If you are new to entrepreneurship or an early-stage startup, you will quickly come to realize that securing funding to build your startup isn’t as easy as the popular pitch shows make it seem. Raising capital from investors or taking out loans from traditional banks comes with many scrutinies, red tape, and stipulations. As a result, only a fraction of applicants ever see the funding they hoped to receive. The number of traditionally funded startups drops significantly for minority founders. So how can an early-stage entrepreneur acquire seed funding for their startup? Stay tuned; we’re about to explore five different alternatives to traditional startup financing.
We’ve all heard of significant successes and failures in the crowdfunding space. However, this option is excellent for both new ideas and startups alike. The idea behind crowdfunding is to collect small contributions from multiple individuals to reach your funding goal. Modern crowdfunding is a concept that’s been around for decades. The first online crowdfunding occurred in 1997 when British rock band Marillion raised funds for their entire reunion tour from online fan donations. It even sprouted the first crowdfunding platform in 2000, ArtistShare. Since then, crowdfunding has taken off as a significant source of capital for entrepreneurs.
Crowdfunding has quickly emerged as a valuable tool for startups over the years. There are two types of crowdfunding. Donation crowdfunding is the most popular option and instantly comes to mind when people think of successful campaigns. Donation crowdfunding allows supporters to donate money in exchange for perks, including special pricing, rewards, shout-outs, and even the product itself. Some of the most popular donation crowdfunding platforms are Kickstarter and Indiegogo. On the flip side, a new crowdfunding model has emerged. Investment crowdfunding is where businesses sell a stake in ownership in the form of equity or debt. As a result, investors become shareholders in the company and will receive benefits in returns. An example of this type of platform is Crowdfunder.
Crowdfunding requires substantial effort to be successful. Many campaigns include detailed plans, graphics, videos, and periodic updates to satisfy supporters and investors. Crowdfunding has also become a great way to demonstrate an initial market interest in the product or service, but it is not a replacement for product market fit. Read our excellent guide on product market fit here to understand the difference.
Some organizations specialize in microloans that bypass traditional banks and allow business owners access to a small amount of capital. Microloans typically range from $5,000 to $50,000 and are an excellent option for startups that do not have access to traditional financing or credit cards. Microloan lenders are usually non-profit organizations that use money received from donors to finance the loans. Many of these microloans are subsidized by federal, state, or local grants. These organizations focus on a specific subset of entrepreneurs like women, minorities, or tech and food startups.
There are many benefits associated with using microlenders that entrepreneurs would not receive from traditional financing. Many of these organizations provide workshops, coaching, and additional education to new entrepreneurs. They also break down the barriers to capital that many women and minority business owners face. Some things to consider when accessing a microloan include the interest rate. In many instances, a microloan will have a slightly higher interest rate than a bank because a personal guarantee does not always back the loan. Another consideration is the loan term which is based on the credit score of the borrower. The loan term of a typical microloan will have a repayment length of about six years. These terms could lead to higher payments than a traditional bank loan. If you have little or no credit history, a small loan from a peer-to-peer investing network may be your best alternative to microloans.
Peer-to-peer lending or P2P is a type of social lending. The main difference between P2P and traditional loans is that they are a bundle of small amounts of money from different lenders that make up the total loan. P2P loans usually have lower rates than bank rates and can range from $1,000 to $40,000. Anyone can be a P2P lender, and investors can pledge as little as $25 to an entrepreneur. What this does is help diversify an investor’s portfolio while minimizing their risk. Mitigating risk allows P2P lending to work because these are not loans from banks but individual investors, wealth advisors, or small fixed-income funds.
Peer-to-peer loans are primarily done through an online lending platform. The platforms usually require a borrower to verify financial information to perform a credit check. One thing to keep in mind is that these loans are not FDIC insured. That means that both the lender and the borrower are at risk. The FDIC or federal deposit insurance corporation was created to protect the assets in an individual’s account if a bank goes out of business. As with any loan, it is advisable to scrutinize the terms. For example, most P2P loans do not include prepayment penalties but do include loan origination fees and closing costs, which can impact the total cost of the loan.
Angel investors are wealthy individuals who finance business ventures in exchange for equity. Which is different from venture capital, where an investment fund provides the financing. Instead, Angel investors use their own money to provide means to startups. Angel investors allow more flexibility in contract terms that can give startups an upper hand. Angel investors will be more involved in your startup than, say, a bank or a microlender would. Since they have skin in the game, they will likely want to know your exit strategy, whether it’s an IPO or acquisition.
Going this route can be very beneficial to your business, depending on your startup’s stage. If you need capital to develop a product or scale your business, you may want to consider finding an angel investor who will be invested in your success. Many angel investors also serve as mentors or provide connections that can significantly impact your company. The only downside to this type of investment is that angels will typically take around 10-50% equity in your startup. Therefore, it is crucial to consider the ramifications of giving up too much equity at one time. In addition, if you give up too much equity to an angel investor, there is always the possibility that you may lose control of your company when things are not running smoothly.
Bootcamps, accelerators, and startup incubators all have one goal in common: they are all designed to facilitate the development and growth of your startup. Startup incubators provide resources to cash-strapped startups, including physical office space, mentoring, legal services, community support, and seed funding that can range anywhere from $1000 to $250,000. Depending on the amount of seed funding, most startup incubators will take a small predetermined stake in equity from your company. Interestingly, according to the National Business Incubation Association (NBIA), startups joining incubator programs are nearly twice as likely to succeed with a five-year survival rate of 87% vs. 44% for non-incubated startups.
You can find startup incubators all around the country, with many focusing on a specific industry or space. Many of the earliest incubators began at universities but have since branched out to include the greater community. Many startup incubators include partnerships between private companies, universities, healthcare systems, and many more organizations that work in conjunction to encourage innovation. The application process for startup incubators depends on the complexity and prestige of the program. Many incubators required relocation in the past; however, most have switched to a virtual environment due to the current pandemic. If you would like to learn more about bootcamps, accelerators, and incubators, check out our resource guide here.
Determining the correct funding option for your startup will take time. However, if you allow yourself to sit down and look through all your options, you will likely save a lot of time, money, and stress in the long run. Today there are many options for entrepreneurs that did not exist only ten years ago. There are also many zero equity funding sources and programs available to entrepreneurs today. At Future Founders, we pride ourselves on breaking down the barriers to entrepreneurship that many of our founders experience. We offer zero equity programs such as our Startup Bootcamp, Fellowship, and U. Pitch competition because we believe every youth can be an entrepreneur.
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