Business Funding Options for Startups
When starting a business, expenses can far exceed revenue and more often than not a startup will need to explore potential funding options. Below are common scenarios:
- A seed stage business generally won’t have any revenue at all and needs funding to start up.
- An early stage business might have started trading but revenues are low and the founders can’t keep bank rolling the business.
- A growth stage business planning to scale rapidly might require expansion capital.
In each case, the business might have a lot of potential for high growth in future, but right now there’s a revenue gap and/or a lack of capital to finance rapid growth.
However, startup business is high risk and funding options are limited. Most businesses starting up get self-funded initially and early and expansion stage business funding options are generally equity financing as opposed to debt financing. In the case of equity financing, the investors become shareholders in the business and back both the business and the entrepreneur(s) behind it risking that their initial investment (now shares in the business) will be worth a lot more when the business succeeds.
Seed and Early Stage Business Funding Options:
- When starting a business, the most common and generally easiest business funding method is Self-Funding which involves the startup getting self-funded by the founder(s). This is the first option because often your best chance of getting enough capital to fund your business (particularly in its earliest stages) is by funding it yourself. Read more information on Self-Funding.
- Funding from the founders Close Personal Network (commonly referred to as the 3F’s) is also a common funding method and often combined with the founders funds to provide the required start-up capital.
- Sweat Equity (as an alternative to business funding). Instead of paying cash for a particular resource or service, equity in the business is provided as compensation for the time and effort provided by the individual or service provider. This might be a suitable alternative to funding in cases where that service is a major component of starting up or growing the business (for example website or tech development) and funding would otherwise be needed to pay for the service. Read more information on Sweat Equity.
- Angel Investors are another option for business funding for seed or early stage startups. Individual angels typically invest anything from $10,000 up to $500,000 in high potential startups in return for equity in the business. Some Angels invest at the concept stage prior to a business being established but the majority invest once the business concept (and the entrepreneur) has been validated to some degree. By validated it might be that the business has received revenue, got a few customers, established partnerships, gained users or some other validation and the Angel Investor can see a clear growth path for the business. Read more information on Angel Investors.
- Incubators: An increasing number of startup incubators are popping up as both a business funding and mentoring source for startups. Typically incubators invest between $10,000 and $50,000 into a startup in return for between 5% and 20% equity in the business. Where they differ from other funding sources is that a startup incubator will work very closely with the startup founders mentoring and advising the startup, often the startup might work out of the incubators office and sometimes the incubator might provide additional services like technical development.
- Venture CapitalWhile the term Venture Capital is used fairly regularly in the context of business funding or capital raising, in reality raising capital from a VC fund is a rare event in the startup industry. Most VC funds will look only for expansion stage opportunities, but occasionally if a very high potential early stage opportunity is presented some VC funds might make a small investment in an early stage business with an option for additional follow-on rounds. Read more information on Venture Capital.
Expansion Stage Business Funding Options:
- Angel Investors: While angel investors typically invest at seed or early stage business, some very high net worth angels will provide business funding for expansion stage startups if the opportunity is right. For very high potential businesses seeking significant expansion capital more likely a small group of angels will join together to make the required investment. Read more information on Angel Investors.
- Venture Capital: Venture Capitalists are very selective in the investments they make and typically invest $1,000,000+ in return for equity in expansion stage businesses in a ratio resembling 1 out of every 100 opportunities they see. As such only extremely high growth potential startups will gain venture capital and then only if they fit the specific investment criteria of the Venture Capital Fund. Read more information on Venture Capital.
Other Business Funding Options:
- Loans / Debt Financing: In the current financial climate getting a loan from a debt supplier like a bank is not an easy task for an entrepreneur trying to start a business. The benefit of business funding via debt (rather than equity like most of the above funding options) is that the founder(s) retain ownership of the business. The availability of debt financing will depend on such things as the type of business, the industry, the credit rating of the founders and might require guaranteeing the loan against personal assets of the founders.
- Government Grants: Both the Australian Federal and individual State Governments offer grants to new and early stage businesses. The grant programs on offer change with elected governments but typically aim to support Australian productivity, innovation, exporters, selective industries and geographical regions. While the majority of new and early stage businesses won’t be eligible for a Government Grant it’s worth checking to see if your business is eligible.