4 Financing Options for Startups and Entrepreneurs
Getting your business off the ground isn't easy. If it was, more people would turn to entrepreneurship. Most startups require some amount of seed money to get started, but without any history of credit or revenue, they can face difficulties securing a loan from the bank - still the most popular form of business financing for 62% of small businesses across Europe.
With the availability of bank loans to European startups declining by 9% in 2014, it's more important than ever to be aware of your options as an entrepreneur. Whether this means going it alone, leaning on your friends or opting for "alternative" finance. Here's a guide to startup finance at all stages of your business development.
1) The three F's
Family, friends, and fools have been the cornerstones of entrepreneurship since time began. They are the lowest tier of investors: the only people likely to believe in newbies, with only minimal product evidence or business experience.
Yet surprisingly, according to statistics on Fundable, friends and family are the major funding source for all entrepreneurs, investing over $60 billion in new ventures last year, almost triple the amount coming from venture capital sources. The average amount per startup was $23,000, usually in the form of a convertible loan, rather than an equity investment.
Of course, most startups ultimately need much more than this amount to scale the business, but some prior contribution from friends and family (as well as your own sweat equity) is normally expected as a qualification before professional investors will consider entering the game. Their logic is that if your family won’t invest in you, then why should they?
When opting for three F's it's important to treat them as any other investor. Ask for a specific amount to meet a specific milestone and draw up a formal agreement. Also, don't take advantage of your unsuspecting grandmother: choose people with business experience, communicate the risks up front and don't ask for more than they can afford to lose.
2) Small business loan
As discussed, bank loans are still one of the most popular financing options for startups. However, the rise of alternative finance means there are now several viable options for when the bank manager says no. In fact, this was the case for 39% of startups in the Netherlands last year.
As traditional business lending declines, the growth of peer-to-peer and peer-to-business lending has been nothing short of meteoric, with exponential growth figures above 140% over the last couple of years. Now there are many platforms offering various forms of P2P and P2B lending.
The concept is simple. A small business wanting to raise funding to scale up its operations advertises its need on a crowdfunding website. It provides a basic business description, the purpose for which the funds will be used and some financial records. In some cases the site itself then generates some sort of credit score for the business, linked to a risk rating. We at Symbid, however, use an independent scoring agency for this. Individuals then select businesses to lend to based on the projected interest rate over the duration of the loan.
It's important to note that loan crowdfunding may be out of reach for some startups; many lending platforms require a credit and financial history, positive cash flows etc. For younger startups, equity crowdfunding is probably more relevant. We at Symbid believe peer-to-business lending has huge potential for displacing bank financing as the go-to funding option for small, growing businesses.
3) Equity crowdfunding
Symbid actually began its life as one of the first equity crowdfunding platforms back in 2011, and has since then funded millions of euro's for over 130 companies, ranging from start-ups to fast growing companies. With the global equity crowdfunding industry growing by over 100% year on year, it is soon set to overtake angel investing and venture capital in terms of size.
Equity crowdfunding is highly suited for young, early-stage startups that are not yet mature enough for a loan. The barriers to entry for equity crowdfunding can be quite low, depending on the platform, and the key is to show the crowd your business potential. Crowdfunding investors don't expect strong revenue growth (although it is a bonus), they're more interested in the innovativeness of your business model and your competency as an entrepreneur. Equity crowdfunding involves investors providing capital to a startup in exchange for a share of ownership in the business, with the expectation of profit if/when the business becomes successful.
A main benefit of equity crowdfunding for entrepreneurs is the ability to draw upon the knowledge, expertise and networks of a larger crowd of investors. There are generally two ways for an investor to earn returns through equity crowdfunding. One is through a dividend paid to shareholders by the business: this is unlikely to happen until the business has grown substantially and is making profits. The second is through growth in the value of your shares in the business.
However, only certain crowdfunding platforms – Symbid being one of them – enable investors to “sell” their shares in a business to other investors. In general, the uncertainty of returns makes equity crowdfunding riskier than loan crowdfunding, where investors can expect fixed returns. Check out our comparison of the key investor considerations for loan and equity crowdfunding here.
4) Angel investors
An angel investor is a (typically) high net-worth individual with private money to invest in a company in anticipation of an exit (or equity event) in the future. Most angel investors are interested in the next generation of ideas and are willing to fund startup ideas they believe in. As a consequence, they tend to focus heavily on technology startups.
The process to receive funding from an angel can be relatively straightforward, but they will expect to see your complete business plan with financial projections. Make sure you understand these 10 key metrics for startup investors before you begin your capital search. The business owner raises capital by selling equity in the company. Typical shares granted to angels range from 10-50% of the business.
This funding option can be a good fit for technology-focused businesses that are established beyond the beginning startup stages, but still need guidance with marketing and product creation. An angel investor may not only provide money, but also mentorship for a startup owner who’s looking for more experienced partners or guidance. They may also expect a certain degree of influence over how the company is run.
Finding the right angel can be a challenge. There are online communities where angels congregate and your local university is another good place to look. A Google search in your area for angel investors will likely reveal groups closer to your business. At Symbid we use independent financial advisors to guide our entrepreneurs to the right investor at the right time.