Starting a business can be a complex process, and one of the biggest challenges entrepreneurs face is securing the funding they need to get their idea off the ground or scale up their business.
Pre-read: Why do Startups Raise Funding?
Fortunately, there are a variety of funding options available for startups, each with its own unique set of advantages and disadvantages.
Funds can come from a variety of sources, and although the media is often buzzing with Venture Capitalists and Angel Investors, these are just 2 sources of startup capital.
Here are the 8 most widely sources that founders or entrepreneurs use to raise funding:
It’s very common for the founders to be the first ones to fund a startup. Many startups never take on outside capital, primarily at the early stage. This is commonly referred to as a “bootstrapped” startup.
Bootstrapping is a self-funded method of starting a business, where the entrepreneur uses their own personal savings or earns income from their day job or through a side hustle to finance their business. Funding through income generated by the startup also falls under the preview of bootstrapping.
80% of small businesses rely on their founders' personal savings for their initial capital needs i.e. launching their business (EU Startup Monitor Report 2018).
This is the simplest and least risky method of funding a startup and is often the first choice for entrepreneurs who do not want to take on debt or give up (early) equity in their company.
Bootstrapping works best during the early stages when the startup is on the path to discovering its product/market fit, and the founder doesn't have to answer to any investors, on the choices s/he makes.
2. Debt Loans
Bank loans are a form of debt financing that can be used to fund a startup. Taking out a loan on a credit card is a widely used funding source to launch a startup. These are the loans, where you pay interest and do not part with the equity.
Banks typically require a solid business plan and a good credit score, as well as collateral, to approve a loan for a startup. Bank loans can provide a lower cost of capital than other sources, and in some countries like India, the interest payments are tax-deductible.
3. Friends and Family (F&F)
Friends and family members are other good sources to raise funding for your startup, which invests in the early stages. These are the people who are close to you and believe in you, and thus you don't have to convince them hard. This can be a great way to strengthen a relationship with someone close to you. F&F typically invests in the range from $5K to $150K.
But this route also comes with risks. Some founders avoid going through this route, as they don't want to risk their personal relationships. Thus, keep this process thoroughly professional, and ensure they are aware of the inherent risks associated with it. Also, never let friends and family invest more in your company than they’re comfortable losing.
The government also offers a variety of schemes and incentives to support the growth of the startup ecosystem in the respective countries. Government offers grants to fund innovations or specific projects that could create a growth impetus for businesses or GDP in particular.
Crowdfunding is another funding source for startups, where they raise small amounts of capital from a large number of individuals, typically via the platforms. Depending on the type of crowdfunding, investors can either donate money voluntarily or get rewards i.e. early access to the product or equity in the company that raised the money.
Crowdfunding is a low-riskier source for startups to raise capital, and it can be a great tool to create a demand for your innovation. However, a key problem when raising through crowdfunding is if you fail to raise a full amount, the entire collected amount is reversed, concluding it to be a zero gain activity.
Some of the well-known crowdfunding websites are Kickstarter, Indiegogo, GoFundMe, Fundable (US), Crowdcube (UK), Crowdfunder, etc.
6. Incubators and Accelerators
Incubators incubate very early-stage entrepreneurs or businesses by helping them convert their ideas into viable businesses. They provide spaces, IT infrastructure, and few resources, often at monthly subscription charges. Some startups take mentors/advisors on their board instead of incubators, to help them with long-term mentoring, and fundraising.
Accelerators run programs/cohorts typically of 1-3 months for selective startups by providing them mentorship, resources, and funding in exchange for part equity. Some of the renowned accelerators include Y Combinator, Techstars, 500 Startups, Founder Institute, etc. However, these accelerators can be very selective, and the success ratio in each cohort is often less than 0.5%.
Large corporate houses also run strategic innovation programs (boot camps/hackathons) to fund the startups or ideas (innovations) that can help them to expand into newer markets or grow their product base for cross-sell opportunities. You should explore the respective corporate houses who operate in the market as yours, to see if they run any such programs.
7. Angel Investors
Angel investment is a form of private equity investment in which an individual investor provides capital to a startup in exchange for an ownership stake in the company. Angel investors give funding and mentoring support to early-stage startups when institutional investors are not ready to invest yet. Angel investors typically invest in the range from $100K to $1M. Besides funding, angel investors are known to help in faster growth, provide valuable mentorship and support, and bring in a vast network of investors and customers.
Angel investors are typically high net worth individuals (HNIs) who are looking to invest in early-stage companies with high growth potential. In the US, they must qualify as “Accredited Investors.”
8. Venture Capital
Venture capital is a form of private equity investment in which a professional investment firm provides capital to a startup in exchange for an ownership stake in the company. Venture capitalist firms are typically interested in investing in startups with a proven track record (traction) and a potential for exponential growth. VCs typically invest in the range from $500K to $10M.
These startups have somewhat validated their product/service with customers or convincing research. And, the funding is typically used for product development and business expansion (this is when the first full-time Sales & Marketing team is hired.)
Like Angel Investors, VCs provide significant capital to fuel growth, valuable mentorship, and support, along with access to a network of experienced/large investors. Their goal is to leverage huge returns (100X+) in the form of an acquisition of the startup or during its IPO.
9. Venture Debt
Venture Debt is a institution that lends you money to extend the runway and drive organic growth, and in exchange ask for the interest component (8%-12+%), and/or the right to buy equity at a certain price in the future (warrants).
Venture debt provides liquidity to the (typically venture-funded) startups that have achieved good traction, and want to use this loan as a bridge round to achieve a milestone, thereby enabling them to raise subsequent equity rounds (Series A - F) with better valuation, to repay the loan.
10. Growth Stage Investors (Private Equity Firms)
Private equity (PE) firms, on the other hand, invest in more mature companies that have an established track record of revenue and earnings. PE firms invest in startups that have a proven Product/Market Fit and have achieved substantial growth both in terms of revenues and cash flow. PE also targets mature companies that may be close to listing on a stock exchange or are large in size. PE firms typically invest in the range from $50M and upwards.
Factors to Consider When Choosing an Investor
When choosing a funding option for your startup, there are several factors you should consider, including (not limited to):
The amount of capital you need to raise.
The stage of your company's development.
Your current financial situation.
The amount of control you want to retain over your company.
The level of risk you are willing to take on.
Who Invests at What Stages i.e. Whom to Raise from?
The picture below depicts the type of investors who invests vis-a-vis the investment size, the stage or round of fundraising, and the amount of investment holding period.
Statistics of Startup Funding Sources
The below EU statistics highlight the sources of funding that founders raised right from bootstrapping to various rounds of funding (pre-seed/seed to IPO.) This is still relevant globally and in 2023.
To summarize, the choice of funding source/option for your startup will depend on a variety of factors, including the stage of your company's development, and the amount of equity/control you want to retain.
That's it. folks. Comment to let us know if there are other funding sources that we haven't explored or covered in this article.
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