The first challenge many startups face is collecting the funds needed to open their business. While some business owners can afford to invest in their company personally, others may need financial assistance.
By understanding the different startup financing options, owners can determine which funding source best fits their unique situation.
5 Funding Options for Startups
Regardless of how well a business model is planned out, a startup's success relies on their ability to generate and sustain profits. Although many owners fund their own businesses in the beginning, startups have several financing options, including-
1. Angel Financing
Angel financing refers to investors who allocate funds to startups in exchange for an ownership percentage. While angel investors are few and far between, they have helped create successful companies, including Uber, WhatsApp, and Facebook.
These investments typically range from $25,000 to $100,000 per company. Angel investors, also known as angels, tend to focus on-
- The startups' quality, passion, integrity, and mission statement.
- A market opportunity and expansion potential.
- A detailed business plan.
- Modern technology and unique intellectual property.
- Lower valuations with negotiable terms.
While there are angel investors in nearly every field, common angels include-
- Investment bankers
The best way to find angel investors is to join a network of serial entrepreneurs with solid reputations. Aside from money, credible investors provide-
- Contacts to potential capitalists, partners, employees, and customers
- A good reputation
- Market knowledge
Crowdfunding refers to raising funds through various donations, typically via crowdfunding websites. Many startups rely on crowdfunding to promote their products and services.
Creating a crowdfunding campaign is relatively simple - owners can set up a profile on a crowdfunding site describing their company and how much money they plan to raise. Anyone can visit these sites and choose which startup they would like to donate to. However, many companies provide a reward for donations, such as a product, coupon, or other incentives meant to familiarize consumers with the business.
Successful crowdfunding depends on how well owners can express their mission, values, products, and services. By illustrating the business's goals, owners can attract like-minded people to donate to a worthy cause. Some startups are able to collect hundreds of thousands of dollars just from crowdfunding campaigns.
Rewards-based crowdfunding is the typical go-to for startups as it doesn't require an exchange of equity or ownership for donations. Instead, companies can introduce their products and services. With these campaigns, owners do not have to worry about interest or principal repayments.
Startups can also run equity crowdfunding campaigns, where owners sell stock for cash. However, this option requires compliance with strict federal and state regulations. Therefore, business owners should consult a lawyer before delving into an equity crowdfunding campaign.
Aside from raising funds, crowdfunding can create a community of donors that support a new business, establishing a potential customer base.
3. Small Business Credit Cards
Many financial institutions offer small business credit cards for startups with benefits, such as cashback and air mileage points.
However, most credit unions require a credit report to open an account. Therefore, owners would have to use their name and personal credit score to establish business credit. This means that any default payments would impact the owner's personal finances.
Some new card issuers market directly towards small businesses and do not require personal guarantees but typically have a lower credit limit.
Unlike most personal cards, business credit cards typically have high interest rates, ranging from 5% to nearly 20%. However, there are some that offer an interest-free probationary period.
4. Venture Capital
Startups looking for business guidance as well as funding can visit venture capital (VC) firms, which provide-
- Strategic assistance
- Networking guidance
- Potential employees/partners
VC financing is not easy to obtain as capitalists tend to invest in businesses that have the potential for significant growth and already have gained traction with other investors. This makes it difficult for startups without long-term goals or those with business models catered to smaller audiences.
Venture capitalists typically base their investments on a strict criterion-
- Specific Industry Sectors, such as software, mobile, biotechnology, and digital media.
- Stage of the Company, such as startups, early-stage seed, and later-stage rounds for businesses that have consistent revenue.
- Geography, such as major cities, states, and national regions.
It is important to note that venture capitalists receive a large number of unsolicited requests via email, most of which are ignored. Therefore, business owners should approach a capitalist through a personal introduction by networking with colleagues and acquaintances.
The approval process for VC is time-consuming, but owners need to understand how to negotiate their terms. Startups should negotiate-
- Investment amount
- Investment form
- Liquidation preference
- Board of directors
- Financial reporting
- Anti-dilution protection
- Redemption rights
- Refusal rights
- Registration rights
5. Small Business Loans
One of the most common financing options for startups is traditional small business loans. There are six primary types of small business loans-
- Line of Credit - By establishing a line of credit, startups can retrieve funds from lenders as needed, rather than borrowing a lump sum that may never be used. Credit lines typically have a limit and require a set-up fee, as well as monthly interest and principal payments.
- Accounts Receivable Financing - Accounts receivable (AR) financing is secured by the business's AR department and enables the startup to receive cash immediately.
- Working Capital Loans - A working capital loan is for businesses with fluctuating incomes in need of revenue stabilization. Companies typically need to secure working capital loans with collateral if they do not have existing credit.
- Small Business Term Loans - Term loans are usually set at a specific dollar amount and are used to fund daily operations or specific projects, such as marketing efforts. These loans are great for startups that need a one-time lump sum.
- SBA Loans - Many banks offer low-interest loans for startups that are guaranteed by the Small Business Administration (SBA). SBA loans typically range from $30,000 to $5,000,000.
- Equipment Loans - Startups that require special equipment can apply for an equipment loan, which typically requires a 20% down payment. These loans will range from $5,000 to $500,000 and accrue interest at a fixed or variable rate.
By understanding the different startup financing options, future business owners can determine which assistance program best fits their model.