Starting a new business is an exciting endeavor, but it also requires capital to get off the ground. Whether you need money to rent office space, hire employees, or develop a product, finding the right type of startup financing can be a challenge. This comprehensive guide will walk you through the most common options entrepreneurs use to fund their startups.
What is Startup Financing?
Startup financing refers to the money invested in a new business venture. It provides the capital necessary to pay for expenses like research and development, equipment, inventory, marketing, and hiring team members in the early stages of launching a company.
Without startup financing, most entrepreneurs would not have the funds required to get their business idea up and running. While some types of financing must be repaid with interest, others only require giving up equity or a share of ownership in the company.
Useful Information: How to Get a Startup Business Loan With No Money
Startup Financing Options
There are a variety of sources entrepreneurs can turn to for startup funding:
Personal Funds
The most accessible source of startup financing is often the founder’s personal savings and assets. Many entrepreneurs self-fund their businesses by bootstrapping, meaning they rely on their own money rather than outside investments.
Sources of personal funds include:
- Savings accounts
- 401(k) or IRA retirement accounts
- Home equity lines of credit
- Credit cards
- Cashing out stocks and bonds
While self-funding gives entrepreneurs full control, it also puts personal assets at risk if the business fails. It also limits how much capital is available to grow the company unless other sources are secured.
Loans
Startup business loans provide debt financing, which means the borrowed money must be repaid with interest according to the loan terms. Loans do not require giving up ownership in your company.
Some top small business loan options include:
- Term loans – These provide a lump sum upfront and are paid back over a set repayment term. They may come from banks, credit unions, online lenders, or the U.S. Small Business Administration (SBA).
- Business lines of credit – With a line of credit, you can access funds as needed up to a set limit. Interest is only charged on the amount used.
- Equipment financing – Lenders provide loans specifically to purchase large equipment or machinery. Payments are made over time.
- SBA microloans – The SBA offers loans up to $50,000 to fund working capital.
- Credit cards – Business credit cards can provide quick, short-term financing for startup costs. However, interest rates are usually higher.
Equity Financing
Equity financing involves selling partial company ownership to outside investors in exchange for their investment. It does not need to be repaid like a loan as long as the shares are not bought back.
Common equity financing options for startups include:
- Venture capital – Venture capital firms provide substantial funding in return for equity. They often want an active role in the company.
- Angel investors – Wealthy individuals provide smaller investments than venture capitalists. Requirements are often less stringent.
- Crowdfunding – Entrepreneurs can raise small investments online from a large number of backers.
- Friends and family – Asking those close to you to invest provides startup capital without the bureaucracy of professional investors.
While equity financing does not need to be repaid, it does mean giving up decision-making control and sharing future profits. High-growth companies are the best candidates for equity funding.
Grants
Startup grants provide funding that does not require repayment or giving up company equity. Grants are offered by government agencies, nonprofit groups, corporations, and even universities.
For example, the SBA has various grants for women entrepreneurs, veteran-owned businesses, and other underserved groups. Most grants have strict eligibility requirements and extensive application processes. Competition is high, so grants should not be relied on as a sole source of startup financing.
Other Options
Some other creative methods of funding a new business include:
- Reward-based crowdfunding where backers receive gifts or early products
- Business plan competitions for a chance to win cash prizes
- Accelerator/incubator programs that provide funding in exchange for equity
- Small business incentive programs and economic development subsidies
- Payment in advance from customers
- Fundraising events
- Credit card rewards points
Factors to Consider When Choosing Startup Financing
With so many options on the table, how do you decide which funding sources to pursue? Here are some key factors to think through:
Amount of Capital Needed
Consider how much money your startup realistically requires to achieve its early milestones. This will help determine if self-funding is feasible or if you need to look at outside investors and lenders. Know how much equity you are willing to give up or how large of a loan payment you can handle.
Timeframe
Some types of financing can take months to secure, while others provide funds more quickly. For example, crowdfunding campaigns and venture capital pitches will require more time than using personal credit cards or a business line of credit. Evaluate when you need access to capital.
Risk Tolerance
Equity financing involves giving up ownership and control, while loans put personal assets at risk if you are unable to make payments. Determine how comfortable you are with different risks and potential downsides.
Growth Potential
If your business is built to scale rapidly, venture capital or angel investors may be worthwhile since they offer larger amounts of capital. But if you anticipate slower, organic growth, term loans may better suit your needs.
Industry and Location
Research if certain industries or geographic areas have more financing options available. For example, technology companies on the coasts tend to attract more venture capital. Take advantage of programs targeted to your specific business type and location.
Step-by-Step Process for Securing Startup Financing
Once you decide which funding routes to pursue, follow these steps to set your startup up for success:
Step 1: Create a Business Plan
Develop a comprehensive business plan that covers your product or service, market analysis, competitive advantages, operations plan, management team, and detailed financial projections. This document is essential for convincing investors and lenders to provide startup capital.
Step 2: Prepare Required Documents
Lenders and investors will ask to review key financial statements and legal paperwork, such as:
- Projected profit and loss statements
- Cash flow projections
- Personal and business tax returns
- Personal financial statements
- Legal formation documents
- Intellectual property details
Having these ready will make your business appear professional and save time.
Step 3: Research Your Options
Spend time identifying potential investors and lenders that seem like a good fit based on their requirements, portfolio, and history. Reach out to your network for introductions and recommendations.
Step 4: Pitch Your Business
Start presenting your business plan and requesting meetings with prospective sources of financing. Be prepared to explain what the capital will be used for and how it will lead to profitability. Demonstrate how you will repay loans or provide return on investment.
Step 5: Negotiate the Terms
Carefully negotiate the best possible terms for any financing you secure. Consult professionals to review documents and ensure the terms are favorable before signing.
Step 6: Manage the Funds Responsibly
Keep detailed financial records, use capital only for intended purposes, make payments on time, and meet reporting requirements for investors/lenders. This will position you for future rounds of financing.
Frequently Asked Questions About Startup Financing
How much money do startups generally need?
This depends heavily on your specific business model and industry. Most experts recommend having at least 12 months of operating expenses secured, which could range from tens of thousands to over a million dollars.
What if I cannot get external funding?
Look at ways to get creative with bootstrap funding – minimize overhead, buy used equipment, use independent contractors rather than employees, etc. You may also need to rework your business model to be less capital-intensive.
What stage is best for seeking venture capital?
Venture capital firms look for startups that already have an MVP, initial traction, and a plan for rapid expansion. Unless you are already generating revenue or have a proven management team, VC is hard to secure.
Should I use personal or business credit cards?
Business credit cards often have higher limits and come with protections if the business fails. But personal cards are sometimes used if business credit is not yet established. Avoid high fees and interest rates.
How much equity do investors want?
This varies greatly, but it is common for investors to negotiate for ownership of 10-25% of the company, a board seat, and voting rights on major decisions.
Can I get a bank loan for a brand new business?
It can be very difficult to get approved for traditional SBA and bank loans without two years of operations unless you provide collateral or a personal guarantee. Online lenders may offer terms for newer businesses.
