Before discussing ways to get funding for a startup business, let us first understand the importance of funding or capital.

“Start-up financing is not just about raising funds, it is a holistic process that involves proper business planning with thoughtful growth targets, deciding business valuation as per the current market standards, planning potential exit options for investors.” – Nucleus Partners

A startup refers to a newly started business & essentially involves new products, ideas or techniques.

Funds are rightly said to be the lifeblood of a business. A startup business, in order to get incorporated, commence and continue its operations requires a sizeable amount of funds.

As per a research, overall 90% of the start-ups fail & 50% of all startups fail within the first five years of starting their businesses. One of the major reasons for the failure of startups is the failure to raise funds.

At the outset, a startup has to ask itself whether it is a suitable venture where investors will like to invest their hard earned money. This is because the investors want 4 to 5X return on their startup investments.

A matter of regret is that 75% of the start-ups funded by venture capital fail to show investors a good return on their money.

Now, let’s dive in & start exploring how to finance a startup business.

WAYS TO GET FUNDING FOR A STARTUP BUSINESS

1. Bootstrapping

Many start-ups are financed by owned funds by way of personal savings of the founders, and borrowings from family and friends. These businesses are known as “Bootstraps”. Here are some examples of successful bootstrapped startups.

In the initial phases of the initiation of a business, bootstrapping, which is also known as self-financing, is an effective means of financing the business.

But this is not possible always.

When a business grows, it needs huge funds, which the founders are not able to provide from their own pockets. Thus, in order to meet substantial financial requirements, the business has to raise funds from outside sources.

An issue that arises here is that how the entrepreneur can be able to convince the investors to invest in his/her venture. For this purpose, the entrepreneur has to first invest his/her own money and also invite his/her family and friends to invest in the business. This practice instills confidence in the minds of the outside investors.

When the prospective investors see that the founder himself/herself is interested in the business and his/her family and friends also show interest in it, they get a feeling of security and start investing there.

2. Business Partner Funding

If starting the business with own funds seems difficult, the entrepreneur may decide to have a business partner.

Over the past few years, more than half of Inc 500 CEOs said they started their companies with partners.

A business partner or a co-founder can not only provide startup capital but also the much needed human capital.

A co-founder, apart from infusing fresh capital, should possess the following skills:

  • Marketing
  • People management
  • Strategy
  • Innovation

But, how do you find a suitable co-founder?. The answer is Networking. Try to shortlist some suitable candidates from the pool of your friends & colleagues.

Alternatively, you may consider using platforms like CoFoundersLab.

3. Bank Loan

A bank loan is one of the most preferred sources of raising borrowed funds for startups.

Banks offer both long-term and working capital loans in different forms to the entrepreneurs. For this purpose, the bank verifies the start-up’s credit score, business plan, project report, project viability, prospects of the business, etc.

The loan can be extended in varied forms such as term loans, cash credit, overdraft, letters of credit, equipment leasing, bills discounting, etc.

Remember, a bank loan may be one of the easiest ways to raise funds but it involves considerable risk. You should not be opting for this funding method until unless your startup is breaking-even.

Unlike angel & VC investing, you have to repay bank loan & that too with a double-digit interest rate.

Having said that, bank loan as a source of funds has got one huge advantage. That is non-dilution of your equity capital. Yes, as the case with angel & venture funding, you won’t be giving equity shares to your bankers.

Small Business Administration

Startups in the USA can avail low-interest bearing, long-term loans guaranteed by SBA. Started in 1953, SBA is an independent agency of the US Federal Government that assists the Americans to start, build and grow businesses. SBA doesn’t give direct loans or grants but guarantees the loans given by financial institutions that are in line with its prescribed guidelines.

SBA 7(a) loan is one of the most popular forms of small business loans. The Federal Agency provides guarantees on these loans. Since these loans are secured by Government guarantee, the lenders offer SBA 7(a) loans at lower interest rates.

Microloans up to $50,000 are provided by SBA to the eligible startups to finance their businesses. These loans should be repaid within 6 months.

SBA’s average loan amount in 2016 was $3,75,000.

Summary of SBA loan types:

Loan typeWhat you need to know7(a) loan program (SBA’s flagship loan program)

  • Federally guaranteed term loans of up to $5 million
  • Funds for working capital, expansion, equipment purchases
  • Processed through banks, credit unions, specialized lenders504 loan program
  • Federally guaranteed loans of up to $5 million
  • Funds for buying land, machinery, facilities
  • Processed through private-sector lenders and nonprofitsMicroloans
  • ·Loans of up to $50,000
  • ·Funds for working capital, inventory, equipment, starting a business
  • ·Processed through community-based nonprofitsSBA disaster loans
  • Loans of up to $2 million
  • Funds for small-business owners affected by natural disasters and other emergencies
  • Processed through the SBA

Source: https://www.nerdwallet.com/blog/small-business/small-business-loans-sba-loans/

4. Angel Investment

An angel investor is a highly affluent individual who invests his/her personal savings in a highly risky startup.

Angel investment generally is made before the startup generates revenue or profits, in exchange for a share in the company’s equity.

Since angel investors are individuals, they can’t provide a huge amount of investment to the startups. Business angels typically invest between $25000 and $100000, though they may sometimes invest below or above the given extremes.

In order to understand how angel investors work, we have to consider the following example.

Mr. A has a good and feasible business project idea but he doesn’t have adequate personal savings to finance the business. Thus he approaches Mr. C, who is a relative of one of the friends of Mr. A, for funds. Mr. C is a rich person and is a successful businessman. He appreciates the business idea of Mr. A and sees high growth perspective in it and invests $100000 in Mr. A’s business in exchange for 30% stake in the equity of the company.

Jeff Bezos and Paul Buchheit are two big examples of angel investors.

Angel investors are most desirable for companies who face financial hardship during their initial stages of business.

Since such investors provide funds mostly against equity stake, the company doesn’t have any fixed financial obligation (such as interest or installments of principal that could arise in case of debt financing) and can focus upon long-term success.

You may consider using platforms like Angel.Co for pitching to angel investors.

5. Venture Capital

Venture capital is a sort of equity financing that is provided by investment banks and other financial institutions to startups and small companies having high growth potential.

These investors are known as venture capitalists.

As we know, the return is directly proportional to risk. Thus venture capitalists invest in companies having high risk-return profiles, expecting better returns in the long-run to compensate for the risks undertaken. But at the same time, they take calculated risks and satisfy themselves about the growth potential of the client.

Before taking the investment decisions, the venture capitalists evaluate the following:

  • The viability of the project
  • Prospects in the long run
  • Skill and potential of the management
  • Product’s usefulness
  • The total addressable market
  • Opportunities for expansion and growth, etc.

They may provide funds either all at a time or in rounds.

Besides providing funds, some venture capitalists also extend support through managerial and technical assistance. They advise and monitor the progress and performance of the client to safeguard their interest in the business.

A venture capital firm is a collective group of investors who contribute to a common fund which is then used to invest in small businesses and startups. The investors are known as limited partners and the firm as a limited partnership.

Venture capitalists come after angel investors and invest in companies which are already generating some revenue and profit.

Usually, newly established companies face problems to raise capital by making IPO because they are new in the industry and people may not keep faith in them.

Thus, by providing financial support to startups, venture capitalists act as catalysts in the growth of industry and economy of a nation. Once the company grows up and become 4 to 6 years old in the industry, the venture capital firm exits on the company making a public offer of securities.

Venture capital funding can be provided in different rounds or series (usually named in alphabets i.e. A, B and C). Usually, a company getting funding in series B indicates that the company has a higher valuation than a company getting funding under series A. Similarly, a company getting funding in series c indicates a still higher valuation.

Examples of Some of the biggest VCs in the world are Sequoia Capital, Benchmark Capital, General Catalyst, Accel Partners, etc.

6. Crowdfunding

As the name suggests, “crowdfunding” means funding a business from a large number of people called “crowd”.

Crowdfunding is one of the non-traditional modes of financing start-ups. It is a method of raising funds in small amounts from a large number of investors, especially through the internet.

Crowdfunding is facilitated by a number of crowdfunding websites such as

Kickstarter,

CircleUp,

Indiegogo,

CrowdFunder,

GoFundMe,

RocketHub,

YouCaring.com,

FirstGiving, etc.

These websites provide suitable platforms where entrepreneurs can raise funds online to finance their businesses. Crowdfunding platforms act as links between entrepreneurs and investors. Thus, crowdfunding makes fundraising easier for all entrepreneurs who want funds for their businesses by providing access to thousands of investors. The investors in a crowdfunding platform are also known as backers.

With a view to mitigating the risk of loss of money of small savers, some countries like the US have imposed restrictions on the amount of money that an investor can invest in the crowdfunding platforms.

There are mainly three types of crowdfunding, viz.

  • Donation based

Here the backers contribute money, typically in small amounts to non-profit organizations working for the promotion of social causes or for charitable purposes. The backers get no economic benefit in return except wellbeing of the beneficiaries. Tax deductions are available for making contributions to donation based crowdfunding.

  • Reward based

Here the investors invest their money through crowdfunding in return for some rewards which are typically in the form of products/services dealt in by the company.

  • Equity based

This is the most popular type of crowdfunding where the backers invest their money in exchange for stakes in the equity of the business. Thus here the company sells its equity shares to the investors and obtains long term funds. The investors get a right to the profits of the company in the form of dividend and a share in the share capital of the company.

  • Debt based

Here the company raises funds from the crowd by selling them it’s debt securities that carry fixed financial obligations on the part of the company to pay periodical interest and repay the principal on the maturity of the term of the borrowings.

Total Global Crowdfunding Industry estimated fundraising volume in 2015: $34 Billion

7. Business Incubators and Accelerators

Though these two terms are often used interchangeably, there exist several differences between the two.

Business Incubators are the organizations that work for promoting the growth of young entrepreneurs and startups. At the initial stages of startups, incubators provide various support services such as:

  • Office space to carry on business
  • Business direction and guidance,
  • Funds
  • Networking & connections, etc.

They provide business models and marketing plans for nurturing the start ups.

The International Business Innovation Association (InBIA) is an international non-profit organization that works for promoting the growth of start up companies by creating a wide base of incubators. It also conducts research and publishes statistical data on the incubation industry. It has about 2200 members across 62 countries.

To know more about InBIA visit https://inbia.org/.

Startup accelerators, also known as seed accelerators, are the institutions that accelerate the growth of existing companies already having business models in effect. They provide finance to the start up companies in exchange for a share in the equity of the company. Start-up acceleration programs include networking connections, mentorship, seed investments, educational components, etc.

7. Government Grants and Subsidies

The governments in different countries provide grants and subsidies to startups with a view to encouraging entrepreneurial activities.

In India, schemes such as Startup India and Standup India are in force that aims at providing necessary support to the Indian entrepreneurs. Similarly, SMEs can avail easy loans under Micro Units Development and Refinance Agency Ltd. (MUDRA) scheme of the Government of India.

Government grants are available in different forms; such as

  • Direct Grant

The Government may provide direct financial assistance to the startups to help them in financing equipment, setting up business in backward areas, exporting final output, etc.

  • Tax Incentives

The government may charge lower amount of tax or no tax on some startups to encourage entrepreneurship in that industry or to set up the business in specified areas.

  • Soft Loans

These are in the forms of loans at lower interest rates or less stringent terms and conditions.

To check out whether you are eligible for any government grant, visit https://www.grants.gov/.

8. Initial Public Offering (IPO)

Finally, when the company goes public and wants to raise a huge amount of funds from the general public, it can go for an IPO by getting its debt and equity securities listed on any stock exchange.

IPO means an offer of securities by a company directly to the public at large for a subscription. Here the company can raise as much money as required provided the public is interested to subscribe for the securities of the company.

This funding method is not so popular among startups. Why?. Because most countries, to protect general investors, have imposed strict regulatory conditions for raising funds via IPO.

Nevertheless, once your startup becomes eligible, IPO is something you should consider.

Conclusion

Funds being the lifeline of a business, need to be raised in appropriate amounts from appropriate sources.

Selection of the sources of funds depends on the specific requirements of the business. The entrepreneur should analyze the pros and cons of different sources of funds particular to the organization and choose those ones that best suit the business’s requirements. Multiple sources can also be tapped at a time depending upon the requirements.

Further recommended read:

1. The Correct Way To Build  Startup.

2. Difference Between Equity & Debt Financing

What are your thoughts on the aforesaid ways to get funding for a startup business? Please comment below.