Two Funding Options That Might Be Better Than Equity Investment

Esme Verity from Considered Capital recently led an engaging Funding Mastermind workshop with our community of founders where she spoke about the different funding options that are available to startup founders, aside from equity investment which tends to be top of mind when fundraising for an early-stage startup.?

There are tons of different types of funding instruments (to use the jargon!), from equity investment, to grants, to debt financing and crowdfunding, but Esme explained that what you choose really depends on your business stage, your business needs, and what you plan to spend your funding on.?

As many of the startups in our community are early stage, typically with an MVP and some early traction, Esme took us through a few funding options that are available and best placed for this stage of business.?

Grants

Grants are a fantastic option to consider for early-stage startups. Typically they are awarded by the government or a foundation to an individual or organisation. They provide a non diluting (i.e. you don’t have to sell shares in your business in exchange for the cash) and non repayable source of funding and can give the cash injection a business needs to get it off the ground.?

This type of early cash injection is invaluable, and it may mean that you do not have to take any further funding, or it can help you get to a point where you have gained enough initial traction and de-risked your investment opportunity sufficiently, that you can raise equity investment and potentially raise more money at a higher valuation.?

There are many pros and cons of grant funding which Esme outlined:

Pros:

• It's a great option when your business is at its most risky - early on
• No equity taken so there’s no dilution for the founders
• You don't have to repay the amount given
• Its potentially a great way to gain exposure for your business
• It’s a great way to start a project, and provides credibility if you plan to raise in the future
• The first grant often opens the doors to more grants

Cons:

• Grant applications can take a while to apply for
• If you are awarded a grant it may come with administrative burden to show use of funds?
• They can take a long time to process
• Taking small grants may mean gaps in cash flow as you search for new grants
• Taking a grant may make it hard for you to pivot the business - you are funded on a specific project so if you chose to change direction there may be implications for your grant funding

Esme also shared some fantastic resources of where to find grant funding, which included Find a grant, The School for Social Entrepreneurs, The Possibilists. We’ve also put together our top 10 sources of grant funding, and you can check out Considered Capital’s newly launched live Grant Funding Database, that’s actively updated with the latest grants and accelerators available to startups in the UK.

Revenue-based Funding (Debt Funding)

The second financial option Esme discussed was a type of debt funding, known as “revenue-based funding”. Whereas grant funding is ideal for very early-stage businesses, revenue-based funding is better suited for slightly later stage companies, who are generating revenue or very close to generating revenue.??

Revenue-based funding is a fantastic option if your business has a short-term cash need, and requires an advance or working capital. It's a good option for any upfront costs you have where you are confident you will recoup your costs quickly. For example, if you need cash to pay for inventory or advertising, which you know you will get back in sales quickly.

The way revenue-based funding works is that the lenders receive a fixed percentage of your future revenue until you have paid back all the money borrowed plus a pre-agreed multiplier. The good news - and how this type of funding differs from traditional loans - is that if your revenue fluctuates, your repayments will also fluctuate. So it's a great option if your business is seasonal, or you have unpredictable revenues from month-to-month.

Debt funding also tends to be “cheaper” than equity funding. What we mean by that is if you raise equity investment, the investment is swapped for shares. Whilst that doesn't cost you anything upfront, when you come to exit (via a share sale), the value of those shares could be very large, and the money for those shares will go to your investor. With debt funding, you are not swapping the funding for shares, and instead paying back the amount borrowed plus a fixed fee - Its non dilutive and means that once its paid back its done, plus the amount you pay pack is very likely to be less than the value of the shares you give away with equity investment.?

Lenders of revenue-based funding tend to look at your historical revenue and your projected revenue to determine how much to lend you. This is different to traditional debt funding where lenders would assess your business’ credit worthiness and assets. The amount you can borrow will depend on your levels of revenue, but if you have steady predictable revenue it could be a good option for your business.

Here’s a recap of the pros and cons of revenue-based funding

Pros:

• Good for short-term funding rather than equity, or for founders operating in emerging markets where access to VC funding is limited?
• Focus’ your attention on increasing the businesses revenue
• You retain full ownership after the funding is paid off
• It's quick to approve and deliver, and saves you time compared to raising equity funding - sometimes cash can be delivered in 24 / 48 hours!

Cons:

• Not an option for pre-revenue startups
• If your revenue is low you may not be able to borrow much debt funding.

Typically lenders will offer you one-third of your ARR (Annual Recurring Revenue) or 4-7 times your MRR (Monthly Recurring Revenue), and repayment fees are typically 6-12% of revenue but this will depend on interest rates at the time and also what you want to spend the funding on.

Esme noted that different lenders will have different terms, so it's important to shop around to get the best deal for your business. Here are some of the providers checking out: Clear.co, Uplift1, Round2, Forward Advances, Outfund.

If you are considering revenue-based funding, and need to work on your financial projections, check out our latest guide: Financial Forecasting For Startups: How Much Money Do I Need???

If you want to gain insight into other ways to fund your business, read some advice given by 10 founders who have raised investment for their businesses, and take a look at Considered Capital’s Alternative Funding Library, both share the pros and cons of the different funding options available.