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When most people think of funding a startup business, their mind immediately conjures thoughts of venture capitalists fighting each other to throw their money at you and make your business idea a reality. However, VC investment is not the only financing solution for startups. While potentially less risky than other methods, they also will insist on higher stakes of your equity and a more firm guiding hand over your business.
Be sure also to consider some of the many methods startups use to achieve funding, each with its pros and cons to evaluate. As the number of options can be overwhelming, we'll do our best to break down the possibilities for startup financing here.
Startup Funding Methods
1. Cash Flow Loans
Also known as a Working Capital Loan, Cash Flow Loans are term loans given out by financial institutions. Cash Flow Financing is unique because they aren't an asset-based loan and don't require assets to be given as collateral. Instead, the bank grants the loan based on proven cash flows. Generally, Cash Flow Loans are designed to be paid off in a few years.
Cash Flow Loans' primary benefit is that you don't need to pay with your growth with the capital you might need for your day-to-day operations. This means that you can fund your business while keeping cash on hand. If you are nearing your credit limit but are worried about the effect of loans on your money, a Cash Flow Loan could be the right choice for you.
The downside is that Cash Flow Loans often have high fees and interest rates. You should also look for personal guarantees and automatic payments included in the loan and make sure that your business can handle these requirements.
2. Convertible Debt
Convertible debt is another special kind of business loan. In this case, the business borrows money from an investor with the agreement to convert the debt to equity in the future, to be held by the investor. This essentially turns into a delayed "sale" of a share in your company. Some convertible debt does involve the payment of interest, however.
Convertible debt is excellent since it has a minimal effect on the company's cash flow, either in the short term or the long time. They make an excellent method of getting seed capital as they don't significantly impact the immediate operating costs.
However, you do have to realize that they will result in the loaner getting equity in the future - how you feel about this does depend on your plans for the company. There can also be many cations around when the debt converts to equity - often during equity rounds, leaving companies vulnerable between these moments.
3. Angel Investors
An Angel Investor is a Venture Capitalist and can be considered a different type of business loan. While a Venture Capitalist usually is part of a large and established company, an Angel Investor is an individual investor. Since they are an individual not beholden to a company, an Angel Investor is more "nimble" and can pick the projects they like, including smaller startups.
Angel Investors are an excellent option for a business loan since they have a vested, personal interest in your startup's success. Beyond investment, they are often a source of useful experience and guidance.
The downside is that often Angel Investors will have less money to give on loans than larger Venture Capitalist firms. Angel Investors also bring a personal element that must be navigated. You just don't need to prove your idea's financial viability but excite the Angel Investor enough that they want to invest.
4. Partner Financing
Partner Financing is a method of startup financing wherein another player in your industry helps fund your startup. Of course, nothing is free in life, and this naturally comes with some sort of benefit to the company in question. This could include sharing ideas, products, staff, distribution rights, or any other useful asset.
Partner Financing is useful because of how flexible it is, letting you cut the most helpful deal for your immediate situation. Usually, the Partner company is a larger player in the same industry as your startup, allowing you access to industry expertise and knowledge.
Partner Financing will, however, closely tie you and your product to another company and may limit your options going forwards in the future. A partnership is like any other relationship. If it goes well, it makes both sides stronger. It can also be a recipe for conflict and restricted options.
5. CDFI Loans
A Community Development Finance Institution (CDFI) is a special kind of lender, different from a bank. Most CDFIs are more local institutions designed to help boost their community. CDFIs tend to understand credit scores and try to provide the best service possible to small businesses like startups.
CDFIs tend to require much less collateral, understanding their clients might not have much to offer. Interest rates are also often lower with CDFIs since they are designed for clients with less initial capital. They often provide products that try to minimize risk.
However, CDFIs will often have less funding to offer than banks since they operate on a smaller scale. CDFIs also have fewer assets of their own when compared to banks and so tend to take longer to process business loan applications.
6. Crowd Financing
Crowd Financing, or Crowdfunding, has become an increasingly popular way for small businesses with cool ideas to get the ball rolling. Naturally organized through a platform, like Kickstarter or Indiegogo, they let startups pool tiny investments from individual investments into a more considerable sum.
Crowdfunding is great for startups since it is generally low risk, as the individual investors usually only receive a small one-time compensation for their cash. Crowdfunding can be great for raising seed funding to help your startup through the development phase before it's ready to go to discussions with larger investors.
However, only in the most exceptional circumstances will Crowd Financing help past this point. As well, you have to be very careful about the rules and terms of the platform you are using, who make their money off taking a profit from Crowd Financing. Some platforms, for example, require you to meet your stated goals for you to keep the funds raised, adding an element of risk.
7. P2P Lending
Peer-to-Peer (P2P) lending is a similar system to Crowd Financing. However, unlike Crowd Financing, it does involve actual loans with interest. The difference between P2P and traditional banking is that the loaning party is usually an individual who is in contact with your startup through an online platform, such as Lending Club and Prosper. This essentially allows you to receive loans from average persons rather than professional investors.
P2P investments tend to be reasonably easy to access and often have very reasonable interest rates and fees. There also tends to be less needed in the way of credit ratings for those applying for loans.
However, P2P investments have little in the way of insurance or government protection. They may not even be available in certain countries or sub-national entities, not making them the best choice for globally-minded startups.
Want Even More Options?
As you can see, there's more to startup financing than just looking for a Venture Capitalist. Weighing these options' cost-benefit analysis can be a real challenge and make them happen even more so. It helps to have a financial expert in your corner.
At Punch Financial, we specialize in providing high-growth companies with a modern accounting experience. Instead of hiring an in-house CFO at great expense, you can outsource your strategic needs to a firm with proven results for a fraction of the cost.
Our mission is to help you streamline your back-office, provide you with actionable data, and reduce your overhead. Let's connect to give you a customized quote and free consultation. You have nothing to lose but so much to gain.