Finding the right way to fund your startup is one of the most important decisions—and one of the greatest challenges—many entrepreneurs will face.
More than half of new businesses fail during their first year in operation, but it is also true that only about 4 out of 100 businesses survive longer than 10 years. Among the many reasons why this happens, a large issue is not knowing how to raise capital for a startup and a lack of funding. Startups need to raise capital in order to thrive and grow, so finding the right funding source is a crucial step for entrepreneurs.
Below, we discuss the pros and cons of five potential capital sources, so you can choose the right approach for your startup.
6 Common Sources of Startup Capital
1. Bootstrapping
One way founders can provide their startup with capital is to fund the venture themselves, through their personal savings and credit cards.
Funding a startup through bootstrapping means that the business’s cash flow is enough to keep it in operations. The growth potential for bootstrapped startups may seem limited, but the success of startups like Calendly and Mailchimp shows that it is possible to reach high levels of success without outside capital.
Pros of Bootstrapping
Bootstrapping can be a great way to cover a startup’s initial costs. Founders can access funds quickly, without a lengthy qualification process. Bootstrapping may be especially necessary for those startups which don’t yet have a business plan—many sources of outside funding will be inaccessible without one.
For those startups which do hope to eventually seek outside funding, bootstrapping can still be a good place to start. Many outside funding sources, like venture capital investors, look for signs of founders’ commitment to their business idea—founders who have invested their personal capital into a business can more easily prove their commitment, since they have skin in the game.
Cons of Bootstrapping
Though bootstrapping allows founders to avoid the complex process of raising capital and to retain ownership of the business, it is limited by the founders’ wealth and risk tolerance. For those without extensive savings and credit, bootstrapping may not be viable as a long-term solution. Not only is the risk of running out of cash is much higher, bootstrapped founders bear that risk themselves—if the company goes under, they will lose whatever personal assets they’ve invested.
Bootstrapping’s viability also depends on how much capital a business requires. It can be very difficult to bootstrap businesses which require very substantial R&D, sales & marketing, or physical resources. Software businesses are more likely to rely on internal funds initially than more resource-intensive hardware businesses, for example.
While bootstrapping does have the advantage of allowing founders to retain ownership, it can also limit growth. The decision to rely solely on personal funds and eventual profits may entail forgoing investments required for the business to grow and succeed in the long run. That’s why most early-stage businesses with high expected returns on incremental capital investments look to outside investors to supercharge their growth trajectory.
2. Friends and Family
If a founder’s personal savings and credit does not cover all of the costs of a new business, they may decide to raise more capital by seeking loans from or selling equity to their friends and family members. A friends and family round typically raises between $10,000 and $150,000, and occurs at the earliest stages of growth.
Pros of Friends and Family Rounds
Raising funds from friends and family is often much easier for new founders than seeking a business loan or venture financing, because trust in the founder and knowledge of their business idea has already been established. Founders who require more capital than they can provide from their wealth and savings alone may find this to be an ideal source of initial funds.
Cons of Friends and Family Rounds
Friends and family capital is limited in the same way that bootstrapping is limited: at some point, the capital needs of a successful startup will typically exceed the resources a founder’s social circle are willing or able to commit. However, friends and family rounds still dilute equity more—and more quickly—than a founder may realize or intend. Founders should be careful to set a cap on the equity they are willing to give up early on.
Involving friends and family in business can also complicate personal relationships. To minimize confusion and conflict, founders should treat everything formally. They may want to hire a startup lawyer (if they haven’t done so already) to draw up term sheets and repayment plans. Founders will also need to create a cap table so that they can track everyone’s equity ownership in a clear, accurate, and up-to-date way.
3. Crowdfunding
Crowdfunding allows entrepreneurs to receive capital from a large number of people around the world, typically through online platforms like Kickstarter or Indiegogo.
There are multiple types of crowdfunding, including P2P lending (debt crowdfunding), money raised based on consumer interest (reward or donation-based crowdfunding), and equity crowdfunding. Essentially, investors either donate money based on their interest in your idea, or they contribute capital in exchange for equity, early product access, or other rewards.
The crowdfunding market is expected to reach $25.8 billion by 2026, making it a substantial alternative to other forms of raising capital for startups.
Pros of Crowdfunding
Crowdfunding allows startups to access capital from anyone with money to invest, not just accredited investors, giving them access to a more diverse pool of backers. It also provides them with a forum to publicly present their idea and gauge investor interest, while building a global audience. For B2C startups which want to build a strong consumer base, crowdfunding may help them to achieve two goals at once: engaging potential customers and encouraging their loyalty, while simultaneously raising capital.
Cons of Crowdfunding
Crowdfunding campaigns aren’t guaranteed to raise enough money for your startup’s needs; on some platforms, a campaign which fails to meet its goal must return all money pledged to the investors, so the company receives nothing.
Furthermore, campaigns require time and effort to maintain, and many platforms come with hefty fees, ranging between 5 and 12%. Raising money through crowdfunding also does not give founders the same access to expertise and professional mentorship they might get through venture capital or angel investing.
4. Angel Investors
Angel investors (also called private or seed investors) are wealthy individuals or retired executives who invest their own money directly in startups, usually in exchange for convertible debt or equity. They tend to invest in very early stage startups, in smaller transactions than most venture capital firms. In addition to providing capital, angel investors will often join the board or assume some other supervisory position.
Founders can find angel investors through specialized associations or search websites.
Pros of Angel Investors
Angel investors have typically started businesses themselves, and often have extensive technical or management expertise. Entrepreneurs who successfully win the support of an angel investor can thus potentially gain guidance and a solid network of resources, as well as capital.
Angel investors are also typically less risk averse than venture capitalists, because they do not have to justify their investments to limited partners (outside investors). This means young startups or less experienced founding teams may find them easier to convince than a venture capital firm or business lender.
Cons of Angel Investors
Since angel investors are often exchanging their capital for a significant portion of equity in the startup, a clash in personality or motivation can lead to struggles over control of where the business is headed. Founders should be wary of angel investors who are overly attached to the initial business idea, or who have limited experience building and running startups. Additionally, some investors may expect a high return or put pressure on the business to reform. Founders should do as much research as possible on a potential angel investor before accepting an offer, to ensure they are the right fit.
5. Venture Capital
Venture capital firms are institutional asset managers which invest capital into minority stakes in start-ups, in exchange for equity. Since VC firms pool funds from a group of people, they can write bigger checks, ranging from hundreds of thousands to tens of millions of dollars depending on the fund and the stage of a business.
Venture capital firms look for startups with high growth potential, and tend to favor tech-driven enterprises. They take a very hands-on approach with their investments and usually have a place on the startup’s board. Given their experience dealing with many different startups, venture capitalists can be great assets. They can often provide expertise in areas which may be unfamiliar to founders, like corporate governance and finance.
Pros of Venture Capital
For startups seeking funds to complete a promising, but expensive or high risk project, venture capital firms can provide substantially more funding than friends and family or angel investors. Venture capital investors can often also provide significant expertise in running and scaling startups, making them valuable partners in making key decisions. Many VCs also provide legal, tax, and other support to their portfolio companies. VCs also have large networks of contacts to facilitate additional fundraising.
VCs also set aside capital to make follow-on investments. This means that if a start-up receives funding from a VC in one round, the VC will generally be ready and able to invest in the company’s next funding round (assuming the business performs well).
Cons of Venture Capital
For startups outside of the technology sector, it can be difficult to pique the interest of a venture capital investor. Most venture capital firms also want to see a solid business plan and experienced team, plus information on company revenues and valuation. Startups which don’t yet have all these elements in place may want to wait before seeking venture capital investment. To satisfy the requirements of their LPs, VCs must do more due diligence than other investors, which extends the length of their investment process and the timing of receiving funds.
Startup founders who do receive venture funding will also have to contend with sacrificing some control over their business. VCs make highly structured investments in preferred stock that offers them downside protection, which can be highly dilutive to founders in the event a startup does not meet expectations. The securities in which they invest also grant them a degree of control over a start-up’s decision making (e.g., through board seats and other mechanisms).
They may pressure a founder to attempt to grow the business faster at the expense of the likelihood of long-term success. Since most of their investments fail, VCs count on generating large payouts as quickly as possible from the ones that succeed. As with angel investment, founders may face increased pressure to achieve growth targets within a certain time frame.
VCs may also not necessarily bring all of the value that’s promised. Founders should take care to ensure the VC is able to deliver whatever non-capital support their startup needs, such as investor access and sector expertise. (See how Cyndx Raiser makes it easier to find investors aligned with your incentives.)
6. Business Incubators and Accelerators
Business incubators and accelerators provide resources and guidance to startups who need to raise capital. They typically cater to tech startups, especially those working on state-of-the-art or high tech projects.
Incubators do not give startups capital directly. Instead, they help startups early on at the idea stage, by providing space to set up operations and build or test products in development. Accelerators, meanwhile, take existing companies and help them grow and become more attractive to outside investors. Incubators typically don’t have an end date and are focused on the long-term, rather than quick growth. In comparison, accelerators often have a deadline of a few months and provide startups with mentorship and capital throughout and the chance to pitch their business to investors at the end.
Pros of Incubators and Accelerators
Business incubators and accelerators can provide startups with valuable resources, training, and mentoring. For high tech startups which need access to physical space or technical facilities like labs, incubators can be a great way to meet those needs without having to sacrifice any equity. Incubators also provide startups with adequate time and assistance to create a valid business model, making them great for young companies still trying to find product-market fit.
Accelerators, meanwhile, provide opportunities for face-to-face mentoring and extensive networking with potential investors and business partners. Many accelerators also offer educational seminars or other training on how to rapidly scale a business. Some accelerators also carry prestige after having invested early on in start-ups that grew to become enormous, highly successful companies. Start-ups coming out of these ecosystems may attract significant attention from VCs, but they still will be evaluated on their own merits.
Cons of Incubators and Accelerators
Accelerators and incubators are both highly competitive, and it can be difficult for startups to gain entry. Accelerators, in particular, look for startups which already have a minimum viable product and evidence of a promising business model. Of the thousands of companies which apply to an accelerator, only about 1–3% will be accepted.
Startups still in the pre-production phases of product development will find incubators more appropriate. However, incubators can also be quite selective. Startups may want to seek out incubators focused on their specific location, industry, or founder identity; it may improve their chance at acceptance if they can prove they match a particular incubator’s mission.
Takeaway
The above methods are only some of the options startups have to receive capital, and some other ways to secure funding include bank loans, lines of credit, and government loans and programs. Finding the right funding method for your startup is a key challenge many entrepreneurs face, so it’s important to understand all the options available and when is the right time to pursue external investment.
An Innovative Solution to Fundraising
Today’s technology allows entrepreneurs to eliminate labor-intensive research and analysis from capital raising. With AI’s ability to recognize patterns and adapt to changes within datasets and NLP’s ability to pull sentiment from data, entrepreneurs can quickly search for the right investors and get funded.
On an AI and NLP-powered platform like Cyndx Raiser, entrepreneurs can filter and search for the right investor based on their search criteria.
Cyndx Raiser significantly reduces the time and energy many founders must spend on investor sourcing and outreach, by using artificial intelligence to streamline and sharpen the search process. Entrepreneurs can quickly identify the right funding opportunities, instead of spending time pitching to investors unlikely to make a deal. The expanse of Cyndx’s dataset also means entrepreneurs can access a much larger set of ideal potential investors, instead of having to worry about missing out on a promising funding opportunity.
Start Raising Capital Today
Cyndx is the go-to resource for startups which plan to raise capital. With its comprehensive data and powerful AI-enabled search and discovery platform, Cyndx offers a cutting-edge solution that provides unique insights and opportunities that can’t be found anywhere else—helping startups find investors, secure funding, and propel themselves ahead of the competition.
If you’re looking to raise capital and take your business to the next level, see how powerful the search capabilities of Cyndx Raiser are by requesting a demo today.
Additional Sources:
https://www.bdc.ca/en/articles-tools/start-buy-business/start-business/start-up-financing-sources
https://www.fundera.com/business-loans/guides/startup-funding
https://medium.com/swlh/how-long-does-it-really-take-to-raise-venture-capital-910cebce80cb
https://www.entrepreneur.com/article/250999
https://masschallenge.org/article/accelerators-vs-incubators
