The 7 most common ways to finance your Startup

When you have a great business idea, and cannot wait to get started on it, you will eventually run into the essential question:

• How can I finance my endeavor?

Most of the time, people who want to start a company do not have the capital to do so themselves, so they need to look around for other financing options.

You have to keep in mind, that the way of financing that you will seek also highly depends on the kind of business that you want to start. Some forms of financing work for all sectors, some only for tech-based sectors. Many of the more advanced forms of finance are only available if your business idea is highly innovative and can inspire passion in potential investors. New software that will change the lives of millions will attract very different investors than a coffee shop next door.

No matter which way of financing you chose, the first step on this path is always to prepare a great business plan. Take enough time for this and go into details – the better and the more comprehensive your business plan, the better your chances for success when trying to secure funding. Of course, every party that is considering to give you money will want to see what they are investing in. Also, further down the line, the business plan will help you to stick to your vision and to make sure you stay on track. Don’t jump this step of the process and make sure, your business plan is a winner.

There are many different ways of how to finance a Startup, and their practicability also depends a lot on the kind of business you want to open. Sometimes all the options can be overwhelming, so in this article, we want to shed some light on the most common ways to finance your startup and what the pros and cons for all of them are.

1. Getting a loan at the local bank

Even though this does not really sound sexy, getting a small business loan to start a new company is still one of the most common ways to finance a startup. For many people, there is relatively easy access to banking services. Furthermore, most people are familiar with how the system works and thus the barrier to approach this is lower. Depending on your business idea, this can be the best way to start.

When you search for business loans, do very detailed research, as rates and conditions can vary greatly between different banks. Make sure that the interest rates are low to avoid that they crush your company in the first years where you will probably make very little income. A good start can be to make an appointment at your private bank. You already know them, they already know you, and they might have something good to offer to you. Just be clear thought that a good deal on a personal account does not always mean, that they also have great offers for business accounts.

Pro: easy to access, reliable and stable

Con: interest rates, can be difficult to obtain when the idea is very new and there are no securities

2. Venture Capitalists (VC)

Venture Capitalist Firms invest in startups very early in their development in exchange for an equity share. This means, if you want an investment from a VC firm, you have to give up a part of your company – the size of the part depends on how much money you need.

The good thing about this kind of investment is, that VC firms typically also provide some supplemental support, as they want to see your business succeed because they have a financial stake in it. Also, they are experts in the field, so if they show interest in your business idea, at least you know that you are onto something. If your idea was not good, they would not try to have a piece of it.

At the same time, VC firms typically only invest in businesses in specific sectors. More than one-third of all VC investments happen in the software sector, almost a fifth in biotechnology. If your business idea is something unrelated to technology, like a shop or just a service, VC firms will probably not be interested in giving you funding.

You also have to know before you accept funding from VC firms, that they want to see a return on their investment. They might try to push you to make money at an earlier stage than you had planned or might try to influence your company into a direction that you personally might not want to go to, because they want to see a profit. Be aware that you give them influence to a certain degree if you accept financing for your startup from Venture Capitalists.

Pro: support that goes beyond money, financially strong

Con: you have to give them equity share, they might try to influence, the pressure to make quick profits, not in all sectors

3. Angel Investors

Sometimes, people refer to angel investors in the same sense as to Venture Capitalists, but there are some differences between these two forms of financing your startup. Angel Investors tend to be entrepreneurs or former entrepreneurs themselves that want to support small businesses to get off the ground. Many times, they are willing to take a little bit more of a risk, if they believe in the idea that is presented to them.

When you accept investment by an angel investor, you also have to give an equity share in exchange, even though sometimes this can be exchanged for convertible debt. While the investor probably also will want to see money at some point, it is not always there the only motive. If they are really convinced by your idea, they might be willing to wait a bit longer for revenue and let you find your own way.

Angel investors often have a lot of experience in the business world and are willing to share this with you. They might also be willing to help you with their connections. This can sometimes almost be more valuable than the money itself.

While Venture Capitalists are normally a group and a decision takes time, as it has to go through different committees etc., often Angel Investors work relatively independent. While it is of course very important to have a great business plan, you might also be able to convince Angel Investors in a personal meeting if you are able to explain your plan to them in an engaging way that makes them want to be part of your startup.

As you can imagine, Angel investors are not waiting behind every corner. It takes a bit of luck to find an angel investor who is interested in your business. So if you manage to connect with one, that is great, but this should not be your only financing strategy for your startup.

Pro: Support that goes beyond money, can come with few strings attached

Con: you have to give an equity share, they might try to influence, very rarely available

4. Government Subsidies and programs

In many countries, the government wants to support small businesses and startups to boost the economic sector and to create employment. Try to find out, if your country has any of these programs, as they can be a great way to get money to get a project off the ground. Many times, small business loans issued by the government have a lower interest rate than those you would find in the open market.

The government does not always directly offer money to support startups, but sometimes there are other things that can help you. If you are just starting out, you might have to pay less tax, can get someone to help you with your business plan or can just get general advice. Every program is different, so make sure to research thoroughly before you apply to find the best program for your business idea.

Often these programs are limited in size though and they are not necessarily ready to take big risks. If your business idea is very innovative and needs a high volume of investments, direct government support might not be the best choice for you, even if some components still might apply. Also, you might have to fulfill very specific requirements to be eligible for these programs.

Pro: support directly geared at new companies, lower interest rates

Con: risk-averse, you have to follow very specific rules and regulations in many cases

5. Accelerators and Incubators

Accelerators and Incubators are not exactly the same thing, but they are basically aiming at the same goal: Taking a young company or an idea and helping it to grow into something that can become very successful.

Accelerators mostly focus on companies that have already been established, incubators can take up ideas at the very beginning before most of the development work has been done.

While normally there is some funding attached to taking part in an accelerator or an incubator program, the big benefit is taking advantage of the networks they provide. The offer very close mentoring by companies and personalities from the respective fields and make sure, that participants get the chance to run their ideas by experts before they do anything. Basically, they try to speed up the initial business development phase to make the companies ready for the next step earlier than they would be if they would just go through this alone.

At the end of an accelerator or incubator program, often there is a presentation of the results in front of angel investors or VC firms. So even if the direct funding attached to the programs is marginal, it offers the chance to connect to parties who have the means and the interest to invest in new startups and ideas.

Pro: offers much more than funding, can help to get ideas off the ground

Con: very competitive, high pressure

6. Crowdfunding

Crowdfunding can be a great way to get money for your startup, particularly if you have an innovative idea that has the potential to engage people. Crowdfunding basically means, that you put your idea on one of the crowdfunding platforms and ask people to contribute financially towards it. You can set up a system of rewards, or even use this as a pre-order system – once your product is finished, people who contributed towards your campaign will receive it.

Crowdfunding only works in cases though, where the product is interesting and is able to engage people. When you are developing software that will make some processes in the background easier, very few people will be interested in supporting that. If your product looks great and will make a change in people’s lives, you might have a chance. Using a crowdfunding campaign can also create a lot of buzz about your product even before the launch, so it can help you once you have to start marketing. Check out Kickstarter.

Be aware though, that collecting money via crowdfunding will put a lot of pressure on your business to keep deadlines and to succeed. There are a couple of examples out there where a crowdfunding campaign to finance a startup made a huge splash and afterward was not able to deliver on promises made. This attracted a lot of negative press and ultimately led to the discontinuation of the companies. Only enter the crowdfunding space, if you are sure you can deliver on whatever you will promise.

Pro: can be used as a preorder system, creates a lot of buzzes even before launch

Con: not very reliable, high public pressure

7. Family and friends

Asking family and friends for money to start a business is not ideal, but many times startups have to go back to this. Particularly in the very beginning, when you have very little to show for, investors might be hesitant to go all in. Getting some money from friends and family might be a good way to get the very first steps financed, get a prototype or start developing the software, so you have something specific to show investors further down the line. Be aware though that there is a lot of potential for conflict and you should try to make clear contracts about the money, even if you think it is not necessary with family members or friends. In the long run, this will help you to keep personal and professional things apart, even if you run into trouble with your company.

Pro: low-interest rates, few strings attached

Con: high personal risk, might lead to personal problems

So, these are the seven most common ways to finance a startup during the first phases. Which one is right for your business depends a lot on the circumstances, as not all of these ways work for all fields and all situations. Make sure though that you are aware of all options for your startup so that you can make an informed decision to put your business on a stable financial basis.

You might also like to read Business Plan for Your Startup.