Bootstrapping a business with personal funds often proves to be a very herculean task if at all that is possible. Hence, how to secure and leverage external funding opportunities invariably constitutes a focal question in the heart of start-ups or emerging entrepreneurial firms.
Over the years, several corporate financing structures have developed, providing external funding for entrepreneurs or businesses in their early stages. These include Angels, Venture Capitals, Accelerators, Incubators and government grants or public funds. Business owners could choose any one of these alternatives based on their prevailing capital structure, model and stage.
Although each funding structure has its own targeted business or corporate investees, they collectively shape the investment ecosystem as a whole.
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Accelerators
Accelerators focus mainly on early-stage enterprises or start-ups and provide them with contextual support in addition to financial support. In other words, Accelerators provide not only financial support but also mentorship, education, and networking services to enhance and accelerate the growth of early-stage entrepreneurial firms.
Accelerators are more likely to provide contextual support than financial investment as they target highly precarious firms in their early stages which do not particularly interest other institutional investors; especially the VCs. Therefore, Accelerators prefer to invest in firms that VCs think have low profitability.
Accelerators started to wax strongly in the investment ecosystem following the establishment of Y-Combinator in 2005. Since the founding of Y-Combinator other star accelerators like Techstars, and 500 startups have developed. Studies have shown that Accelerators not increase the survival probability of entrepreneurial firms and provide higher and faster returns on investment compared to VCs; they also influence the making of an effective venture ecosystem.
Angel Investors
Angel investors provide early-stage entrepreneurial firms with both financial and technical support to scale. Angel investors are often highly experienced in management and they seek to have appreciable managerial influence on the businesses they are funding. Studies have shown that most angel investors are former entrepreneurs and business managers who are investing their wealth in firms as a way of giving back to society. Therefore, unlike other investor types that are motivated by high returns, angels are motivated by the growth of the funded firms.
Venture Capitalists
Venture Capital is an equity-based financing provided to small businesses or start-ups with high or long-term growth potential. Generally, Venture Capitalists prefer to invest in relatively more mature early-stage entrepreneurial firms characterized by high industry-knowledge and technology as well as the capacity to generate profit by selling shares or initial public offerings. Most VCs concentrate in specific industries where they have expertise and can be able to mitigate risks.
In addition to providing finance support, VCs can also provide mentorship and networking opportunities to the funded companies. Funding decision in VC usually takes more time compared to other investor types because it involves a more painstaking vetting and profiling of potential investees. A type of VC funding called Micro-VC makes investments on a small scale and increases its contextual support for targeted firms, similar to accelerators, to avoid high investment risk.
Incubators
Incubators manage early-stage companies through different developmental phases until the companies have the wherewithal in terms of finances, physical structures and human resources to function independently. Incubators’ support to early-stage companies can include; office space, administrative functions, education and mentorship, access to investors and capital and ideation. These may involve a fee on or an equity stake in the business. Unlike Accelerators that focus on established early-stage businesses, incubators focus on concepts that have yet to transition into a full-fledged business.
Relationship between Investment Types, Behaviours and Performance
Early-stage firms that could access one or more of the aforementioned external funding should have higher survivability and liquidity compared to early enterprises that could not access any of those investment supports. However, studies have shown that investment behaviour and performance can differ according to these investment types.
Choi and Kim (2018), analyzes over 30,000 investment data involving Accelerators, Angels, and Venture Capitalists from the CrunchBase database and discovers that the performance of Accelerators differs from that of Venture Capitalists, but is similar to that of Angels. The study shows that while Accelerators’ investees perform well post funding, Venture Capitals’ investees perform well in terms of survivability.
Resource:
Yunsoo Choi and Dohyeon Kim (2018). The effects of investor types on investee performance: Focusing on the seed accelerator. Cogent economics & finance