Photo Credit: Small Business Support
Whether it’s to pay employee salaries or to fund product development, there’s no denying that entrepreneurs need capital to cover the costs associated with operating a startup. If you’re someone who’s thinking about launching a business for the first time, navigating the maze of funding options out there can be quite difficult.
Here’s an overview of five different types of startup capital that can help you determine which source of capital might be the best for your startup.
(1) Your Own / Company’s Cash
Bootstrapping is always an option for entrepreneurs who want to cut corners and self-fund during early stages of growth. Minimizing salary expenses and keeping your day job are ways to sustain your company without large amounts of capital. If your company is cash-flow positive, reinvesting the earnings you make back into your company’s development can help you delay or even forgo obtaining outside investments. This is especially desirable for those entrepreneurs who want to maintain company ownership and avoid spending time pitching investors.
In some cases, bootstrapped entrepreneurs will eventually find themselves seeking outside financing to scale and grow their businesses. As the bread and butter of startup capital, equity is a common investment vehicle that involves individuals and firms providing money in exchange for an ownership percentage (shares, stocks) in a company. This equity can then be sold by the investors at an exit event when a company goes public (IPO) or gets acquired by a larger company. Equity capital is typically raised via numerous rounds of financing based on the company’s development stage and needs.
While equity financing entails the loss of some ownership, raising capital in this fashion can be beneficial for entrepreneurs who do not expect to generate revenue that can be used to repay loans or reinvest into the company. Additionally, investors provide critical resources such as networks and valuable advice.
Another form of capital is debt, which involves receiving a loan that must be paid back with interest over a certain period of time. Debt financing is attractive for startup founders who wish to maintain company ownership. Moreover, debt interest payments are tax deductible. But the obligation of repayment can be cumbersome for certain business models. For early stage companies without cash flow, revenue projections, or a business model to be analyzed as a credit risk, it may be difficult to convince lending institutions to give out loans. However, SBA loan programs and debt crowdfunding are tools that can be leveraged for entrepreneurs that have difficulty obtaining traditional bank loans.
(4) Convertible Notes
A convertible note is a short-term debt that automatically converts into equity upon future events in a company’s life, such as a later round of financing when a valuation is established. Basically, investors loan money to a startup and instead of expecting the money back with interest, they receive shares in the company at a discounted rate. For pre-revenue startups that do not want to determine valuation until later rounds of financing, convertible notes are a convenient way to raise capital. As a very popular type of startup capital, startup investors are very familiar with this method and may be attracted by lower closing costs related to documentation and associated legal fees.
(5) Grants and Startup Competitions
Grants and startup competitions are great ways to obtain supplementary funding for a startup since money is provided free of charge. While grant opportunities are difficult to locate and secure, startup competitions are held frequently by numerous organizations across the country. Winning a startup competition not only enhances a company’s credentials and publicity, but also provides a decent source of additional funding for bootstrapped entrepreneurs.
A startup can end up using a combination of the above depending on its stage of growth and capital needs. There really is no optimal type of startup capital that an entrepreneur should target, as it all depends on what’s most suitable for a particular startup’s situation. It is critical to analyze the distinguishing factors of each and determine what’s most beneficial for your company. Raising capital might not be the sexiest task for many startup founders, but it’s a critical component of startup life and definitely requires a certain level of preparation for many startup companies.