Types of Startup Financing and the Benefits of Each Kind

Startup financing refers to the money and capital that entrepreneurs raise to start and grow their new businesses. This financing allows startups to pay for essential upfront costs like research and development, equipment, hiring initial employees, leasing office space, and more. Securing financing is one of the biggest early challenges entrepreneurs face when starting a company. But it is also what fuels their ability to turn an idea into a sustainable, thriving business.

Having adequate startup financing is critically important. According to failory.com, 29% of startups fail due to running out of cash and funding. Without financing, most startups cannot afford the talent, technology, marketing, or other resources they need to gain traction. The right financing empowers entrepreneurs to build momentum, achieve key milestones, and ultimately become profitable, sustainable companies.

Types of Startup Financing

There are several common sources entrepreneurs turn to for startup financing:

Self-Funding

Many entrepreneurs begin by self-funding their startups with their own personal savings, credit cards, or funds from friends and family members. While self-funding allows the entrepreneur to maintain complete control and ownership over their business, the amounts raised this way are typically small. Self-funding works best for very early stage startups or those with extremely low initial costs.

Common self-funding sources include:

• Personal Savings - Tapping into personal savings accounts and assets
• Credit Cards - Maxing out limits on personal and business credit cards
• Friends & Family - Borrowing money from friends, parents, relatives

The benefit of financing a startup this way is that you maintain complete ownership and control. The downside is that funds are limited and it can strain personal relationships.

External Funding

Once startups grow beyond the earliest stages, most entrepreneurs turn to external sources for larger amounts of financing. External startup financing options include:

Bank Loans

Bank loans like SBA loans, small business term loans, and lines of credit provide a relatively straightforward way for startups to access financing. The challenge is that most traditional banks want to see significant operating history and revenue before approving loans. Requirements like collateral and high credit scores can also be difficult barriers for young startups to qualify.

Angel Investors

Angel investors are typically high net worth individuals who invest their own money into promising startups in exchange for equity ownership and sometimes board seats. Angels usually support startups at earlier stages than venture capitalists. The challenge for entrepreneurs is convincing angels that their startup has high growth potential.

Venture Capital

Venture capital firms raise pools of money from institutional investors, endowments, and pension funds to invest in high-growth-potential startups in exchange for equity stakes. This type of financing works best for startups that have already gained some traction and appear poised for rapid expansion and market leadership down the road. Convincing VCs to invest requires great pitching skills and traction.

Crowdfunding

Equity crowdfunding platforms allow startups to raise relatively small seed financing from a large pool of investors through an online campaign. It helps entrepreneurs validate their idea and build an initial community of brand supporters. The downside is that running a successful crowdfunding campaign takes lots of preparation and marketing effort.

Peer-to-Peer Lending

Peer-to-peer lending platforms like Lending Club allow investors to provide financing to startups and small businesses in the form of small business loans. Interest rates tend to be higher than bank loans but eligibility requirements are more flexible. Repayment works just like any other loan.

How to Get Startup Financing

The process of securing financing for a startup typically involves:

1. Determining Exact Funding Needed

First, entrepreneurs need to carefully calculate exactly how much funding their new startup requires. Common startup costs include research, product development, office space, equipment, hiring staff, legal fees, licenses, inventory, marketing, and more. Never guess or underestimate funding needs.

2. Building Business Plan and Financial Projections

Most startup investors will expect to see formal business plans and 5-year financial projections before they consider funding. These show the startup's objectives, key milestones, operations, and growth potential - as well as how much funding is needed and how it will be used.

3. Researching the Best Financing Options

With funding needs and business plans developed, entrepreneurs can then research which financing options best match their funding amount, timeline, and business model. The best source depends heavily on the startup's stage, objectives, and financial situation.

4. Preparing Pitches and Application Materials

Startups will need to prepare pitches and application materials tailored to their specific investors and lenders. These convince investors to provide financing and show that there will be a return on investment. Strong applications take lots of time and effort.

5. Formally Applying to Financing Sources

Finally, entrepreneurs submit formal applications and make pitches to pitch decks to their targeted investors and lenders. The goal is build confidence, show potential, provide transparency, and secure the startup funding. Expect lots of investor meetings and negotiations.

Managing Startup Financing

Once startups secure financing, it's critical they properly manage it by:

• Balancing Debt vs Equity - Blend financing via safer debt and higher-risk equity appropriately. Debt must be paid back but equity involves loss of control.
• Managing Cash Flow - Carefully manage cash flow to extend runway. Prioritize spending only where completely necessary.
• Tracking Financing Terms - Use calendars to track financing repayment timelines, interest, investor rights, etc. Surprises are bad.

Key Takeaways

The major options entrepreneurs have for financing their startups include self-funding using personal savings and credit, getting loans from banks, finding angel and venture capital investors, running crowdfunding campaigns, and borrowing through peer-to-peer lending platforms. The best source depends on multiple factors. But no matter where financing comes from, startup founders must determine exact funding needs, develop strong business plans and financial models, prepare polished pitching materials, and diligently manage the capital in order to turn their business ideas into thriving companies.