Launching your own business is challenging, and obtaining capital can be the primary obstacle in an early startup’s life. Luckily, there are many financing options for entrepreneurs, from loans to crowdfunding to business grants. Understanding your different funding options is the first step in securing the right financing for your startup business.
What is startup funding?
Startup funding is the money needed to help get a startup business off the ground. There are a variety of funding sources and the money can be used for any of the initial costs of starting a company, including office space, licenses, hiring employees, and product development. It’s essential for any startup founder to understand the landscape of funding options, which include loans, equity, and grants.
Debt financing and equity financing are the two major categories of funding for startups. In debt financing, the company borrows money that must be repaid over time with interest. Companies that raise equity financing secure funding in exchange for shares of the company. Unlike debt financing, the money doesn’t have to be paid back, but investors may expect a high rate of return. Friends and family, angel investors, and venture capital are three major sources of equity financing for startups.
Types of Startup Business Funding
From loans to equity financing and other alternatives, startups have a range of options for funding. In this section, we will lay out a few of the most common avenues to obtain money to grow your business.
Friends & Family
One of the most common ways that entrepreneurs initially raise money is through personal connections, oftentimes through investments from friends and family. With friends and family funding, you are leveraging your personal relationships and social capital, as the people closest to you trust you and may be inspired by your idea.
Funding from friends and family is often given in the form of an informal loan or in exchange for equity in the business. While this type of funding is generally the easiest to secure, it’s important to understand that with friends and family funding, you may be putting your personal relationships on the line.
Startup businesses often look to credit cards for quick funding, as a founder with a decent personal credit score can get approved for a credit card almost instantly. Credit cards with reasonable interest rates can be a solid short-term financing option for startups, and additionally, a card may offer an introductory 0% annual percentage rate (APR) for a short period of time, allowing cardholders to avoid the high interest rates they may see from other funding options. Business owners can also benefit from a credit card offering rewards points or cash back.
You’ll need to be careful with credit cards, however, as many have high APRs once any introductory offers have lapsed. While business owners can benefit from the quick approval process and fast access to credit, if not managed responsibly, credit cards can leave your business with troublesome debt.
There are a variety of loan products suitable for startups with varying terms, amounts, and rates. Below, we review a few of the most common loan types for startups.
Apply for a loan
- SBA Loans: These loans from local lenders are backed by the U.S. Small Business Administration (SBA), a government agency that provides support to small businesses. While most banks require at least a year of history to issue a loan, SBA loans are easier to access for newer businesses with good business credit. You’ll obtain a set amount of money that must be repaid with interest.
- Microloans: Microloans offer smaller loan amounts, ranging from a few hundred dollars up to $50,000.
- Invoice Financing: Startups can borrow money against their unpaid invoices, with the invoices serving as collateral.
- Equipment Financing: Startups can borrow money in the form of a term loan for the purpose of purchasing equipment, with the equipment serving as collateral.
- Merchant Cash Advance: Startups can borrow a lump sum of cash against future earnings, which they pay back with a percentage of daily sales.
- Personal Business Loan: This is a personal loan that can be used for business purposes. The loan application is based on your personal financial history rather than your company’s financial history.
Angel investors are high net worth individuals or groups of individuals who typically invest at least $25,000 in a startup in exchange for shares of the company. They typically have $1 million or more in assets and an “accredited investor” status with the U.S. Securities and Exchange Committee (SEC).
Angel investors take on a lot of risk to provide capital to startups in the early stages. Their investments focus on helping the founders of startups get off the ground rather than the tangible future profits of the company. Angel investors usually have a strong understanding of the industries they invest in and can provide guidance and resources to the company.
Government organizations, non-profits, and charities give out grants to support small business owners. Grants do not have to be paid back nor require you to give up ownership of your company, but the competition can be intense and the application process may be time-consuming. If you are a female, minority, or veteran business owner, you may qualify for special grants only given to minority-owned businesses.
Business Plan Competitions
Business plan competitions encourage budding entrepreneurs to pitch business plans for monetary prizes, typically ranging anywhere from a few thousand dollars to hundreds of thousands. Aspiring entrepreneurs can pitch their ideas to a panel of judges who are usually successful business people and investors. Founders can win money from the competition to put towards their business and obtain valuable advice and connections at the same time.
Startups can leverage social media and crowdfunding platforms like Kickstarter or Indiegogo to raise small amounts of money from a large pool of individual investors. The startup can raise the money in exchange for shares of the company and a promise of future returns or offer other perks.
While crowdfunding can be a viable way to raise money for your startup, make sure you fully understand how to run a crowdfunding campaign before you jump in. You’ll need to make sure you pick a realistic amount to raise, as some platforms won’t let you keep any money until you’ve raised your full amount. You’ll also want to ensure the milestones you set and the benefits and perks you offer to backers are achievable.
Venture capital is a type of equity financing that’s aimed at startups with high growth potential. Venture capital could be supplied by an individual or a firm that pools the funds of many professional investors. Investors in venture capital funds are typically large institutions such as pensions and financial firms.
Venture capital funding can typically invest a larger amount than what an individual private investor or angel investor can offer. Since venture capital often provides large amounts of funding to startups, they will exert more control over the decisions of the companies and may want a seat on the board.
How to Find Startup Business Funding
There are a great number of organizations that provide competitive funding for startups, but you may not know where to start. We’ve done the research and compiled the following list of resources to help kickstart your search for funding.
Small Business and Startup Grants
|FedEx Small Business Grant Contest||$15,000 to $50,000||At least six months in business and under 100 employees|
|Grants.gov||Varies. Grants available from various government agencies||Varies|
|National Association for the Self-Employed||Up to $4,000||Must be members of NASE|
|Shuttered Venue Operators Grant||Up to 45% of their gross annual revenue||Live performing arts venues, movie theaters, and shuttered venues due to COVID|
|Small Business Innovation Research and Small Business Technology Transfer programs||Typical grants $50,000 to $250,000, but can be up to $2M||R&D for technology innovation and scientific research|
|Visa Everywhere Initiative||$10,000 to $50,000||Innovative startups|
|Targeted Economic Injury Disaster Loan Advance||Up to $10,000||Small businesses in low-income communities impacted by COVID|
Business Plan and Startup Competitions
|Collision PITCH||Varies||Have received less than $3 million in funding|
|Hatch Pitch||$1,000,000||Launched within last two years with less than $3 million revenue|
|Seedstars Summit||$1,000,000||Certain tech industries|
|TechCrunch Disrupt Startup Battlefield||$100,000 grand prize||Launching a product to the public for the first time|
Angel Investor Groups
|Sand Hill Angels||Mountain View, CA|
|Life Science Angels||San Francisco, CA|
|The Angels Forum||Silicon Valley, CA|
|TiE Angels||Silicon Valley, CA|
|TechCoast Angels||Southern California|
|Boston Harbor Angels||Boston Harbor, MA|
|Hyde Park Angels||Chicago, IL|
|Queen City Angels||Cincinnati, OH|
|New York Angels||New York, NY|
|Golden Seeds||New York, NY|
|500 Startups||San Francisco, CA|
|Angelpad||New York, San Francisco|
|Plug and Play||Global|
|Y Combinator||Palo Alto, CA|
How does venture capital work?
Venture capital firms invest in startups when they are already earning revenue to fund the further expansion of the company. They provide capital in exchange for shares of the company and make an exit when the company grows more profitable. Since it takes startups a few years to mature, venture capital investors are typically funding companies with a ten-year timeframe in mind.
Larger institutional investors such as pension funds and financial firms invest in the venture capital funds in order to seek out higher returns on riskier companies. The venture capital fund then identifies and evaluates startups to find high potential investments.
Series A, B, C: How do funding rounds work?
You may have heard of Series A, Series B, and Series C funding when discussing venture capital but were not sure about the different rounds of funding. Each round represents a stage of funding for companies that are at different stages of maturity. For each series, venture capital investors have specific goals or exits in mind.
- Series A: This is the first stage of venture capital funding after the seed rounds of investment by angel investors. A Series A funding round is much larger than any seed round, and it’s generally a big achievement for startups. By this stage, the startup has moved beyond just an idea: the company will have a minimum viable product and some concrete indicators of potential such as a rapidly growing user base or consistent revenue. The Series A invests in the continued development of the product and a strategy for profitability. Only 10% of seed-stage startups will ever receive a Series A funding round.
- Series B: The Series B round of funding helps startups expand their market reach. At the Series B stage, the company already has developed a strong team and product—now it’s time to achieve success on a larger scale.
- Series C: The Series C round is a later-stage investment on startups that have already seen significant success. This later stage investment aims to help the company scale and grow quickly. The capital raised in this round may go towards expansion into new markets, new products, acquisitions, and to prepare for an IPO.
- Series D and beyond: Funding rounds after a Series C are generally intended to finish the goals set at the Series C round or to make a final effort towards an IPO.
There are a variety of sources of funding suitable for different scenarios in the life of a startup. Whether your startup is just an idea at the moment or has an established track record of success, you’ll be able to find multiple sources of funding that can help it develop and expand. Loans and equity are the two primary sources of funding, though winning grants and competitions may also fulfill your need for capital. Each source of funding will have different criteria in which your company will be evaluated. How you decide to fund your startup is one of the most important business decisions you’ll make because it will impact how you run your business.
AdvisorSmith spoke with the following experts to provide critical insight on funding for startup business owners.
- Assistant Professor of Management
- Program Director, Entrepreneurship
- University of Charleston
Q. How should startup businesses determine that they are ready to seek outside funding?
Lisa: Funding options must be attractive to both business owners and potential investors. From an investor’s standpoint, the right time for a business to seek funding is when a repeatable sales trend is in-hand, meaning that a business shows periodic revenue that is likely to be repeated over time.
For a business owner, the time to seek outside funding is when he/she sees the need for additional funding to scale an already healthy revenue stream. In other words, both investors and business owners should be able to recognize opportunity for growth within the established business.
Q. What are the most important traits investors are looking for when investing in startup businesses?
Lisa: Investors generally want to see three things in a business plan: healthy financials, committed business owners, and skilled leadership/management teams. Additionally, a business’s ability to demonstrate intellectual property rights and/or customer commitments is a bonus.
Q. What types of funding sources are available for startup businesses? Are there viable alternatives to equity financing?
Lisa: Bootstrapping is a traditional alternative, meaning that a business grows organically as owners’ cash flow permits reinvestment. A modern alternative that has gained popularity is crowdfunding. Platforms such as StartEngine or SeedInvest provide the opportunity to raise money with the help of multiple small capital donations or pre-purchases. Finally, one can secure a traditional bank loan, rather than trade equity for capital.