Running out of the funds is often cited as one of the most common reasons for startup failure. It's incredibly time consuming for founders and remains a complex area to navigate given the sheer number of options available. We've put together a short guide on the most popular financing options available to startups.
Whilst technically not a fundraising method in the literal sense, it deserves to be mentioned on the list as for an early stage company, it's often very effective due to the ability to retain founder equity for a longer period of time. It's not suitable for many businesses though, especially those that require significant upfront costs.
There are multiple forms of crowdfunding methods including rewards based, equity based and peer-to-peer lending. Crowdfunding provides an excellent way to raise money for consumer facing products and services. Beware though, the most successful crowdfunding campaigns already have some capital from one of the other sources on this list.
Angel investors are generally high net worth individuals that invest up to $500,000 into a company, although the median amount tends to be much smaller. They are renowned for backing companies much earlier on than venture capital firms, although often have a similar appetite for startups with huge growth potential. This alternative form of investing generally occurs in a company’s early stages of growth, with angel investors expecting a up to 20% equity.
Angel investors frequently operate in groups, known as Angel Syndicates which allows them to collectively compete with VCs who might be offering similar check sizes. In addition to the funds, angel investors can provide a valuable source of mentorship to startup founders.
Available in almost every major city are accelerator programs such as Techstars and YCombinator. Other popular ones are listed here. The programs will typically offer a small investment under $100,000 for approximately 5% equity in the startup. In return, they aim toto "accelerate" the startup over a program through the provision of mentorship and support. Accelerator programs typically run for a period of 3 months but are often followed up with an alumni program/network.
Venture capital is financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Venture capital generally comes from well-off investors, investment banks and any other financial institutions. Venture Capital Firms such as Index Ventures provide financial capital to startups in return for equity. They have a tendency to prefer technology based startups that operate in large markets with the potential to be sold in excess of $100m. As a result, it's not a suitable financing method for the majority of SMBs.
The two main categories of loans are secured and unsecured loans.
Secured loans utilise company assets as collateral. For example, a business might use a company car in the name of the business as collateral. This can be called upon in the event of non repayment. The main advantage of secured loans is that they tend to offer lower interest rates than unsecured loans. The downside is that most early phase startups don't yet have any assets to offer as collateral.
Unsecured loans don't require any collateral from the company, although some banks may request a personal guarantee from the founder or another individual that is willing to underwrite the loan in the event of default. The interest rates on unsecured loans tend to be significantly higher.
If you have sales invoices from large companies with established credit ratings, invoice factoring can be a good option. Invoice factoring works by corporations advancing money in anticipating of future revenue from the sales invoices.
Most high street banks will loan up to approximately 85-90% the value of outstanding invoices and there are specialist outfits such as MarketInvoice that specialise in invoice financing.
Government backed loans
Several delivery partners exists for government backed loans such as the UK's government startup loan scheme. These offer unsecured loans of £25,000 to individuals to be used for business purposes and come with a 6% annual interest rate.
Government grants provide an excellent way to obtain funding for your company without having to give away equity or take on significant risks. One of the most popular grants for European startups is Horizon50 but multiple other grants exist on both a national and regional level to support various activities.
The Local Enterprise Partnership (LEP), whose main goal is the growth of businesses and as such offer many grants for their designated area. Each LEP covers one or more counties of the UK.
The European Commission website provides more information on additional grants such as COSME (Competitiveness of Enterprises and SME).
A security token represents an investment contract into an underlying investment security. This include a company stock, bond, real estate or even a fund. The security token represents the ownership information of the investment product that is recorded on-chain. In the company of company shares, investors that provide capital are given the equivalent of a share certificate, except that it's in a digital format with shares legally represented as digital tokens.
Whilst STOs are growing in popularity, they are still an expensive operation due to significant legal compliance required. As such, they are better suited to later stage companies, Series B and onwards.
An Initial Coin Offering (ICO) acts as a type of fundraiser, made popular with digital currency token offerings. Interested investors buy in to the offering, either with fiat currency or with preexisting digital tokens like ether. In exchange for their support, investors receive a new cryptocurrency token specific to the ICO. Investors hope that the token will perform exceptionally well into the future, providing them with a stellar return on investment. The company holding the ICO uses the investor funds as a means of furthering its goals, launching its product, or starting its digital currency. ICOs are used by startups to bypass the rigorous and regulated capital-raising process required by venture capitalists or banks.