Startup Funding Definition, Types, Necessity of funding and how it works
If you go to any startup events you will notice that almost every conversation is about raising money. From this you can easily realize how important startup funding is. Startup funding, startup capital, startup investment- all are the same terms.
Wilbur Labs found data from their analysis on 156 startups- 37% startups fail from 2000 to 2020 only for running out of money. This is the highest rate from reasons they identified. It is clear that funding is a very crucial element to grow a startup.
📃Table of content
- What is Startup Funding?
- Why do startups need funding?
- How Does Startup Funding Work?
- How many types of startup funding?
- 1. Bootstrapping
- a) Personal Savings
- b) Family and Friends
- c) Credit Cards
- 2. Crowdfunding
- 3. Accelerators and Incubators
- 4. Startup events and competitions
- 5. Debt Funding
- a) SBA loans
- b) Microfinance Providers or NBFCs
- c) Credit cards
- d) Short term loans
- e) Asset loans
- f) NGO loan
- 6. Equity investors
- a) Angel Investors
- b) Venture Capitalist (VC) Firms
- 7. Government programs
- 8. Organic Funding
- Which funding is the best option for you?
What is Startup Funding?
Startup funding or startup capital is the money required to launch and run a new business. “Seed money” is another name for startup capital. It is a financial investment for a startup company to use in their product development, manufacturing, sales and marketing, office spaces, inventory or any other expense.
Why do startups need funding?
Finance problem is one of the big reasons to fail in a startup business. By interviewing real startup founders, it is found that most of the startup founders tried to self-fund their businesses. From them maximum numbers of startups fail due to the lack of appropriate budget.
Here are some reasons why you should look for funding:
- To scale up the business operations
- For creating prototype and developing product
- To develop a business website or app
- For hiring and running a team
- For taking taking legal and consulting services
- To buy raw materials and equipment
- To do all necessary licenses and certifications
- To manage working capital
- To manage marketing and sales cost
- For maintaining office space and other admin expenses
- To establish a competitive advantage
- To fund the short-term operational expenses
- To maintain all research and development cost
There are the common reasons for which you need funding for your startup company. Startups are not the same in their pattern. So, you have to find out and justify what your funding needs based on your business pattern.
How Does Startup Funding Work?
Before diving into the types of the funding, it is important to know the basic steps about how the whole system of raising the fund's works. Here is a superb guideline on how company funding works.
Many entrepreneurs take the help of investment bankers and fundraising consultants to manage their funding process smoothly. Still there are some basic steps that every startup founder should follow to get their funds. Steps involved in fundraising rounds are given below:
My personal advice, if you need money between 25 Lakhs to 1 Crore then approach angels. On the other hand, if you need more than 1 crore then approach VC. After getting funds you have to be very careful to utilize it.
How many types of startup funding?
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| Types of startup funding |
Bootstrapping
Bootstrapping in a startup means building a business with little or no outside cash. When you invest your own money or borrow from friends and family to start your business that is called bootstrapping.
Self-funding is the most effective and inexpensive way in startup financing. By bootstrapping, startups generate cash flow in their early stages.
We can categorize bootstrapping in three ways. 1) Personal Savings 2) Friends and Family and 3) Credit Cards
Personal Savings: This is the most convenient source of funding, because you use your own money to start your business and you don’t have to depend on anyone to use it.
Family and Friends: You have a good relationship with your friends and family. You can use this relationship to get funded in your business. You don’t have to convince them the way you would with other equity investors like VC, angel investor or bank. Your family members and friends will believe you easily because they know you more than any other people in the world.
Credit Cards: For your initial need you can use your credit cards. You can buy your primary equipment and meet up your other initial costs by using your credit cards. But you have to try to get funded to pay off the credit card bill with interest.
In bootstrapping you have total control of your business and money. It’s also a mental satisfaction that you are using your own cash to fund your business.
Crowdfunding
Crowdfunding is one of the trendiest processes of raising initial investments from a large number of individual people—friends, family, colleagues, individual investors, and even customers usually via the internet.
Crowdfunding is getting huge popularity in recent times. In this funding you have to create a campaign via social media and crowdfunding platforms by giving details about your business plan and goal as an attractive pitch to get a better reach.
Some of the popular crowdfunding sites in the US, Kickstarter, RocketHub, Dreamfunded, Onevest and GoFundMe.In India, Indiegogo, Wishberry, Ketto, Fundlined and Catapooolt are popular crowdfunding platforms.
Accelerators and Incubators
Accelerators and Incubators programs assist hundreds of startup businesses every year. In your early stage of business, you can consider these programs as a funding option.
Accelerators help startups by giving capital ($50,000 to a couple hundred thousand dollars) usually in seed funding level and also offer support of mentorship, and other forms of guidance.
Meanwhile, Incubators nurture the business providing workspaces, mentorship, training, networking opportunities and resources to a business.
These types of funding and mentorship programs last from a few months to a year. They help the new startup business in exchange for 5-10% of the stock. Both Accelerators and Incubators help to speed your startup company to the next level.
Y Combinator, TechStars, Kicklabs, 500 Startups and AngelPad are some of the popular accelerators and incubators in the US.
In India, Amity Innovation Incubator, AngelPrime, CIIE, IAN Business Incubator, Villgro, Startup Village and TLabs are popular names of accelerators and incubators.
Startup events and competitions
To encourage entrepreneurs many events and competitions are organized all over the world.
Participating and winning startup competitions can also help you to maximize your funds along with gaining some validations and getting some media coverage.
In these events and competitions, you have to build a product with a proper business plan. You need to make your project extraordinary to get success in competitions. You can also present your idea individually. You have an opportunity to pitch it through a business plan. Convincing skills will give you extra benefit.
Some of the popular startups Indian contests are, Microsoft BizSparks, NASSCOM’s 10000 startups, Conquest and NextBigIdea Contest.
Debt Funding
A startup needs funding from its ideation phase to the point of reaching IPO offerings, mergers or acquisitions. When the business starts rolling, a new business needs to raise funds from external sources. Debt funding is one of the major sources of external funding.
In short, debt funding is taking a loan from someone and paying them back with interest after a period of time. Debt funding for startups refers to borrowing money from the investor or venture capital firm against a rate of interest for a given period with company assets as securities. Here the investors don't get any shares of the company but the startup has to repay the amount borrowed along with the interest at predetermined rates.
Here is given some debt funding resources which will help you to raise your funds.
SBA loans: Small Business Administration (SBA) loans are government-sanctioned loans specifically for the small businesses. Basically the U.S. government operate and manage this SBA loans.
When the loans are approved by the SBA you will have to find a local lender who provides SBA loans to get the funding.
Microfinance Providers or NBFCs: If you can’t qualify for a bank loan microfinance is a good option for you. It is becoming popular day by day. NBFCs are Non-Banking Financial Corporations that provide Banking services without meeting legal requirements of a bank.
You can approach the microfinance and NBFCs for the funding. They will usually fund you on the basis of debt and they may ask for security or guarantee.
NBFCs are commonly called NBFIs (Non-Bank Financial Institutions) in the United States. Annapurna Microfinance Pvt Ltd, Arohan Financial Services Pvt Ltd, Bandhan Financial Services Pvt Ltd and BSS Microfinance Pvt Ltd are some of the top microfinance companies in India.
Credit cards: In the bootstrapping section I talked about credit cards. That was for personal credit cards. But business credit cards can be a great option for early-stage startups who need help to grow the business.
Try to get a 0% interest rate on the introductory period of time and pay back the money within the time to avoid high interest rate.
Short term loans: A short term loan is a type of loan that is acquired to meet the temporary business capital need.
In emergency cases if you need money to expand your business then you can take short term loans. From getting the loan you will get a maximum one year to pay back the loan with interest.
Asset loans: In debt funding asset loans are another method to raise capital. It raises higher capital than small bank loans against collateral. Yet, not many founders take this option to raise funds as the chances of losing assets are high.
NGO loan: NGO or NPO is another option to get a micro loan. If one has unreliable financing sources then Micro-lenders and non-profit lenders can be a less difficult source of funds.
Equity investors
Equity funding is a method of raising capital by selling shares in exchange for a cash investment. The people who buy shares are shareholders of the company because they have received ownership interest in the company.
By investing in startup business equity investors make a partnership with the startups – if the company turns a profit, investors will get their money in return with profit; if the startup fails, the investors will lose the money they’ve invested.
Angel Investors and Venture Capitalist (VC) Firms are the most popular equity investors in startups. Here I am breaking down the equity investors which will help you a lot.
Angel Investors: Angel investors are usually wealthy individuals or a group of high-net-worth individuals who invest their money in startups in exchange for ownership equity. They can also offer mentorship alongside giving capital.
In a company’s early stages of growth angel investors invest in the company with expecting a upto 30% equity. They prefer to accept more risks in investment for higher returns. Google, Yahoo and Alibaba are the best examples who are funded by angel investors. But angel investors invest lower amounts than VC.
Fabrice Grinda, Paul Buchheit and Alexis Ohanian are some well-known angel investors in the US.
Indian Angel Network, Mumbai Angels and Hyderabad Angels are popular angel investors in India.
Venture Capitalist (VC) Firms: Venture capitalists are professional investors who invest a considerable amount of money in exchange for equity in the business, and get returns when the business goes through an IPO or an acquisition.
VCs look for companies and startups with high growth potential which will provide good returns on their investment. Most of the time, they also provide consultancy and advisory mentorship to nurture these startups.
After getting into a good revenue process, you may appeal to the venture capitalists for equity-based funding. VCs generally come at a later stage when your startup is established and generating revenue.
Sequoia Capital, Accel, IDG Capital and Khosla Ventures are top class VC in USA.
Sequoia Capital India, Nexus Ventures Partners, Helion Ventures Partners and Kalaari Capital are the most popular VC in India.
Government programs
Government of a country takes various initiatives to boost up a startup business. Development in the business sector will help to maintain a healthy ecosystem of a country’s economy. That’s why the government is trying to help a new business venture in different ways. Subsidies and grants are some of the available government programs to manage funding.
In the US, there is a small business lending fund which is called SBA and a dedicated portal for Government grants available for local businesses.
10,000 Crore Startup Fund, MUDRA, KSSEDM besides these there are various government grants and programs in different states of India to encourage small businesses and startups.
If you fulfill the requirements of those govt. Programs then you can qualify for the funds. So, government grants can be a great funding option for you.
Organic Funding
Organic funding is not outside funding. It comes from the company’s revenues. Basically, organic funding is used in new product development or in marketing cost. Sometimes startup founders perform consulting services or sell other products to generate funds for product development. You may also manage funds by this way.
Which funding is the best option for you?
Every startup company has its own goals and strategies. Before choosing the funding options take a closer look at each type of startup funding option and determine which will be perfect for your business. From the above discussion you can see there are many sources of startup capital to grow your business. Choose the best options based on your business pattern.
Be confident, take a paper-pen, write down a proper funding plan and work according to it to get funding from various sources. I tried to give complete startup funding guidelines in this article which will help you a lot hopefully.