companies that are a part of the first cohort.

On the incubator side, a lot of the universities have a great track record in strong incubators, like UNSW’s Founders, Sydney Uni’s INCUBATE or Melbourne Uni’s MAP.

Antler also has a longstanding reputation for helping take founders with an idea and matching them with co-founders. The downside to this is that not all participants get funded and you need to wait until the end of the program to know whether you’re successful, however, it’s perfect for validating an idea.

Grants

Access to cash to help scale, without giving up equity or taking on debt? It often sounds too good to be true for startups, but government and private sector grants are real and there’s likely more of them than you know of.

The biggest one is the R&D Tax Incentive from the Australian Government, which has helped thousands of startups. The downside is that this is a retrospective return (i.e. you need to have spent the money to then get 43% back at tax time, much like a personal tax return). Companies such as TechAbstract are great and assessing whether you’re eligible and helping with your return.

There are a bunch of other government programs, such as Export Market Development Grants (EMDG), CSIRO kick-start, and state-specific grants based on the state you live in. NSW had some excellent programs such as the MVP Grant which was recently put on hold, much to the disappointment of the startup industry. So if the Premier Chris Minns happens to read this — bring it back!

Overnight Success has a good database of grants, as does Airtree as part of its Open Source VC.

Angels and high-net-worth individuals

The concept of finding a rich angel investor who understands your startup’s sector and is willing to tip in a bunch of cash on good terms is often the dream for many founders. But they are called angels for a reason — they’re rare but often extremely valuable.

And while angels are typically the first cheque a business takes in a very early round, continued investment from high-net-worth individuals is just as valuable and equally as rare. They are often looking for similar companies as VCs, however will have their own return thresholds. They may be happy for example with a company making a 10x return from the seed stage or a 2-5x return at later stages. Unlike VCs, they don’t have the fund economics of their fund to be concerned with.

So how do you go about finding them?

There are a number of good Angel groups around, such as Brisbane Angels and Sydney Angels which many angels are a part of. Aussie Angels is also a syndicated platform for angel investors and can provide good access to a large group of like-minded investors. Again, Airtree Open Source VC has a good list of angel investors and how to contact them.

On the high-net-worth front, these individuals are hard to come by, and often working with an advisor can allow you to tap into their networks. My startup raised a number of rounds of capital through Clinton Capital Partners who gave us access to a huge investor network we otherwise wouldn’t have been able to find.

Venture debt

Venture debt is a form of debt financing specifically tailored to startups. It’s often provided by specialised lenders and allows you to access capital without giving up equity. It is often used to provide working capital or fund specific growth initiatives but typically doesn’t replace equity funding.

Word of warning — it doesn’t come cheap. But if you’re anticipating your startup will grow (which if you’re not, you’re probably in the wrong game), in almost every scenario the cost is typically cheaper than giving up equity.

Venture debt has long been the domain of more mature startups, however, there are more flexible structures now for earlier-stage companies. Tractor Ventures is growing fast in Australia and there are options available for companies with minimal revenues. For scaling companies, you have One Ventures and Partners For Growth which have a long history in the space.

Crowdfunding

In 2018 the investment laws were changed which made crowdfunding a possibility, allowing startups to tap into a large number of individual investors who buy into your product or vision. WithYouWithMe raised our first seed round in 2017, however, if crowdfunding was available then I imagine it would have been an option we would have definitely considered.

Crowdfunding works best for companies and brands that have a large, loyal and engaged community surrounding its brand. For WithYouWithMe, we were helping individuals train and find jobs for free, which would have been the perfect platform to engage those with the means as investors.

You often get to choose your terms, however, there is often a lot of work that needs to go into a raise, including a large marketing spend for those who don’t have a natural community already.

There has also been a range of crowdfunding platforms pop up with different levels of success, however, Birchal and Equitise have built the biggest following and reputation.

KC Ventures can help get you ready for a crowdfunding raise if it’s a route you want to explore.

Corporate VCs

This one may be cheating as it is still technically a VC, however, their economics often work differently to a traditional VC fund. Many large corporations have established venture capital arms that invest in startups relevant to their industry. Partnering with a corporate VC can bring not only investment but also access to distribution channels, customers, and the validation that only comes from the backing of the big end of town.

Often corporate VCs are looking more at the strategic value you can add to the organisation, rather than the simple dollar return an investment can generate. They may see you as a possible acquisition target down the track, or help develop a capability they know they need but are unlikely to be able to innovate quickly enough in-house.

While their return metrics are often different from VCs, generally they are more risk-averse and look at later-stage companies who can demonstrate a track record. And while it may seem tempting to have that 100-pound gorilla in your corner as your scale, often it does restrict your customer and exit opportunities down the track as it makes it more difficult to work with competitors.

Bootstrap

Now we get to my favourite option — bootstrapping. This essentially sees you fund your own business from personal cash, as well as revenues generated from the business.

This may seem like an unrealistic and unattainable goal for many, but the reality is that it is possible to start and grow a business with minimal investment, only looking for outside support when it comes time to scale.

Many VCs often look at companies and value based on software and SaaS revenue multiples, but the reality is that there are a lot of ways for companies to make money in the early days which isn’t as sexy as SaaS. Building a business using services revenue, which can then be reinvested back into the software product is an underrated way of growing a business in my opinion. At WithYouWithMe we funded a lot of our early software build using recruitment revenue, which meant we could take on less outside investment.

The key when looking to bootstrap is:

1. Identify any revenue streams you can think of to access simple cash
2. Allocate your own time and the team’s resources appropriately so you are not getting consumed by it, but you’re still delivering a service customer value
3. Be super tight with your cash flow planning and understand what is coming in and going out
4. Identify the point where you know investment will be needed to take you to the next level.

KC Ventures spends a lot of time with founders working on these plans to get the business humming along before investment is required.

The reality is the longer you can bootstrap and grow your customers and revenues and mature the product, the more likely you will be to secure investment — from VCs or others. There is a Marc Andreessen quote that I often share with founders: “You’re almost always better off making your business better than your pitch better”. Build the business as long as you can and investors will see the value.

So what’s the best option?

The short answer is there is no “right” path for a founder to go down. It is all about understanding your business, understanding your motivations, and what it is you’re trying to build.

But just because a VC says no it doesn’t mean that’s the end of the road. There’s plenty of ways to keep building and hopefully make them regret that ‘No’ down the road!

Are you a founder who wants to know more about funding your startup? Reach out and have a chat at kcventures.com.au