TYPES OF FUNDING

Initiating a business can be very expensive, no doubt about it. But don’t let that crush your dreams in starting a business of your own. There are many people out there who have great ideas and because they do not have the funding to create a business out of it, they tend to leave them as only ideas. What they don’t know is that there are many types of funding which can help them make their ideas become a reality.

There are entrepreneurs who are lucky enough to cover most of the startup expenses through their own savings. But not all of us have enough personal funds. Even rich entrepreneurs tend to look for the funding in places like incubators or accelerators. There are two types of funding that you can opt for when you do not have the cash to start your own business: equity financing and debt financing.

Both of these types of funding are different in many aspects, but they both end in getting cash for the growth of your company.

Debt funding is taking a loan from a lender to fund your business and paying it back to the lender with interest. Equity funding is very different where you get funding for your business in return for equity of your company.

For those who are new to the funding world, this article would help you understand the various types of funding that you can opt for, such as accelerators, incubators, angel investments, and many more.

TYPES OF FUNDING

If you are searching for funds, it is important to understand that the bankers do not see themselves as the old source of funds for businesses. And if you just come to them for the first time looking for funds without trying out other alternatives, they usually take it as something negative. Therefore, it is important to be proactive in obtaining funds for your business.

In the end, it doesn’t matter which source you turn to for getting the funding. All the types of funding have their own advantages and disadvantages, which means that none of them are perfect. Other than this, the criteria for your business is also a factor that should be kept in mind when looking for funding.

THE MOST COMMON TYPES OF FUNDING OPTIONS:

Selecting the right financing structure that would help you in funding a business is a very critical choice for most founders.

And with all the types of funding around you, there are many other factors that you might come across like regulatory, tax, and legal issues.

Below are the main types of funding explained in detail, along with the considerations of every other factor that might come in the way.

BOOTSTRAPPING

Any startup that bootstraps is basically funding the business via the use of personal funds, which usually is the use of a credit card or the savings of the person. The owners that follow this path usually have the goal of enhancing their product that they are putting on the market and eventually want to raise revenue from it. This money is then used for the growth of the company, without the help from an investor.

A lot of companies begin bootstrapping and then feel that they need additional help by taking up a bank loan, or from other types of funding sources like venture capital financing, private equity, or loans from family and friends. But the fact they have already set up the business with their own money makes it easy for them to get the next funding.

Pros

The reasons why bootstrapping is one of the best types of funding are:

• Attractive to future investors as it displays credibility and drive.
• Founders continue to focus more on the company and less on the fundraising.
• Operating well needs more disciplined decision making.
• Doesn’t reduce the control or equity ownership for the shareholders.

Cons

Just like there are pros, here are some of the cons that the bootstrap funding option.

• Not sharing with others can be a risk, mostly since networks are important in the business world.
• Often not sustainable if earnings are not quickly achieved.
• Might not support a paycheck for the owners.
• Depending on the capital with the owners, it could put a lot of extra stress on the team as well as the owners.
• Might reduce the growth rate due to the lack of cash.
• Possible lack of capital and cash flow.

With all the points above, if you feel this is an option that suits you, you can start with using your money and then opt for another one of the types of funding available.

CROWDFUNDING

Crowdfunding has it all in its name itself. As a matter of fact, it is one of the best ways for a new business to enter the market and see where it stands. In this method, the company can share the product in the market and add incentives to the purchases. The company would be able to raise a lot of capital to cover the complete production of the product, and learn about the demand in the market.

Unlike the other types of funding, crowdfunding can be equity-based or rewards-based as well. There are many crowdfunding sites like Indiegogo and Kickstarter which are reward-based that make the security concerns simple and offer startups a webpage.

This webpage is used for setting the goal of their fundraising, give purchasing incentives (like the person who purchases one would get one free), create a fan/donor base, and increase the brand awareness with social sharing. There have been successful companies that have raised funding this way.

Other than this, there are websites like Crowdfunder, Wefunder, and MicroVentures that are equity-based crowdfunding sites. These sites involve state and federal securities law, due to which there are greater compliance costs in these websites. Here are the pros and cons of crowdfunding as compared to the other types of funding.

Pros

There are many reasons why crowdfunding is considered by many and the reasons are:

• Permits the company to prepare for shipping and production costs.
• Enhances the attractiveness to future investors if the business is successful.
• Doesn’t dilute the control or equity for the owners of the company, if the crowdfunding is reward-based.
• Boosts the brand awareness via social sharing abilities.
• Permits the startup to test their product in the market: gives customer data and market validation (R&D).
• Access to “cheap” money as no equity is transferred (but this is only for the rewards-based crowdfunding).

Cons

Just like everything has its benefits, there are drawbacks as well for a crowdfunding option, which are:

• The funds might not be enough for getting the product to the main market.
• High regulatory and legal costs for the crowdfunding that is equity-based.
• Develops the risks of resource waste and failure. These campaigns have a high cost due to legal, advertising and marketing expenses.
• Requires operational competence to meet the demands of customers.

Due to some of the points mentioned above, many usually avoid this option and move on with venture capital and angel investments.

VENTURE CAPITALIST & ANGELS INVESTORS

From the past articles, you might have come across equity financing in which an investor offers funds in exchange for a percentage of the company’s ownership. And under equity funding, there are three types of funding which are Venture Capital funds, Private Equity funds, and Angel Investors.

While looking for the right types of funding and investors, the company should raise funds from firms that have both the extensive network and subject matter expertise in the industry. In addition to this, in case the investors want a part in controlling the company, the owners should interview the references they have and ensure that the person is a suitable candidate. That is when you can get both funding and knowledge for the growth of the company.

ANGEL INVESTORS

Angels, also called angel investors, are people who invest in companies during their early stages for growth. The normal amount that angels commit to is between $10k and $100k, though there are a few super angels who offer several times that amount. As a matter of fact, startups seek capital from various angels and the total amount of funds that the company gets can reach up to hundreds of thousands or millions of dollars.

During the initial stages of the company when the owners reach out to angels for funding, they do not have an established customer base or a functional product, even though they have an exciting idea. But the angels still tend to fund these companies. In short, angels normally take up the most risk as compared to those investors who fund the company in its later stages.

VENTURE CAPITAL INVESTORS

Venture Capitals, or VCs for short, usually enter the funding cycle of a company after the angels, but before the other types of funding sources like banks. A VC can be both a person or a firm that offer funds for the growth of a company, which is also one reason why the funding amount is normally larger. Basically, the amount is something that other sources cannot offer the company, which is why they reached out to a VC firm for assistance.

The goal of a VC is to fund a company during the initial stages and grow the company’s value, after which they then sell their stake for a large amount in the market. For lending an amount for the growth of the company, VCs normally get at least one seat in the company’s board of directors.

VCs usually invest about $500k and more in those companies that have high-growth potential. In short, VCs work together to fund high potential deals and obtain larger profits out of it.

So, if you are planning to contact either one of the above mentioned funders, keep the following pros and cons in mind before doing so.

Pros

The reasons why these types of funding options are popular among new and existing entrepreneurs are:

• There are no interest payments.
• Ownership percentages are certain.
• Commonly acquired with nearly uniform standards across the industry.
• Progresses reputation of the startup.
• Infuses resources for the growth of the company.
• Offers expertise and a more extensive network for the company to leverage.

Cons

Just like there are pros, there are cons for these types of funding options, and they are:

• Give up large parts of equity to the investors
• Requires more resources, money, and time for obtaining a deal.
• Transfers control to third-parties (that is, the investors) which frequently ends in more complex corporate governance.
• Reduces the shares for the founders, at times a significant portion.

Even with all the negative points, a lot of people benefit from these types of funding as compared to the incubators, or crowdfunding options.

ACCELERATOR & INCUBATORS

Joining an incubator or accelerator is one of the many methods for obtaining seed funding and for establishing market credibility. In both institutions, the startup is temporarily relocated within the vicinity with other rising businesses. Even though the words incubators and accelerator are used interchangeably, there are a few differences between them.

ACCELERATOR

An accelerator offers a short but an essential period of mentoring along with a small seed investment. And being accepted in the top accelerator programs is normally not easy due to high competition. After about one to four months, the startups should graduate from the accelerator and reach out to VCs for the further funding. Y Combinator is one of the most successful accelerators in Silicon Valley.

INCUBATORS

Incubators are environments where entrepreneurs can develop their ideas to make businesses out of it. These incubators are normally sponsored by universities, governments, or economic development organizations. As compared to accelerators, the incubators have a less rigid time frame, do not offer capital, and lack a proper instruction program. Moreover, they aim to achieve success faster as compared to accelerators.

There are companies that spend years in incubators to develop their products, while there are some that come out in just weeks. Low-cost office space and collaboration with fellow innovators are a positive for incubators, while the accelerator’s advantages include training and instructions. And due to the advantages of both, some companies participate in both together.

To understand their pros and cons better, here are the points:

Pros

• Collaboration is available with other founders to grow your ideas.
• Incubators are normally filled with mentors, investors, and VCs who have the right experience to help you fund your ideas.
• Your network expands being a part of the incubators or accelerator.
• Accelerator and incubators provide resources such as IT equipment and Wi-Fi, which is important for the initial stages for cutting costs.

Cons

• In case you are using incubators for your business idea, you would not be in the center of the specific market, which is not good for your product.
• You would have to give up equity.
• Incubators are not a secure resource for obtaining funds, where ideas can be duplicated.

So, from the above mentioned pros and cons, if you feel that this option is not right for you, you can check out the other types of funding. You would usually not come across a funding option with no faults. Hence, you need to choose the ones that would suit you the best.

SEED FUNDING

Seed funding?is another type of funding, and it is the most common funding used to start a business for the growth of the company. Seed funding is the?initial investment?that is made for a startup in exchange of equity of the company.

The basic idea for seed funding is that it is done at the beginning of the life of the business for the company to get a head start and eventually grow the company. Customarily, this funding helps the company to?move to the next round for funding?or to help the company get in the situation where it can generate its own profits.

A seed round or seed funding is the initial round of financing for the company. The next subsequent round of funding is the?Series A, then the?Series B?round and so on. At the stage of Series A, venture capitalists (VCs) and angel investors come in. The rounds continues until the company is able to earn enough and grow with its earned income. Therefore, it is vital to understand the differences for?each of the funding rounds?so that you can efficiently analyze the newspaper headlines regarding any kind of investment and startups along with your company’s investments.

Each of the rounds is a stepping stone to turn an idea into a huge business, and one day become a successful publicly listed company via an?initial public offering?(IPO). The next article would give a much better explanation regarding the various rounds of the seed funding.

WHICH TYPE OF FUNDING BEST FOR YOUR STARTUP?

Now that you have understood all about the types of funding and how they help in the growth of the company, your company can get capital from nearly any place. By understanding the various types of funding, you can choose the type that best suits your needs, as well as your business needs and goals. Just ensure that you keep your options open and explore more than one option.