How Startup Funding Works: From Using Your Own Money To Securing Investments
Startups are a great way for entrepreneurs to leverage their ideas and skills and turn them into a profitable product. However, just having an idea is often not enough and chances are that your startup will fail. According to a study by CB Insights, the second most common reason why startups fail is startup funding. Running out of a cash is a sure way to get your business into the ground.
Running on enthusiasm alone is not enough for a business. You also need money for an office space, for employees, for supplies and many many other things. You can take a look at our breakdown of some of the main startup costs.
To make sure that your startup stays afloat until it generates enough revenue to cover the expenses, you need to fund it. There are different ways to fund your startup and each has some of its own intricacies that you must keep in mind.
Startup Funding with Your Own Money or Borrowing from Friends and Family
You can always go out and try to get money from investors. However, most investors receive thousands of requests for funding. Therefore, it’s likely that you will have to do everything on your own. Lucky for you there are several ways to proceed.
You can always tap into your savings if you have any. If you don’t have any savings you can always use credit cards or try to secure a bank loan. Credit cards are easier, but they charge a higher interest rate (at least 10%) and can carry some penalties if the debt is not repaid at the end of the month.
Bank loans are a bit more difficult to obtain, since a bank officer will have to approve it, but the interest rates are more attractive.
In addition, in the last couple of years peer-to-peer lending has taken off in some countries. Companies like Lending Club provide a platform that connects borrowers with people that can provide loans. They usually work by splitting your loan into equal parts and each lender can acquire as many parts as they want to diversify risk. For people with good credit scores, P2P lending can be an even more attractive option compared to credit cards or bank loans.
Another option is to sell some assets or get a mortgage on your house. But you risk losing your house if the business doesn’t generate any profits.
Your last resort for startup funding is asking your friends and family for a loan. It’s easier to convince your parents or your friends to get on board with your business idea than it is a bank or an outside investor. However, there is a chance that your business will fail and you can’t pay them back. It’s likely it’ll strain your relationship and make Thanksgiving dinners very awkward.
Angel Investor or VC Funding
The main issue with using your own money or money borrowed from friends and family for startup funding is that you assume all the risks. Moreover, while this approach is perfectly fine for seed capital to get you off the ground, once you grow, you might need some more serious cash.
To get more serious cash, you can go to an Angel Investor or to a Venture Capital Fund. Both provide startup funding, but Angel Investors are usually more low-key. There are several organizations, such as AngelList that can give you access to Angel Investors. They also hold events where entrepreneurs and investors can interact.
Angel Investors get stock in exchange for their money. In addition to startup funding, Angel Investors are often willing to share their skills and experience.
Venture Capital funds usually cater to high net-worth individuals who give them money to invest in early stage companies. According to Pitch Book, US VC funds received more than $84 billion from investors in 2017.
Venture Capital funding usually goes in several stages named A, B, C, etc. Each startup funding round includes a valuation of the company based on its performance. If the company is making good progress, then it’s value goes up. In exchange for funding, VC funds get preferred stock. Venture Capital invests in startups in the hope of cashing on their stock when the company ultimately goes public or is acquired by another entity.
Join an Accelerator or Incubator
There are thousands of accelerators and incubators these days. They are not used for startup funding, but more for their mentorship and resources they provide. Nevertheless, some incubators can provide startups with some money from investors.
At Ideaction, we have launched an incubator-like program for entrepreneurs. We can take entrepreneurs on board and help them validate their ideas using our highly-skilled team of UX/UI designers and software developers. Once the idea is validated we can help startups secure funding to continue their growth.
Which One to Choose?
Deciding which startup funding method is best for each entrepreneur should be discussed on a case-by-case basis. One thing to keep in mind is that using your own cash is easier, but involves more risk, which can result in additional pressure.
Taking a bank loan or using credit cars is an approach that should be considered before other options are exhausted, in our opinion.
Securing money from outside investors is tricky and the process itself is difficult, but it’s often worth it, as it provides startups not only with money but with other resources. Joining an incubator or accelerator has its benefits, but the application process can be very long. Also, incubators and accelerators take a share of equity, but don’t always provide funding.