Each entrepreneur seeks to build a successful business, but only one out of twelve business owners succeed.
There are many reasons for this. At least four of the top 20 reasons startups crash are money-related, according to CB Insights. Namely:
29% — ran out of cash
18% — pricing/cost issues
13% — disharmony among team/investors
8% — no financing / investor interest
For a startup, finding a reliable and stable source of capital is the recipe for the projects prosperity. You also need to know how to divide startup equities to optimize your budgeting. There are many financing options, the key ones will be considered below.
Startup Financing Option #1: Bootstrapping
According to the EU Startup Monitor report 2018, about 80% of small businesses rely on their founders personal savings for their initial capital needs. Bootstrapping is a type of startup financing, when founders use their own incomes and savings for business development. This financing option is good because it motivates founders to better control costs and to work hard to earn back the invested money.
- no influence of external investors;
- the ability to take risks ("free floating");
- no need to share equity with anyone.
- you need to search for startup experts and mentors by yourself;
- the risk of losing equity;
- not fast startup growth.
Tip: Learn how to use limited resources wisely, maximizing the value of each.
Startup Financing Option #2: Family and friends
Family and friends are perhaps the first unofficial startup investors. Of course, this source of financing is very unstable, but it makes possible the attraction of financial resources without sky-high interest rates. When asking relatives for funding, it’s nice if you treat them the same way you would treat external investors - prepare the project presentation, share all the details, and answer their questions.
- they are easier to convince to lend money than bank officials;
- loved ones are unlikely to require strict repayment conditions.
- limited resources - sooner or later you'll have to apply to external sources of financing;
- source instability;
- a great risk of spoiling the relationship (in case of business failure or if it takes more time to pay off the debt).
Tip: Trust is good, of course, but when borrowing money even from loved ones, clearly state all the conditions: loan date, amount, interest (if any), repayment schedule, and even draft a written contract for their inspection.
Startup Financing Option #3: Crowdfunding
This is a way to get investment for a project without bank loans and borrowing from relatives. Through a crowdfunding platform, a large number of people can become your investors who are interested in implementing the project or they just like your idea. This type of startup financing allows companies to combine small investments from several investors instead of looking for a single source.
- accessibility for everyone;
- transparency of information on collected funds and their lack;
- it’s a good way to test the market;
- access to the so-called "cheap money";
- pre-financing of your next product.
- some platforms charge the payment processing fees;
- possibility of low funds if platform users don’t like product;
- the presence of scammers.
- When choosing a crowdfunding platform, carefully read its terms and conditions.
- Prepare your startup project well before applying for finance. Describe your idea in detail so that people understand what they are investing in. Determine the required amount and designate it.
Startup Financing Option #4: Peer-to-peer (P2P) or marketplace lending
P2P lending marketplace is a form of lending, which is a hybrid of crowdfunding and market lending. The previous type of startup financing and this concept is often confused, but there is a difference between them. Crowdfunding is about equity, and at P2P, it's about debt, here investors will benefit from a percentage of its repayment.
- ease of application;
- the ability to quick receipt of funds;
- no need to personally contact the bank or wait for approval;
- low interest rates;
- accelerated solutions.
- not available in all states;
- a small fundraiser;
- interest rates are higher if the credit rating is below average;
- a large interest rate for issuing a loan (up to 6%);
- insufficient regulatory framework;
- lack of personal communication.
Startup Financing Option #5: Grants
Another good opportunity to receive financial support for the small business developments are government grants provided by the US government and other organizations. To get it, your startup must first and foremost be interested in research and have a goal to improve people's lives. Competition in the pursuit of grants is tough, but it’s worth it - this type of startup financing will help reduce the initial costs of your small business and save money.
- money is non-refundable;
- high availability;
- financing in various R&D categories;
- the number of grant applications is not limited.
- the complexity of the application process;
- the availability of financial conditions;
- violation of the rules may lead to the return of grant money;
- reporting on the grant use.
Although financing is one of the most important stages while creating a startup - there are many others. Moreover, if you forget about even single one of them, your whole grandiose enterprise might fail. Fortunately, we have already prepared the comprehensible Startup Checklist for you, so you won’t forget anything.
Startup Financing Option #6: Incubators and Accelerators
They help companies not only get money, but also other types of assistance. Incubators and accelerators are very similar in nature, suitable for the early stages of startup development, but there are still differences between them.
Unlike incubators, accelerators are fixed programs for startups that have a developed basis and ideas and wish to accelerate their growth. Usually, accelerators are funded by corporations that provide startups with a place in their offices, as well as provide mentoring and guidance. In addition, the accelerator program usually lasts 3-4 months. Incubators do not work on a well-established schedule, working with them, a startup gets access to long-term support. In short, incubators give startups the opportunity to quickly start their company and develop it, while accelerators allow startups to rapidly scale their business.
- provide mentoring and training;
- marketing, infrastructure and financial assistance (free office space, hosting loans, financing advice and other resources);
- access to potential partners network;
- contacts with alumni, mentors and consultants (network effect);
- the increased credibility and recognition of your business to potential investors, employees and other companies;
- incubators help develop a product or service from scratch, develop a vision and strategy;
- incubators provide access to long-term support.
- an extended and complicated application process;
- a high competition for a place in the program;
- plenty of activities required to visit;
- not all incubators / accelerators are created the same;
- the absence of fixed program dates may have disadvantages.
Tip: if you are a fast-growing company, then an accelerator might be the right fit. But if your growth plan is still being developed, the best option would be an incubator.
Startup Financing Option #7: Small Business Administration (SBA) Loans
The peculiarity of these organizations is that SBA do not provide loans. Instead, it guarantees part of a loan issued by a bank, credit union, non-profit, or other lender. This means that the SBA will pay off part of the remaining debt if you do not fulfill the loan obligations (important: the size of the loan should not exceed $5 million).
- reasonable conditions: low advance payments, available restructuring options, limited interest rates;
- SBA lenders are more likely to issue loans to “risky” startups.
- difficulties with application submission;
- pretty high interest rates;
- risk of losing personal assets.
Tip: apply for an SBA loan only if you think you can repay your loan responsibly.
Startup Financing Option #8: Angel investors
Typically, these are investors who are successful in a particular industry and are looking for new opportunities in it. They invest in startups in exchange for a stake in a new business. As you can see from the infographic below, most angel deals prevail in the field of information technology and financial technology.
This is the main source of external financing for new companies with the potential for rapid growth. Business Angels help startups overcome the stage when the amount of resources needed for development already exceeds the capabilities of the founders, but is not large enough to interest an investment fund. Incidentally, such fast-growing giants as Pinterest, Carbonite, Facebook, Google, Clarisonic and Zipcar were also funded by Angels.
- business angels are willing to take risks;
- no payments and interest;
- access to knowledge and contacts in the field of your investor;
- access to investor mentoring.
- a business angel expects great recoil and high profitability;
- your future profit is limited (you give part of it in return for equity);
- possible partial loss of control over the business;
- not suitable for investments below £10,000 or more than £500,000 (which is approximately $13,000 - $650,000).
Tip: Examine the terms of the contract to ensure that the amount of ownership requested by the investor does not hinder your company's ability to make a profit.
Startup Financing Option #9: Venture capitalists
Venture capitalists are investors who, in exchange for the provided funds, receive a share of the company's equity and the possibility of a subsequent profitable sale of this share. Venture capitalists invest in companies that have already shown the ability to generate profits.
Micro-venture capital is an investment of startups in the early stages, with less funding than traditional venture capital. Venture capital investments can range from US $100,000 for the Seed stage and over US $25 million for more mature startups in large markets. Unlike the latter, micro-venture capital is used in companies that have not yet gained momentum, and consists of small initial investments, usually from $25,000 to $500,000.
According to Crunchbase, in the third quarter of 2019 around the world, about $75.6 billion was invested in 9,100 venture capital transactions.
- the opportunity to raise high capital;
- the access to experienced management;
- higher startup publicity;
- you do not need to repay the debt in the event of failure;
- the possibility of rapid growth;
- assistance in team building and risk management;
- no monthly payments.
- big competition for financing by venture companies;
- VC owns a share of your business;
- a formal reporting structure and board of directors are required;
- extensive due diligence is required;
- funds are provided according to the execution schedule;
- lack of discipline in spendings.
Tip: Before you make a deal with VC, make sure your business is ready to scale.
Useful links: MicroVentures, Collaborative Fund, NextView Ventures, Micro-VC/seed fund spreadsheet, Authentic-ventures, The National Venture Capital Association, Top 100 VCs in Europe, The Top 20 Venture Capitalists
Startup financing is, of course, not a rocket launched into space, forgive us Elon :). But still, startup financing requires serious planning and efforts. Each startup founder should weigh the advantages and disadvantages of financing options and determine which sources of funds provide the most flexibility at the lowest cost.
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