Many associate the term "start-up" solely with tech companies chasing unicorn status.
This is a misconception. Often, the most inspiring entrepreneurs are much closer to home than you'd expect.
The local farmer's market vendor, your local coffee shop, and the cutting-edge tech start-up, these are all forms of entrepreneurship. Even in this boom of AI, many 'small' businesses are popping up.
Now, let’s explore how to choose the right financing option for your business idea and the longer term implications of each choice.
Listed no particular order,
1. Personal Savings
Bootstrapping your business is a solid option if you can manage your finances effectively without compromising your overall quality of life.
Since you’ll be using your own funds, careful budgeting is crucial, for both your business and personal expenses. You'll need to ensure you have enough financial runway to support your venture and sustain yourself while seeing the business through to success.
Best for
- Business ideas that doesn't have massive upfront costs
Long-term impact:
- Ownership: Bootstrapping means you retain full ownership of your business. As the valuation grows, the financial benefits of a potential exit will go entirely to you. Higher personal risk but higher upside.
- Control: You maintain complete control over decision-making, allowing you to steer the business in line with your vision without external interference.
2. Angel Investors
An angel investor is an individual who provides capital for a business, usually in exchange for convertible debt or ownership equity.
These individuals are typically high net-worth individuals and ex-entrepreneurs who are willing to sponsor a business from the early get-go. While it is indeed an investment on their part, due to the risk factor being so high at that stage, these people first tend to have an emotional connection with the business and just want to be involved.
Best for:
- All businesses
Long-term impact:
- Having angels on board offers initial capital and (in most cases) flexibility to move the business in the direction you see fit. These angels are also typically highly connected people and can help to connect the business with financiers at a later stage.
- Selecting the right angel investor is important, because it will be a relationship you will hold for the duration of the business.
3. Crowdfunding
Crowdfunding is a process of funding businesses or projects by raising money from individual investors, usually around the world. Over the last decade or so, it has become extremely popular and more sophisticated. By 2028 it is estimated the Crowdfunding market size will be nearly USD $29B. The average transaction for crowdfunding campaigns in 2022 was USD $7.26K.
There are three types of crowdfunding:
Non-Equity - You receive money without selling any % of the company. Donors give money because they want to support the project with no strings attached. You typically need a compelling story to make this work.
Equity - Receiving money and selling part of the company to crowdfunding investors. Ie. allocating a percentage of the business and giving it to the investors.
Gift Equity - Receiving money in exchange for gifts from your business (like free tokens on your platform, or a taste tester of your product etc.).
Recently, plant-based meat company Heura Foods raised USD $5M in less than 4 hours on the Crowdcube platform.
Heura Foods crowdfunding
And one of the most famous companies that financed themselves via crowdfunding is the bank Revolut, which initial investors have experienced a 40,000% increase in value in their shares. It's one of the best performing companies, ever.
Best for:
- Businesses with an interesting brand / compelling story that can attract a relatively large audience who'd want to support you.
Long-term impact:
- If you do an equity-based crowdfunding campaign, the Venture Capital (VC) industry can sometimes still be perceived as an 'unprofessional' way of financing a business - and it can deter some potential venture capital firms. This sentiment is changing fast but it is important to remember to always syndicate all the individual investors to keep a tidy cap table and to put valuations that are in keeping with what VCs are willing to pay. But outside of that, Crowdfunding I suspect will only get more popular in the future as more individual investors are looking for projects that they can support, a trend that reflects the growing democratisation of investment opportunities.
4. Accelerator Programs
A startup accelerator is a business program that supports early-stage, growth-driven companies through education, mentorship, and financing. Startups typically enter accelerators for a fixed period of time and as part of a cohort of companies.
Two well-known examples of accelerator programs include Y-Combinator and Techstars.
The pros of accelerators are that they give structure and organisation to the development of your business. They often create a more straightforward pathway to receiving investment from VCs. Programs like the ones listed above are associated with high quality and thus when you enter the program you typically are perceived as a desirable young business.
Keep in mind many of these accelerators are not all that they lived up to be and cannot support the business's growth. Accelerators are also known to buy into the business at a very cheap rate (you need to sell approx. 6-10% of the company as the benchmark to participate). Accelerators are also extremely time-consuming so only recommended to if you believe that you need the structure and guidelines.
Best for:
- Tech startups that need structure / guidance on how to get started
- Tech startups that need access to larger network
Long-term impact:
- Valuations. Accelerators get in at a cheap rate, so it's important to be able to quickly jump up from the valuation you let the accelerator buy in at and the future rounds you hope to raise. Make sure the accelerator has reputable track record in the eyes of venture capital firms.
5. Venture Capital
VC funds are for startups and emerging companies that have been deemed to have high growth potential or which have already demonstrated high growth.
When it comes to the fund itself, it only has a lifespan of 10 years, and limited partners (the people who invested in the funds) are eager to get their investment earnings back. Because of this underlying dynamic, VCs only select businesses that have the ambition to grow quickly, and oftentimes, irrationally fast.
This financing choice is popular for high-growth tech companies because the size of cheques can be quite significant - meaning, you can have an injection of capital that implies fast development.
However, once on this pathway, there is typically high pressure to succeed from the fund, as they are trying to force an outcome (acquisition or IPO) so that they can return the money to their limited partners. Companies that embark on this financing journey have a growth at all costs mindset.
Below is a graph from the 50,000 startups how many turn out to reach 'unicorn' status ($1B+ valuation).
Best for:
- High-growth tech and ambitious companies
Long-term impact:
- Once you have VCs on your cap table, this tends to be an irreversible dynamic. You will need to grow quite fast. However, with a solid reputable VC and the support they give, this often can be one of the key reasons the business succeeds.
6. Venture Debt
Venture debt is a type of loan offered by banks and nonbank lenders that are designed specifically for early-stage, high-growth companies with venture capital backing.
For most lenders, startups are considered too high risk and therefore prefer to issue a loan with an interest rate attached (for example, 8%). This mechanism works similarly to a bank, but this instrument is angled towards startups. Some firms will do a combination of debt and equity ie. $500,000 USD in debt and $200,000 USD in equity (typically at a lower valuation) because of the debt component.
Best for:
- Companies that need quick runway extension
- Companies that are unable to raise at high valuations
- Companies that have all equity financing and want to have debt just as an extra boost of capital
Long-term impact:
- You need to pay back the debt at the interest rate applied. However, if the company does not succeed, you as a founder will have no personal liability for the debt.
7. Government Grants
A government grant is an equity-free instrument given to businesses that the government perceives as having a positive impact on society.
Typically when you become a recipient of a Government grant, the only work that needs to be carried out is supplying evidence that you are hitting the milestones you agreed to in the grant application.
Because this is equity free (and debt free) money, it is widely considered the best money in the market, cause it is essentially 'free', provided you do the work you commit to do. However, winning a grant is not easy and often tedious, and therefore you'd need to assess whether you have the time resources to apply for it.
Best for:
- All businesses and in particular social impact businesses
Long-term impact:
- Only need to declare and present the results of project milestones that you set out in the grant proposal. Grants are the best financing in the game, i'd say.
And, you may need to adopt a combination of these financing methods - but it is key to factor in what each of them implies to the business and to the lifestyle that you want next to your business.
The good news is, funding markets tend to grow as the economy grows, with some instruments having more activity than others, so keep an eye out on what is happening!
In this article, we are missing some other financial vehicles such as family and friends, CVCs, bank loans and private equity.
In short:
- Bank loan: I would avoid if it is possible
- Family and friends: I would avoid unless the expectations are clear
- CVCs: Corporate Venture Capital, it is the VC arm of large companies. Depending on the firm, it could be strategic, but these opportunities typically only arise when you start to have some customers and revenues.
- Private Equity: Tend to only become a possibility at a later stage when the business is more consolidated.
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Hello! Thanks for making it to the end of this article! In the spirit of transparency as we try to integrate all these crazy new AI tools to our content flows. I don't use AI tools for the conception or production of articles. I may use it to restructure a sentence that I feel stuck on and want to be presented with a different option, but that's about it. Human to human, always.