What are The Different Types of Funding for Startups?
Finding the right way to grow a company from the ground up, constantly adapt, and change to survive is not for everyone. One of the biggest steps a startup takes is to find the right type of funding. This can make or break your business. But how do you decide what type of funding is for you? Finding the right type of funding can be a daunting task if not done properly.
There are numerous types of startup funding options. You have to think about your current situation to know which type of funding works best for you and how you can use all the resources at your disposal to receive the funding you need. Here are the most widely used funding mechanisms:-
1. Business Loans
When it comes to funding sources, small business loans are the bread and butter of the business. Small business loans are similar to personal loans, meaning you have to be approved for a set amount of funding. You can get small business loans through banks and other financial institutions. A lot of them can be found through Small Business Administration (SBA). Just like a personal loan, you will need solid business credit. Alternatively, you can have strong personal credit. This will help you acquire a bigger loan with a lower interest rate and reduce the amount of loan cost you have on the whole.
This is ideal for startups with good credit and responsible spending habits. It is good for non-scalable startups and companies that do not want to give up equity. You must have a plan for the funds before acquiring them, as defaulting on a small business loan can lead to big consequences. Spend it wisely because you may not be approved for a second one.
2. Seed Funding
Seed funding is the first investment in a startup company in exchange for equity/partial ownership of the company. Seed funding can come from a variety of sources, such as friends and family, Angel Investors, Venture Capitalists (VC), Crowdfunding, and startup accelerators. The reason for seed money is to help startup founders test an idea to see if they can demonstrate some product/market fit. Getting seed funding is really about networking as well as selling the dream. Seed funding varies widely from just tens of thousands of dollars to up to around $10 million. Startups usually give up 10%–25% equity for seed funding. We will explain a bit more about some of the most common funding methods as this is VenturX’s speciality.
Angel Investors — Angel investors are individuals with the money to back startups and aspiring business owners. But angel investors expect a return on their investment as they have purchased some form of equity or ownership from your company.
To get angel investors on board, you will want to make sure that your business is organized and has a plan to move forward. They are hard to come by. They can be friends or family. This makes them a bit of a wild card. If you know someone with funds, they could be a potential investor.
Equity crowdfunding — Equity crowdfunding is similar to crowdfunding in that you are looking for funding from a large group of people. Unlike traditional crowdfunding, you are not selling your product or service. Equity crowdfunding involves selling equity in your company. This means you are essentially selling numerous stakes in your company, through stocks, revenue shares, etc.
Equity crowdfunding involves selling equity and not a viable product or service. Equity crowdfunding can be better-suited to businesses in the early stages. If you are comfortable selling equity and you have a solid business idea, equity crowdfunding can be a great way to get your business off the ground. Equity crowdfunding requires you to find accredited investors which might be a little difficult. In that case, you can use Regulation A+ funding.
Regulation A+(Reg A+) — Launched in May 2015 as part of a government act, Reg A+ refers to an exemption that allows small companies to sell their shares to the general public, making it possible for almost anyone to invest in a business through crowdfunding. It enables startups and crowdfunding platforms to raise money from both accredited and non-accredited investors — for the public to invest in private companies. It also enables companies seeking equity funding to publicly advertise their offerings. It has helped create an effective way for companies to raise capital while also providing investor protection. Typical Reg A+ offerings are far less dilutive for the founders than venture capital rounds. The ability to increase the price of your company during the Reg A+ offering adds the flexibility to handle a more substantial capital raise than you initially planned. Reg+A is a uniquely good option for mid-stage companies that offers a fresh and less costly approach.
Incubators —It is a group dedicated to helping aspiring businesses take off. Incubators are generally founded and funded by other companies that want to help young business startups reach their full potential. Incubators often offer co-working space, funding assistance, and mentorship.
Those with a solid business idea and team will get the most out of it, but even early-stage startups that have barely left the ground can benefit greatly from the right incubator.
Venture Capitalists (VC)— Venture capital is funding that is invested in startups and small businesses that are usually high risk, but have the potential for exponential growth. Venture Capitalists are the high-end investors that invest in a new venture after looking into various parameters such as market conditions, founder vision, growth potential. Venture capital is usually run by a handful of partners who have raised a large sum of money from a group of limited partners (LP)’s to invest on their behalf. The LPs are typically large institutions using the services of the VC to help generate big returns on their money.
Venture debt is another form of financing alternative to venture capital. Check out our blog post here to understand what it is and to learn more about it.
Venture capital is a great option for startups looking to scale big and quickly because investments are fairly big. Your startup needs to be prepared to take the money and grow. VCs are also known for doing Series funding rounds which are going to be explained.
3. Series Funding
Funding rounds are divided into groups; Series A, Series B, Series C, and so on. They each correspond to the different stages in the company’s growth cycle.
Series A — Series A funding, (also known as Series A financing or Series A investment) is venture capital funding for a startup. The Series A funding round follows a startup company’s seed round and precedes the Series B funding round.
Receiving a Series A round is an important milestone for startup companies. Aside from the funding being much larger than a seed round, companies need to demonstrate they have a minimum viable product (MVP) to acquire a Series A round. It is not easy for seed-funded companies to move to a Series A funding round.
These are some types of financing that can be used to reach Series A:-
Bridge round funding — A bridge round is a connecting round of funding from seed round to Series A. It is used when a startup needs more money. One way of doing this through using SAFE and convertible notes, which you can read more about in our previous blog post here.
Micro funding — Micro venture capital is money invested to seed early-stage emerging companies with amounts of finance that is typically less than that of traditional venture capital. It is the smaller version of a traditional VC fund. It is usually considered micro if the fund is under $100 million. Investments range from $25k —$ 500k. There are specific companies started by super angels. These are angel investors with a proven track record of successful investments as angels, but there is no agreed threshold distinguishing them from other angels.
Post-seed round funding — Post-seed valuations are usually closer to seed valuations than Series A valuations. Post-seed rounds only make sense if the subsequent Series A round is raised. A valuation significantly higher than that would be possible on just a bridge round. From a dilution perspective, it makes sense to raise a small bridge round rather than a larger post-seed round.
This picture goes into better detail about the concrete differences between a Bridge round and a Post-Seed round.
To learn about investment stages, capital traction, and more, check out our slides here.
Here we can see a real-life example of how Uber and Airbnb did in their stages of funding rounds. This article should be used just as a guideline to show how two very successful companies did in their early growth phase. You can find examples of many other successful companies online.
So we have glossed over many of the different types of funding available. You need to put in the time and effort to see which type of funding works best for you and how you can reach out to potential investors. We usually talk about how this can be done effectively at our monthly ‘Startup Funding and Success Webinars.’ Setting yourself apart to investors is not easy but with a good amount of research and networking, it can be solved and will take your startup growth to the next level. Contact us through firstname.lastname@example.org or through our social media below to receive an invitation to our next webinar.
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VenturX is a web platform that helps entrepreneurs through their journey from idea to launch and beyond. VenturX uses data-driven analytics to score and connect startups and investors at Seed and Series A financing.