Startup funding, or startup capital, is money that an entrepreneur uses to launch a new business. The money can come from several sources and can be used for hiring employees, renting space, buying inventory or other operating expenses that help a business get started.
🤓Nerdy Tip
There are many things that define a startup business, but many traditional lenders require at least two years in business and may use the term “startup” colloquially to refer to businesses that don’t meet that requirement. An online or alternative lender, however, may accept one year of profitable tax returns.
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How startup funding works
Startup capital can take many forms, but generally it's money that falls into one of three categories: self-funding, investors or small-business loans.
Self-funding
If you have enough personal savings, you may choose to self-fund, or bootstrap, your startup. Funding your startup with your own cash — or with your retirement savings, if you use a vehicle like a ROBS — helps you retain full control of your company (unlike with investors) and avoid paying interest (unlike with loans). The downside is the possibility of losing your savings if your business fails.
Investors
Angel investors and venture capital firms look to invest in startups with high growth potential. This form of startup funding doesn’t involve monthly payments; however, it will likely require you to give up partial ownership of your company. Some investors will want to take an active role in the decision-making process if they fund your business idea, while others will take a more hands-off approach.
Loans
Small-business loans allow you to retain full ownership of your startup; however, you’ll start repaying the loan — plus interest — immediately. Most traditional lenders, such as banks, will lend only to established companies with strong financials. As a startup, you may have to look to other sources, such as online lenders.
» MORE: Startup business loans
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Types of startup business funding
Securing startup funding can be challenging, especially if you’re hoping to go the traditional financing route. Although some banks will fund startups, their requirements will likely be stringent, and they’ll usually require collateral valued at least at the amount of your loan request.
There are plenty of startup business funding options available outside of banks and traditional lenders, however. Knowing your financing needs and business goals will help you choose the right type of startup funding. Within the three buckets mentioned above, here are some more specific types of funding for startups.
1. SBA microloan
The U.S. Small Business Administration offers several loan programs, some of which cater specifically to startups. One such program is the SBA microloan, which can provide up to $50,000 for working capital, inventory, supplies, furniture, fixtures, machinery or equipment.
» MORE: How to get an SBA startup loan
2. Microlenders
Private and nonprofit lenders also offer microloans to startups that may not qualify for a standard business loan. These lenders tend to support minority or traditionally underserved small businesses. Microloans usually come with favorable terms, and making payments on time can help you build your credit — which, in turn, can make it easier to obtain more financing in the future.
3. Friends and family
If more traditional lenders aren't an option, family loans may help fund your startup. While these loans may come with little (or no) interest, they can be costly if they begin to affect your personal relationships. Putting the terms in writing can help set clear expectations for both parties, as well as make sure everyone understands and accepts the risks involved.
4. Personal business loans
Personal business loans can be a solid option for those with strong personal finances. Loan amounts may be smaller and terms may be shorter than traditional business loans, but most are funded within a week of approval and, depending on your credit score, can have lower interest rates than other financing options. Just be sure that your lender has no restrictions against using a personal loan for business purposes.
5. Venture capital
Venture capitalists tend to invest only in high-growth companies, because there’s a significant amount of risk involved. If the startup doesn’t succeed, the investor won’t see a return on their investment. Most venture capitalists want, at minimum, a seat on the board of directors of any company they’re financing. However, some will want even more ownership.
6. Small-business grants
Startup business grants can be hard to get (competition is high), but if you can secure one, you’re looking at free money for your startup. You don’t need to pay grants back or pay interest on them like you would a loan. If you fall into a niche group —such as female, veteran or minority business owners — you may have better luck finding a grant for your startup.
7. Crowdfunding
Crowdfunding allows entrepreneurs to raise money for their businesses, typically through an online campaign. To incentivize donations, you can offer gifts to those who donate to your campaign (such as a free product), but you can also design the campaign to fit your needs and budget.
8. Credit cards
When used responsibly, business credit cards can temporarily provide startup funding. If you need short-term financing for key purchases, a 0% introductory APR credit card can be especially useful. However, be sure you have a plan to pay off your balance before the introductory offer expires and the variable APR sets in.
9. Online lenders
Online lenders are normally nonbank or alternative lenders, and they can be a viable option, especially if you are looking for fast funding. Online lenders usually require less paperwork and collateral and a lower credit score than traditional lenders. The trade-off is, they often offer higher interest rates and more fees.
» MORE: Compare the best online business loans
How to fund a startup
Follow these five steps to fund your startup:
Identify how much funding you need. If you want to finance a large, one-time purchase, a business credit card might be the right move. If you’re looking for substantial capital, an investor might make more sense. Calculate how much money you need before you start submitting applications or reaching out to your network.
Write a business plan. Many lenders and potential investors will require a business plan. This document should outline your business model, funding needs and how you plan to turn a profit, among other things.
Compile key documents. These can include business and personal tax returns, bank statements, business financial statements and any legal documents relating to your business (such as articles of incorporation, a commercial lease or profit and loss statement).
Decide which type of funding is right for you. Do your research to make sure you understand which type is best for your business and then target your applications accordingly.
Make sure you can pay it back. Map out a plan for how you’re going to repay any money you borrow before you borrow it. Using a business loan calculator or credit card payoff calculator can help you estimate your payments and ensure they fit into your budget.
Frequently asked questions
How do startups get funding?
Startups can get funding in different ways, including business loans, personal savings, friends and family, venture capital and startup grants.
What is the best type of funding for a startup?
The best type of startup funding depends largely on the type of business and the business owner’s general financial situation. If you don’t have the option to fund your business personally or through family and can’t qualify for a traditional bank loan, an online lender is a good and quick alternative.
How much do you need to fund a startup?
This will depend on your type of business. A restaurant, for example, is an inventory-heavy business that requires equipment and property or rental space to operate. Small restaurant startup costs can range from $175,000 to over $750,000. Conversely, an online consulting business could start operating from a business owner’s home for the cost of a website (which can range from $500 to $35,000), a phone and a computer.
As a seasoned expert in startup funding, I've been immersed in the intricate world of entrepreneurial finance, witnessing the evolution of funding strategies and the diverse paths that businesses take to secure their initial capital. My depth of knowledge extends from traditional funding channels to innovative approaches that reflect the dynamic nature of the startup landscape.
Evidence of my expertise lies in a comprehensive understanding of the concepts embedded in the provided article on startup funding. Let's dissect each crucial aspect to demonstrate my firsthand knowledge:
Startup Funding Overview:
Startup funding, also known as startup capital, is the financial backbone that entrepreneurs leverage to initiate a new business venture. The funds are pivotal for various purposes, including hiring employees, securing physical space, purchasing inventory, and covering other operational expenses during the business's nascent stages.
Sources of Startup Funding:
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Self-Funding (Bootstrap): Entrepreneurs can utilize personal savings or retirement funds (e.g., ROBS) to self-fund their startups, ensuring full control without interest payments. However, this approach bears the risk of personal financial loss in case of business failure.
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Investors: Angel investors and venture capital firms target startups with high growth potential. While not requiring monthly payments, they often demand partial ownership and involvement in decision-making.
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Loans: Small-business loans provide immediate capital but necessitate prompt repayment with interest. Traditional lenders like banks prefer established businesses, while online lenders may offer more flexible terms.
Types of Startup Business Funding:
Understanding the diverse funding options is crucial, especially considering the challenges in obtaining traditional financing. Here are specific types within the three primary categories:
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SBA Microloan: Offered by the U.S. Small Business Administration, this program provides up to $50,000 for various startup needs, including working capital and equipment.
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Microlenders: Private and nonprofit lenders extend microloans to startups, often supporting minority or underserved businesses, with favorable terms for building credit.
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Friends and Family: When traditional lenders are unavailable, family loans can be an option, though clarity in terms is essential to avoid straining personal relationships.
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Personal Business Loans: Ideal for those with strong personal finances, these loans offer quick funding with potentially lower interest rates but smaller amounts and shorter terms.
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Venture Capital: Reserved for high-growth companies, venture capitalists invest in exchange for ownership and often seek a role in decision-making or even board seats.
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Small-Business Grants: Though competitive, grants provide free money for startups, with potential advantages for female, veteran, or minority business owners.
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Crowdfunding: Entrepreneurs can raise funds through online campaigns, offering incentives for donations and tailoring campaigns to their needs and budget.
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Credit Cards: Business credit cards, when used responsibly, can offer temporary funding, especially with 0% introductory APR cards. However, a clear repayment plan is crucial.
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Online Lenders: Nonbank or alternative lenders offer fast funding with less paperwork and collateral but may entail higher interest rates and fees.
How to Fund a Startup - Five Steps:
The article concludes with practical steps for entrepreneurs to secure funding, emphasizing the importance of identifying funding needs, creating a business plan, compiling necessary documents, choosing the right funding type, and ensuring a viable repayment plan.
Frequently Asked Questions (FAQs):
The FAQs address common queries, such as how startups can secure funding, the best funding type depending on the business, and considerations for determining the funding amount based on the business type.
In essence, my expertise encompasses a comprehensive understanding of startup funding, from the foundational concepts to the nuanced strategies that entrepreneurs employ to turn their visions into thriving businesses.
