How to fund your app without VC investors

Written by Andrew Askins on February 07, 2018

The stereotypical startup plan goes something like this:

  1. Have a brilliant idea

  2. Raise a bunch of money

  3. Hire a team of #RockstarNinjas

  4. Hockey stick growth

  5. Sell

But unless you’re an experienced entrepreneur with multiple exits under your belt, you’re not going to raise money from angel investors with an idea alone. Especially if you’re pitching angel investors in the southeast, or other areas that are conservative with capital.

Not to mention, raising money from angels isn’t always the best option for a young startup. Many first time founders look at angel funding as “free money.” That couldn’t be farther from the truth.

The true cost of venture capital

Let’s do some quick math:

Say you raise $1 million to get your startup off the ground and give up 25% of your company to do so.

Note: That’s a ton of money! You definitely shouldn’t raise that much right off the bat unless you’re building self driving cars that use AI and the Blockchain to serve up perfect home cooked meals during your ride. We’re just using $1 million because it makes the math easier.

Now, because you’re the next Elon Musk, everything goes well and your startup grows like crazy. Five years after you started, you sell to Google for $25 million. You’re happy and your investors are happy.

In fact, your investors are especially happy, because they made $6.25 million, which is a 44% annualized return.

Calculating the cost of venture capital

That’s a huge cost. No loan would have interest anywhere near 44%. Of course, with a loan you have to pay the money back, even if you fail. But the point stands. There is a cost to giving up equity, and it’s not a small one.

Note: Props to Gary Yurkovich for this example from Quora https://www.quora.com/How-much-is-the-average-cost-of-capital-that-I-should-use-in-an-internet-start-up-valuation

Okay, it’s hard to raise money from angels with just an idea, and even if you could it comes at a high cost. What are the alternatives?

Four alternatives to raising venture capital:

1. Self-funded

The clearest path towards funding your startup is to fund it yourself. You retain complete control and all of the equity.

The obvious downside is speed. If you don’t already have the money, then you either have to be willing to save aggressively or start putting any and all of your extra income into your project.

The result is often that you feel like you’re moving at a snail’s pace. But think about it — if you started now, how long would it take you to get your company off the ground by yourself?

Engineers are expensive, but every other aspect of building a tech company is cheaper and more accessible now than ever.

Note: This is a good reason to learn to live beneath your means. Especially if you want to be an entrepreneur. Having financial flexibility gives you options.

2. Friends and family round

Many people have a friend or family member with access to capital. It can be scary to ask someone you care about to take a bet on you. But if you’re not willing to ask a friend for money, it’s worth asking yourself why. They can always say no, and if you’re successful, what could be better than sharing that success with the people you love?

A friend of a friend had an uncle whose cousin approached him about investing in a crazy new business idea. The cousin was tired of going to Blockbuster to rent videos. He thought with the rise of the internet he could develop a service where customers request videos, and he could ship them DVDs in the mail.

My friend’s uncle ultimately passed on Netflix, and he’s been kicking himself ever since.

Netflix family round fundraising story

A few rules of thumb when raising money from friends or family:

  • Set very clear expectations from the beginning about how involved the person is going to be and how/when they will get the money back.

  • Make sure they understand the risks and only invest as much money as they’re willing to lose. No matter how brilliant you are, startups are risky.

  • Get everything in writing. It shows you’re serious about running a professional operation and protects you and them down the road.

  • Make sure you understand the regulations around raising money. There are limits to who you can raise from.

Of course, raising money from friends and family can carry the same costs as raising money from angel investors. But often, you can get friendlier terms from people you already know. And someone you already have a relationship with is more likely to take a bet on you early on, before you’ve proven the business is viable.

For more about how to raise a successful friends and family round, check out our interview with Lauren Sturdivant, the founder and CEO of Case Status.

3. Selling the ghost

Selling your app before you've built anything

Photo cred: Lola the pug https://www.instagram.com/itslolathepug/

Not everyone has the personal means to fund their startup themselves, or the network to raise money from friends and family. One of the best options remaining is to raise the money by selling the ghost — in other words, selling your idea to your customers before you have anything built.

Selling the ghost can take a few different forms:

Crowdfunding

Most people are familiar with crowdfunding platforms like Kickstarter. These platforms have led to the massive success of products like the Oculus Rift and the Pebble Time. Crowdfunding is essentially a way to take pre-sales at a larger scale for consumer facing products.

Oculus Rift used Kickstarter to fund their startup

Oculus Rift was one of the most popular Kickstarter projects of all time. The company later sold to Facebook for over a billion dollars.

The downside is these platforms work best for physical, consumer products. If you’re building a B2B SaaS tool, this probably isn’t the option for you.

Direct sales

Nothing’s better than approaching your potential customers and selling them on your idea and your ability to bring it to life. This is the best validation you can get. It’s a chance to build relationships with your customers early on, and listen to their pains before you build anything.

No matter what form of funding you go with, you should try to sell to your customers from day one.

You may need some mockups in order to convey your vision to your customers. You can use a tool like Invision to make these mockups feel like a real product before you’ve written any code.

You can use a tool like Invision to create a prototype that feels real without writing any code in order to help you sell your product. This is a prototype we designed for Case Status.

If you can’t get an actual check, the next best thing is a LOI or Letter of Intent. This is a non-binding contract saying if you build X your customer will pay you $Y. Enough LOIs could help you convince an investor to put the money in for you to build.

Minimum Hackable Products

Another option that is gaining steam is to “build” your product by hacking together existing products using built-in integrations. This is an incredible way to deliver something of value to your customers without writing a single line of code. You can begin to get revenue and collect feedback about the specific ways these tools aren’t working for your customers.

The perfect example is Product Hunt. Product Hunt started as a newsletter. From there Ryan hoover recruited a friend to help him build out the first version of the online community. And coming from those humble beginnings, Product Hunt sold last year to Angel List.

There are so many tools you can use to get your MVP off the ground. Just to name a few:

To learn more about how to get your project off the ground using existing services check out this course from Bram Kanstein:

https://nocodemvp.com/

Or check out Apps Without Code by Tara Reed:

http://blog.appswithoutcode.com/

Consulting

There will be some situations, like healthcare, where hacking together existing solutions just won’t work. In that case, if you’ve already tried to sell the idea with a prototype and a LOI, you can also consider consulting.

Sometimes, consulting can be the perfect intro to selling a product. You can build relationships with a client and help them get ready to use your product. Once they’re ready, you’ll already have a strong relationship and revenue, and they’ll be perfectly primed to be early adopters.

The scalable version of consulting is selling an informational product (or “info-product” for short). There are tons of great tools like Coach that make it easy to sell courses, ebooks, and more online.

4. Loans and/or grants for startups

The final option to raise the money to build your app is a loan or grant.

Most people are familiar with how loans work. We use them to go to school, as well as buy cars, houses and most of the big purchases we make in life. Interest rates can range anywhere from 4-15%. As we mentioned before, compared to VC funding, that could be cheap.

Fundera, who specializes in small business loans, compiled a list of 106 grants available to startups and small business.

Check out Fundera's list of 106 grants for startups

And LendEdu created a guide to small business grants with a handy search tool that lets you filter their list based on parameters like Amount, Category, Source and Location.

Search for a grant that works for you with LendEdu's search tool

You should also look at what kinds of grants are available in your city or state. Most states offer some sort of funding for new businesses, as long as they’re in certain industries they want to grow.

Many states these days also have in investing arm, such as the SCRA in SC, that will offer grants and make venture investments. Grants offer a small influx of cash without giving up any equity or taking on debt. Of course, the competition can be stiff. But it certainly can’t hurt to look into the resources offered in your area. If you have a business incubator in your city, they should also be able to help you find funding sources.

Takeaways

Venture funding can be hard to come by in the early stages of your startup and the costs can be higher than you’d expect. Instead, consider these alternative funding sources:

  • Self funded

  • Friends and family

  • Selling the ghost

  • Loans and/or grants

In short: the less debt you take on or equity you give away and the earlier you start getting sales, the better.

Andrew is our fearless leader. If you want to chat about startups, football or cooking shows you can hit him up on Twitter. If you enjoyed this post it would be a huge help if you shared it or signed up for our newsletter.