The different types of funding for new entrepreneurs
rom venture capital to bootstrapping, these are some of the options available to you as you set out to raise money for your startup. We know that choosing the type of funding that suits you best can be overwhelming, which is why we’ve come up with a list of some of the most common ones and their pros and cons.
While the funding options available to early-stage startups has grown in recent years, a key thing to remember is that the needs of your business and the milestones you hope to achieve determine which type is most suitable for you.
But raising money is relatively easy compared to the other tasks you’ll need to carry out during your entrepreneurial journey, according to Eileen Burbidge. At a talk hosted by Google last year, the early-stage tech VC said that “it ultimately comes down to human interaction and personal relationships.”
If for instance, you’re building something people are talking about or want to join because it’s meaningful, you will be attractive to funding sources, Burbidge added. With the importance of nurturing human relationships in mind, there’s really nothing to fear when it comes to going about financing your business.
The funding history of the startups featured in our books are visualized with handy illustrations; bootstrapping - symbolized by an illustration of a boot - is no exception. Believed to have evolved from the term pulling oneself up by one’s bootstraps, which means to achieve success by your own efforts, in this context bootstrap means to get cash going using personal savings or the financial support of family and friends.
For some, launching a business financially without the help of anyone else brings a unique sense of satisfaction. It also comes with the knowledge that you’ll have to come to terms with the hard work put into your savings if your company fails.
A well known example of a company that bootstrapped its way to global success is American intimate apparel company Spanx. When founder and CEO of Spanx Sara Blakely launched her business in 2000, she used all $5,000 of her personal savings. Nowadays the company drives an estimated $400 million in sales.
Also under the umbrella of bootstrapping is the monetary support of friends and family. This type of funding has less to do with trust in the company and more to do with the relationship the person has with the entrepreneur.
Among the advantages of this type of funding is that it offers faster processes and flexible payment methods. On the other side of the coin, it can possibly strain relationships. As well, besides the initial capital, friends and family don’t typically bring anything more to the table as an investor.
When a startup is in its early stages, investment from investors or “business angels” is common. Oftentimes these are wealthy people or experienced founders who can offer helpful guidance and want to invest in promising startups.
In exchange for initial or growth capital, the investor gets a stake in the company. And while the business agreements in this method of funding could be more flexible than investment from venture capital firms, a potential disadvantage is that you might find yourself having to give up a degree of control over your company.
Another possibility is that you could find yourself having to search for multiple angel investors in order to get the capital you need and subsequently managing multiple relationships and people. Still, new founders who haven’t had much luck with other types of investors might find angel investors to be a good option.
High-profile examples of tech giants which convinced business angels to invest in their venture include Whatsapp and Facebook.
Venture capital (VC)
Venture capitalists, otherwise known as VCs, work at venture capital firms and invest in companies with high growth potential in return for equity. Prior to getting involved they prefer to see some return, which is why they’re not typically interested in early-stage startups.
A pro that comes with choosing to seek a VC rather than bootstrapping or borrowing money from a bank is that the person can offer expertise and mentorship in helping you develop your business. Venture capital funding can also add credibility to your company, as well as open doors further down the road when you might be looking for future partners and investors.
One useful thing to note is that there are some venture capital firms across the globe that are set up as a sort of hybrid between a firm and a startup, meaning that their teams are comprised of people who are ex-founders rather than just money experts.
Read also: Startup jargon you need to know
Keep in mind though there are “vulture capitalists” that exist out there. These are money-minded investors who might go to extreme lengths to see a return on their investment. There’s also the possibility VCs might try steer your company in a direction that goes against your vision.
One of the more traditional ways to kickstart a business is to take out a bank loan. But before you make a beeline for your nearest banking institution, know that getting your startup loan approved may be challenging, especially in comparison to getting a mortgage or car loan.
Unlike investors that include family and friends, banks want to be sure your business plan is feasible and that you can tackle challenges should they arise. This means that you may be considered riskier than more established businesses and thus have a harder time getting off the ground if a bank loan is your only available funding method.
Many banks are well aware of this. For instance Denmark’s largest bank, Dankse Bank, believes venture capital is still an ideal option for startups. “When we first engaged with startups, the dialog often ended with a negative response because they expected us to be part of the funding, and we couldn’t and still can’t,” senior manager at Danske Bank Martin Wuertz said in an interview for the Startup Guide Copenhagen book.
As a result Danske Bank decided to launch a platform that connects startups with relevant resources, including networks, financing and talent. This gives startups the possibility to evolve so the bank can be a potential financing partner for them later in their life cycle, Wuertz said.
Some pros for startup bank loans include having an array of financing options available to you and potentially lower interest rates. Moreover, banks don’t take a share of your business, unlike angel investors and VCs.
Another term you are likely to come across on the topic of funding for is seed. The startups featured in our books that have used seed as a funding method are accompanied by - surprise, surprise - an illustration of a small plant. Seed funding refers to the first round of raising capital. This early-stage investment can come not only from banks or investors, but also from friends or family.
Crowdfunding as a means of raising money could be worth considering, especially during the seed investment stage, as it can demonstrate that an idea attracted early adopters and created lots of interest. Crowdfunding essentially refers to the practice of funding an idea by raising money from lots of people. Typically each of them gives a relatively small amount via the internet; it could be seen as an advantage that these people aren’t shareholders in the company.
A well-known example of a successful business which initially raised money through crowdfunding is Oculus VR - a virtual reality headset that all began as a side project in a garage in California. After launching with the help of crowdfunding platform Kickstarter, Oculus VR was bought by Facebook for $2 billion in 2014.
If you’re trying to get through the first run of your product, or if you’re interested in future funding from an angel investor or a VC, crowdfunding could make sense in that it can help you prove your idea. However it might not be the best option in terms of funding for the long-term.
Another challenge to consider that’s particular to crowdfunding is that in order to get people to give you money, you have to convince them beforehand to care about your product and be able to communicate to them why it matters.
On the upside, younger investors are more and more willing to look at a broader range of channels when it comes to obtaining funding. According to HSBC Private Banking’s Essence of Enterprise 2018 report, crowdfunding platforms are nearly twice as popular as a means of sourcing investment among people under the age of 35 than for those aged over 55. In countries like the UK and France, more than a third of investors are using such platforms.
Main photo: Rawpixel/Unsplash
*This article was originally published on October 17th, 2018 and updated on December 11th, 2018.