5 Different Funding Options for Startups & 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.

Starting a new business is easier than ever before. Within a single day, anyone can create an LLC and build an online presence. Technology has made it possible to turn entrepreneurial dreams into reality. However, the reality is that most businesses fold after a few years. Two out of ten businesses will fail within the first year alone.

One of the biggest reasons businesses fail is because they don’t have the money to continue operations. Most companies take years to become profitable and in the meantime, they rely on funding opportunities to keep them afloat. For entrepreneurs, there are several funding paths to choose from. Understanding the pros and cons of each can help you make a better decision for the future of your business:

Angel Investors

Angel investors are investors who use their personal money to invest in startup companies. Entrepreneurs who have some 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 are less concerned with personal credit, business history, collateral, or sales. Still, there are pros and cons to working with angel investors:

Pros

  • Early stage startups are welcome
  • No monthly payments required
  • Mentorship and guidance
  • Potential for additional future financial assistance
  • Quicker paperwork process (compared to traditional government financing)

Cons

  • Finding an angel investors can be time consuming
  • Angels expect rapid growth
  • Angels expect higher equity amounts (typically between 20% to 40%)
  • Reduced founder control

Bank Loans

When you think of financing and loans, banks are likely the first thing that comes to mind. Banks provide a variety of loan types to business owners who meet their qualifications. Bank loans work similarly to personal loans, where you’re charged interest on top of the loan amount you’re given. Payments are made over a specified period of time and are deducted automatically from your business account.

Every bank will ask to see your business plan before even considering a financing arrangement. Bankers will analyze your business plan with scrutiny to help them make a decision on whether to finance you. Business owners should 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 take a look at 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 likely a requirement

Crowdfunding

Crowdfunding is a great funding avenue for companies with physical products. Crowdfunding platforms like Kickstarter and Indiegogo allow entrepreneurs to connect with potential “backers” who help support business growth by contributing funds in exchange for various rewards. Many great products have used crowdfunding to jumpstart their businesses, including Pebble, SkyBell, and the 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

Startup incubators are programs designed to help startup founders accelerate the growth of their businesses. Programs are typically 3-4 months and include mentorship, office space, and small starting capital. How much money you can get depends on the program you join. One of the most popular programs, Y Combinator, offers $ 125,000 in exchange for 7% equity. Other incubators offer smaller funding options of around $ 20,000.

However, these programs offer indirect forms of funding in terms of opportunities they present. Most programs culminate in a Demo Day, where entrepreneurs have the opportunity to pitch their company to a room full of investors.

Pros:

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

Cons:

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

Government Programs/Small Business Grants

Small business grants and other government programs provide financial assistance to small businesses and startups in need. There are hundreds of grants to choose from; you can apply to grants that target minority-owned businesses or grants that assist companies in specific industries. Some grants are better for growing businesses, while others are ideal for established business. And other programs target highly niche startups; for example, the Halstead Jewelry Grant Award offers $ 7,500 to jewelry startups. Do your research to find grants that work for you.

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

The financial assistance that’s best for you depends on the type of business you’re running and your financial circumstances. Do you need money quickly or do you have time to wait? Local brick and mortar businesses are more likely to opt for a bank loan than to work with an angel investor. Software startups might prefer an angel investor, while product-led startups might opt for crowdfunding. There’s no right or wrong answer, and as a business owner, it’s important to work through the fear of rejection. Early funding can mean the difference between success and failure. Weigh your options and make a list of your own pros and cons for each.

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Author: Dave Lavinsky

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