Most entrepreneurs venture into startups once they figure out a disruptive idea. But without funds, the business will never see the light of the day, even if it can revolutionize an industry. Fortunately for them that there are many startup business investors options.
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Traditional Funding Sources
In the past, the most common source of funding are:
1. Close Friends and Family
At the earliest stage of pre-startups, all the entrepreneurs have are ideas. There is not even enough evidence to prove the viability of their visions. Hence, it is tough to raise funds, so many have to rely on their savings. This process of using their money is bootstrapping.
Others in the same situation also turn to their family and friends. In a sense, the people closest to them are the most likely to trust them enough to put up some money.
How much funding they can raise depends on the wealth and willingness of their network. Usually, the amount is in the thousands. While some individuals can raise hundreds of thousands, it is rarely in the millions.
No matter what amount they can raise, the fund is what people in the investment industry call “friends and family.”
2. Banks and Other Financial Institutions
Banking and other financial institutions have seen the rise of entrepreneurs. As expected, they have created and now offer competitive business loan packages. The requirements for small amounts are not as restrictive for individuals to fulfill. On the other hand, securing large loans is not as easy.
At any rate, the disadvantage of taking this route is that borrowers need to pay back the money. Not only the principal, but they also have to pay interest, which accrues over time. By the way, financial institutions charge people with poor credit scores higher interest rates.
At any rate, those who could not secure a business loan may turn to other types of loans. Personal loans are very popular in the USA because borrowers can use the funds for almost any purpose. But some lenders may have a stipulation restricting its use for business.
If the amount needed is in the hundreds or a few thousand dollars, some people may use credit cards. For example, they can charge expenditures to their cards or take out cash advances. Unfortunately, they have to pay atrocious interest rates.
Borrowing money from a bank may be the most viable option for some entrepreneurs without other funding sources. But the interest payments can impact profitability, which future investors may perceive as a negative. If there is any silver lining, startups do not have to give up a share of their equity.
3. Government Agencies and Grants
Entrepreneurs may be able to secure funds from a government agency. In most cases, the availability depends on their location as state programs vary.
The U.S. Small Business Administration (SBA) helps entrepreneurs at the federal level. One of their programs, for example, is the Small Business Investment Company (SBIC). These are private companies licensed by the SBA to provide funds to small startups.
SBICs, though, only fund small businesses that are profitable in mature markets. As such, individuals who have yet to enter the market will have to look elsewhere.
In the future, things may change for the better. During the pandemic, for instance, small businesses solidified their status as the backbone of the U.S. economy. Economists and legislators may introduce more measures to help more people become entrepreneurs.
4. Credit Unions
Credit unions are all over the United States. They are financial cooperatives that vary in the scale of operation. Some, for example, are small, comprising volunteers. Large organizations, meanwhile, can have thousands of members.
In essence, credit unions provide traditional financial services. They can also let members borrow money and use it for startup seed funding. An advantage they have over banks is that their interest rates are lower.
Startup Business Investors
Investors are different from banking and other lending institutions. Instead of getting paid back with interest, most of them take ownership equity.
5. Equity Crowdfunding
Crowdfunding, also called crowd investing or investment crowdfunding, is a popular fundraising method. This practice entails several individual investors pooling their resources. With most other types of investors, one person or entity puts up the money.
There are several methods of crowdfunding, such as:
Most startups in the early stages receive funds from equity crowd funders. In exchange, they have to give up a fraction of equity ownership. In this regard, they are the same as venture capital investments. Some of the most crowdfunding platforms are Kickstarter, Indiegogo, and GoFundMe.
6. Angel Investors and Angel Groups
Angel investors, also called business angels, are individuals with high net worth. They fund startups, usually in exchange for ownership equity or convertible debt.
Angel investors invest mainly in very early startups, preferring to fund several companies instead of only one or a few. And, being individuals, the amount of money they provide is in the thousands. Some of them, however, can invest up to five million dollars.
Many entrepreneurs find angel investors more advantageous than other funding sources:
They are more ready to fund seed rounds than venture capital firms.
Experienced angel investors, adept at business themselves, do not waste time. They do not impose any unnecessary procedures. Also, they make decisions themselves, not having to go through a corporate hierarchy.
Because they invest in businesses that they are familiar with, their experience is valuable to startups. If needed, they can provide proven tips and guidance.
Angel investors are usually well-connected, which benefits early-stage startups in the future.
Angel investor networks, or angel groups, are an option. Individual angel investors can lower their risks by diversifying and investing small amounts. By pooling their resources together, they can provide more considerable funds to startups.
Finding angel investors is more accessible today, as many startup investor platforms exist. Startups can also find them at live pitch events or through referrals from other entrepreneurs.
7. Incubators and Accelerators
One of the most sought-after types of investors is the incubators and accelerators. These are programs offered by private companies, government, educational, and other organizations.
In essence, both programs provide startups with mentorship, office space, and resources. They can also provide or help startups get anywhere from $10,000 to $120,000 seed funds.
Although similar in some ways, these two programs are also distinct.
Incubators, for example, help startups during the idea stage. These entrepreneurs do not have a viable product or business model.
On the other hand, accelerators only work with later-stage startups that already have a minimum viable product. Their goal is to help entrepreneurs polish their business models and get them to the market in the shortest time possible.
With incubators, there is no time frame. But a typical program may last between 6 months to several years. Accelerators operate at warp speed, usually lasting only 2 to 6 months.
Startups can expect to meet industry and thought leaders, venture capitalists, and other startup investors in either program.
8. Family Offices
A fundamental problem encountered by new investors is not being savvy in investments. Other investors, meanwhile, prefer to spend their time on matters other than investing. Their recourse is to “outsource” their wealth management to family offices.
Family offices are private wealth management advisory firms. Primarily, they serve the needs of high-net-worth individuals (HNWI) – managing their finances and investments. Apart from these, they can also take care of insurance, taxes, budgeting, and more.
Family offices invest in hedge funds, private equities, and real estate in building wealth. They also invest in venture capital opportunities, making them a funding source for startup companies.
Given the opportunity to secure funds from a family office, it is in the best interest of a startup company to consider the disadvantages. For example, a unique challenge they might encounter is that some family offices may lack organization.
9. Venture Capital Firms
Venture capitalists (VCs) are private equity firms that provide funds to businesses. In some circles, they are called the holy grail of fundraising. For one thing, they can write huge checks. One venture capitalist alone, for example, may put up $1 to $100 million in one round.
Usually, VCs invest in early-stage startups with high growth potential. But it is not unusual for them to participate in Series A, B, and C rounds. As a matter of fact, many of them prefer to invest in startups that are ready to enter the market.
Besides funding, VCs also provide other benefits. A well-known VC, for example, can raise consumers’ awareness of startups they invest in and their credibility.
VCs tend to keep a close tab because their goal is to cash out with a considerable return on investment (ROI). As such, they offer guidance to help startups grow.
Finding VCs, though, may prove to be difficult for most startups. One way to ease the fundraising effort is to use startup investing platforms. Allianse, for instance, uses the latest AI technology to find and match startups with potential investors.
10. Corporate Investors
An incorporated company investing in another company is not unusual. Usually, though, their purpose is to take over the business. On why they do this, there are several reasons:
Gain control of a business that produces goods and services they need. This way, they can reduce the cost of acquiring those resources.
Taking over a competitor in a hostile takeover increases their market share.
Profit by buying a company and then dismantling it by selling its assets.
At any rate, the above reasons do not benefit companies that need funding. What they need are corporations that want to generate more revenue. Unfortunately, those that may invest in startups are rare as they prefer established businesses.
Final Words on Startup Business Investors
For startups to turn a business idea into a viable product or service, they need capital. If the money needed is small, entrepreneurs can use their own money. But if they need a significant amount, then there are three main choices:
Find a family or friend who can lend money.
Get a loan from a bank, credit union, a licensed SBIC, or seek grants.
Seek funding from an investor(s).
Family and friends may be willing to put up some cash without requiring interest. But the inability to pay back the money can burn relationships. Also, without a clear understanding, some may claim ownership if the venture is successful.
Borrowing money with interest reduces profit margin. There is also pressure to pay monthly installments on time. Defaulting is not an option as there are legal ramifications. Furthermore, it reflects negatively on credit score.
The last option is to find investors. As you learned, there are several choices:
Unlike borrowing money in which startups have complete control of their ventures, startups typically give ownership equity to investors in exchange for funding.
In most cases, the choice of funding source comes down to factors, such as:
Startup stage and business plan
Availability of the source
At the same time, there are other considerations. An example would be an accelerator. Besides funding, startups can gain from their mentorship and networking.
Yes, as a startup in need of financial resources, you need to think before deciding which type of investor is ideal. If there is any consolation, it is that you have more choices than in the past.