Funding is essential when starting a small business or looking to expand an existing one. Not only does it enable you to reach your objectives, but it also gives your startup a strong foundation for growth and development.
Funding can come in the form of equity, debt or grants. Each has their advantages and drawbacks; therefore, it’s essential to determine which type of money you require for your business venture.
Equity
Equity funding is an increasingly popular way for startups and businesses to raise capital. It’s less risky than debt financing, allowing companies to reach their growth objectives more easily. Nonetheless, it’s essential that businesses understand the potential drawbacks before proceeding with any deal.
Startup equity is typically distributed among employees, founders and investors in exchange for their investment in the company. The amount of equity awarded to an individual depends on several factors such as their level of contribution to the business and its valuation at distribution time.
Therefore, the equity package you receive can differ drastically between startups. For instance, if a startup offers you 50,000 shares at 0.05% of their total equity, this may seem like a great deal but in reality this 0.05% only represents 0.015% of their total pie. Therefore, each time they raise new capital your share in the pie gets smaller and smaller.
Debt
Debt financing is a form of startup capital that doesn’t necessitate the company to issue equity or dilute shares. Unlike equity financing, debt requires the startup to repay the loan within an agreed-upon time frame.
Debt can provide additional advantages, such as tax deductions. Generally though, debt should only be used when you feel confident about your ability to repay it.
Lenders may charge high interest rates on loans and take action to seize control of your business or assets if you default on repayments.
If you are considering debt financing, consult with your VC investors about the terms that appeal to you. It is also important for founders to be aware of covenants – conditions that must be fulfilled in order for a lender to remain in good standing; these could include minimum liquidity requirements or debt-to-equity ratios.
Crowdfunding
Crowdfunding is a popular way to obtain startup capital. It offers an easy, risk-free and inexpensive means of raising capital that makes it ideal for new businesses that may not qualify for traditional sources of funding.
Crowdfunding can have its drawbacks, however. One common misstep is selecting an inappropriate platform. Furthermore, some entrepreneurs fail to recognize how much effort and planning goes into running a successful campaign; this can take considerable amounts of time.
Another common error is underestimating the significance of marketing and promotion for a crowdfunding campaign. Entrepreneurs should use social media to spread awareness about their campaign and encourage people to donate. They also need to keep backers updated on project progress as well as offering them rewards in return.
Angel Investors
Angel investors are individuals who provide small amounts of capital in exchange for a portion of equity in a startup company. Although they do not hold an official position on the board, they can provide valuable assistance with business development and planning.
They offer a range of services, such as connections and networking opportunities, recruitment solutions, technical advice or assurance and more. As such, they may be an effective source of funding for startups.
However, startups seeking angel funding should be wary of some potential pitfalls.
One major hurdle is the time and energy invested into securing angel investment. This involves multiple iterations on messaging, pitch decks and executive summaries that may feel like wasted effort if your venture does not succeed.
Bank Loans
If you need business financing, bank loans can be a viable option. But before applying, it is essential to weigh the potential drawbacks of taking out such a loan.
Bank loans can be challenging for startups to acquire until they establish a reliable track record. Banks usually require that startups possess both an impressive credit history and sufficient assets that can serve as collateral.
Startups also have the option to access a line of credit that provides them with the funds they require as needed. This can be an attractive alternative to bank loans for those with less-than-perfect personal credit or who haven’t been in business long enough to qualify for term loans.
