Raising capital is a daunting challenge faced by startup founders. While venture capital (VC) funding seems like an ideal source of startup capital, the reality is that less than 1% of startups receive VC backing. The competition is fierce and founders need a strong network and track record to get in front of the right investors.
Venture capital is also biased towards companies in specific industries such as technology. The vast majority of businesses are not strong candidates for a VC investment. Raising money from outside investors can prove challenging until traction to prove the business model is achieved.
Fortunately, VC funding is only one of many ways to get a startup off the ground. Financial innovation has made fundraising as well as credit more accessible in a variety of structures for business owners and founders to secure the capital they need to start and grow a business or even finance investments such as real estate.
From the basics of raising friends and family money to accessing common business loans such as SBA, crowdfunding, or collateralized loans, there are options that every founder should consider.
1. Friends and Family
One of the most common sources of early startup funding comes from an entrepreneur’s closest connections: friends and family. While they may not have the deep pockets of VC firms, friends and family are often more willing to take a chance on someone they know and trust.
Entrepreneurs should remember that small investments from multiple individuals can quickly add up. Founders can consider offering perks like a small equity share to encourage funds from friends and family.
Entrepreneurs should keep thorough documentation whenever seeking funding this way, as mixing business and personal relationships can become complicated.
2. Crowdfunding
Crowdfunding platforms like Kickstarter and Indiegogo allow entrepreneurs to raise funds directly from individuals online. The idea is for founders to pitch their product or business to potential customers and supporters to generate excitement and capital.
A significant benefit of crowdfunding is market validation. If people are willing to put money behind an idea, that indicates a product-market fit. However, These platforms take a percentage of funds raised and sometimes won’t release any money until entrepreneurs reach the total campaign amount.
3. SBA Loans
The Small Business Administration (SBA) guarantees loans from banks and other lenders to small businesses struggling to secure traditional financing. There are general small business loans, but SBA offers more specialized options, like disaster assistance or microloans.
A clear benefit of SBA loans is lower qualification barriers than traditional loans. That said, maximum loan amounts are capped, and the process still involves extensive paperwork. Additionally, defaulting on SBA loans can hurt the borrower’s credit score.
4. Personal Loans
While personal bank loans can be a high-risk option that puts your personal credit score at stake, they can still become a source of last-resort capital if you have exhausted options for other lenders and investors. It’s essential to remember that qualifying for a personal loan will require meeting the lending standards of your local bank, and if your business fails, you are still liable for the repayment of the loan.
5. Equity Loans
A lesser-known source of personal loans is borrowing against personal assets that could be used as collateral.
Equity loans are becoming an increasingly common lending source when liquidity tightens. They allow an entrepreneur to tap into the value of their luxury assets without selling them. These loans are sometimes known as collateral loans, where borrowers use items like diamond jewelry, watches, and designer handbags as collateral for quick business financing.
The lender appraises the market value of the items and extends a cash loan up to a certain percentage of that value. The collateral is then held securely by the lender during the loan term and returned to the borrower upon repayment.
Mills Menser, the CEO of Diamond Banc, one of the largest jewelry equity lenders, explained, “Your ability to borrow is primarily based on the liquid value of the collateral you provide, facilitating a quick and uncomplicated funding process.”
These types of loans can offer access to expedited funds and the benefit of not impacting your credit score. “Loans up to $75k are typically funded within a day,” Menser explained. “For loans exceeding $75k, funding usually occurs within 24-36 hours, depending on the borrower’s efficiency and responsiveness.”
6. Peer-to-Peer Lending
Startup business founders who cannot qualify for traditional loans or venture capital funding might benefit from peer-to-peer (P2P) lending. This type of funding has gained popularity in recent years as an alternative way to secure the financing of various projects, including starting a new business.
This type of business funding involves connecting individual investors or lenders with borrowers through online platforms. Entrepreneurs can list their financing needs on these platforms, including the amount and purpose of the loan. Investors can browse these listings and select the projects they are interested in funding.
P2P lending offers a unique opportunity due to its accessibility. For founders who may not have access to a traditional bank, P2P lending provides competitive interest rates and a viable alternative to conventional funding options. However, it is important to note that interest rates can vary widely depending on the borrower’s creditworthiness.
This alternative type of financing comes with risks. Not all P2P loan applications are successful, as investors may choose not to fund a particular project. Late or missed payments can also negatively impact the borrower’s credit score.
Despite the risks, P2P lending can be a viable financing option for startup founders who may otherwise be unqualified for traditional loans or venture capital funding.
7. Government Grants and Programs
In addition to the various types of business funding options available, founders should consider exploring government grants and programs designed to support small businesses and startups.
Small Business Grants:
Though highly competitive, small business grants are popular among entrepreneurs in specific industries or with a focus on research and development. Offered at both the state and local levels, these grants are a desirable option because they do not require repayment. There is, however, a downside: the application process can be daunting and usually has strict eligibility and reporting requirements. Applicants need to take their time and do their research before applying for a small business grant.
Small Business Administration (SBA) Programs
The Small Business Administration is an excellent resource for small businesses, including startups. This agency offers various programs and services to support entrepreneurs and their endeavors. Programs offered by the SBA can include access to loans with favorable terms, technical assistance, and mentorship. The SBA also offers disaster relief programs for businesses affected by natural disasters or economic downturns.
State and Local Economic Development Initiatives
To draw business to their jurisdictions, many state and local governments offer economic development initiatives. These programs vary by region but can include tax credits, grants, low-interest loans, and site selection and workforce development assistance. Founders should conduct thorough research to explore what programs are available in their area.
Research and Development (R&D) Tax Credits
If your startup is engaged in research and development activities, R&D tax credits are offered by some governments as a viable option for funding. These credits can offset the costs associated with product development and other innovations within your startup. Technology-related startups may find R&D tax credits particularly beneficial to their operation.
Founders engaged in R&D activities should research federal and state-level R&D tax credit programs to determine eligibility for these incentives. Consult with a tax professional or experienced tax accountant to maximize the value of these programs.
Incubators and Accelerators
Incubators and accelerators aren’t direct government funding. But, they can provide business startups with access to investors, resources, and mentorship programs. Often, founders can seize opportunities through these programs to participate in demo days or pitch events to showcase their business to potential investors.
Incubators, as the name suggests, nurture startups from the very beginning stages. They tend to offer a broader range of supportive services. Accelerators are designed to accelerate the growth of more established startups and have a more specific focus on scaling the business and securing funding. Founders should consider their business’s particular stage of development, needs, and goals when deciding whether to join either of these programs.
More Than One Way to Fund a Startup
Raising startup capital takes creativity, especially if you want to avoid the rigors of traditional lending and VC funding. By tapping into personal networks, online crowds, government-backed programs, and luxury assets, entrepreneurs have more options than ever to get their ventures off the ground.
While not without risks, alternative financing solutions allow founders to validate and launch new products and businesses on their own terms. As your business grows and builds a track record, you can always circle back to institutional investors down the line.
Featured Image Credit: Photo by RDNE Stock project; Pexels; Thank you.
