Five Different Funding Options for Startups and their Pros and Cons

Five Different Funding Options for Startups and their Pros and Cons

Although it’s difficult to pinpoint the precise number of new businesses launched each year, numerous studies have shown an increase in new business launches over the past decade. According to Oberlo, 4.4 million new businesses were started in 2020, up nearly 27% from the previous decade.

It is easier than ever to start a new business. Anyone can create an LLC and build an online presence within a day. Technology makes it possible for anyone to become an entrepreneur. However, most businesses fail after a few years. Around two out of ten businesses fail within the first year.

 

Startup Funding: 10 Best Sources and How to Get it!

 

Businesses fail because they do not have the funds to continue operating. It takes most companies years to become profitable, and in the meantime, they rely on funding opportunities to stay afloat. Entrepreneurs have several funding options at their disposal. If you understand the pros and cons of each, you can make a better decision for the future of your business:

Angel Investors

Angel investors use their own money to invest in startups. Entrepreneurs with early traction and promising potential are uniquely positioned to attract angel investors. Typically, angel investors are willing to take a risk on companies (and founders) they feel confident in, and they are less concerned with personal credit, business history, collateral, or sales performance. Even so, there are pros and cons to working with angel investors:

Pros

  • Startups in the early stages are welcome
  • There are no monthly payments required
  • Mentoring and guidance
  • Potential for additional financial assistance in the future
  • Faster paperwork process (compared to traditional government financing)

Cons

  • Finding angel investors can take a lot of time
  • Growth is expected to be rapid for angels
  • Angels expect higher equity amounts (typically between 20% to 40%)
  • Reduced founder control

Bank Loans

Banks are often the first thing that comes to mind when you think of financing and loans. Business owners who meet certain qualifications can apply for a variety of loan types from banks. Personal loans work similarly to bank loans in that you're charged interest on top of the loan amount. The payments are made over a specified period of time and deducted automatically from your business account.

Every bank will ask to see your business plan before even considering a loan. Your business plan will be scrutinized by banks before they decide whether to finance you or not. Take a look at an example of a business plan and consider working with a writer to create an effective business plan. Banks will also examine your personal and business credit.

Banks could be an ideal solution for long-term financing, but might not be viable options for individuals with bad credit or who need funds quickly.

Pros

  • Different lending options available to suit your needs
  • Low, fixed interest rates
  • Build your business credit
  • Flat-cost, predictable monthly payments

Cons

  • Long wait time to receive funds
  • Strong personal and business credit necessary
  • Lengthy paperwork process
  • Collateral is likely a requirement

Crowdfunding

Crowdfunding is a great way for companies with physical products to raise money. Crowdfunding platforms such as Kickstarter and Indiegogo allow entrepreneurs to connect with potential "backers" who contribute funds in exchange for various rewards. Crowdfunding has helped many great products get off the ground, including Pebble, SkyBell, and Coolest Cooler.

Pros

  • Little financial risk
  • Ability to validate your market
  • Keep all your equity
  • Build your community

Cons

  • Campaign development is time-consuming and costly
  • Most campaigns do not reach their funding goal
  • Fees paid to crowdfunding sites eat into your profit
  • Only suitable for consumer-facing products

Startup Incubators

The purpose of startups incubators is to help startup founders accelerate the growth of their businesses. Programs usually last 3-4 months and include mentorship, office space, and small startup capital. The amount of money you can receive varies by program. Y Combinator, one of the most popular programs, offers $125,000 in exchange for 7% equity. Other incubators offer smaller funding options, around $20,000.

In terms of the opportunities they present, these programs offer indirect forms of funding. Entrepreneurs have the opportunity to pitch their companies to investors during a Demo Day, which culminates most programs.

Pros:

  • Early-stage investment
  • Mentorship from experienced professionals
  • Free workspace
  • Access to business development programs
  • Opportunities to pitch to investors

Cons:

  • The highly competitive application process
  • Lose some equity in your company
  • Structured schedules and obligations = less personal and professional freedom during the program

Government Programs/Small Business Grants

Small business grants and other government programs provide financial assistance to startups and small businesses in need. There are dozens of grants available; you can choose between grants that target minority-owned businesses or grants that target specific industries. Growing businesses may benefit from some grants, whereas established businesses may benefit from others. Other programs offer to fund to highly niche startups; the Halstead Jewelry Grant Award offers $7,500 to jewellery startups. Look for grants that suit your needs.

Pros:

  • No repayment required
  • Variety of grants to choose from

Cons:

  • Low financial assistance (you may need additional capital to supplement it)
  • Complex application and approval process

It depends on the type of business you run and your financial situation as to which financial assistance is right for you. Do you need money immediately or can you wait? Brick and mortar businesses are more likely to take out a bank loan than to work with angel investors. Startups in the software industry might prefer angel investors, while product-driven companies might consider crowdfunding. There's no right or wrong answer, and as a business owner, it's important to work through rejection. Early funding can make the difference between success and failure. Make a list of the pros and cons of each option.