One of the first things on any new entrepreneur’s to-do list is figuring how to fund their start-up. While at the beginning many founders use their own savings or borrow from friends and family to get their idea off the ground, eventually they’ll need additional cash to scale and grow.
In this article we explore the different kinds of business start-up funding, from bootstrap to bank loans, and look at the kinds of investment for start-ups that funders typically prefer.
- Types of start-up funding – the basics
- What are the different types of investment available for start-ups?
- Funding rounds and the alphabet of series funding explained
- Business loans for start-ups
- Angel investment in start-up businesses
- Equity crowdfunding for start-ups
- How to attract seed funding
- Attracting funding via an incubator
Types of start-up funding – the basics
There are lots of different types of start-up capital, and what’s available largely depends on what stage of growth your company has reached. In the beginning, this means you’ll likely use savings or other forms of private capital to launch (bootstrap finance). As you start to generate sales and grow your business, you’ll typically need more cash than you’ve at hand, and turn either to borrowing or investors to scale.
If you choose the investment route, outside investors bring their own cash in return for partial ownership of your business. In the early stages, before you start generating income, this kind of investment is known as ‘pre-seed’ or ‘seed’ funding and may come from ‘angel’ investors who sometimes bring their expertise as well as resources to your start-up. Alternatively, you can try to crowdfund your business by inviting the public to provide cash in return for equity.
Later on, you may go to the wider investor market and look for different types of start-up financing via A, B C or even D funding rounds, as the business progresses.
What are the different types of investment available for start-ups?
Here’s a brief line-up of the different types of investment available, and some of the key features of these kinds of business start-up funding:
Bootstrap finance is provided by your immediate circle of friends and family, as well as your own resources. Funding is given on the basis of trust in you and your idea. Amounts are likely to be relatively small.
The advantage of this type of investment is that it’s easy to raise. The existence of a healthy amount of bootstrap finance can also be a good signal to future investors that those closest to you believe in you and the potential for your business. The downside of bootstrap finance is that you may be asked for equity in return for funding. However, if you give away too much early on, this can negatively affect your ability to control the business and impact your ability to attract outside investors later on because of the share structure of your company.
Banks and government grants
While these aren’t investors as such, large organisations can sometimes be willing to advance funds to start-ups. This can be in the form of grants for certain types of business, credit cards, overdrafts or occasionally loans.
The advantage of this type of funding is that you won’t have to give up any equity in your company in return for the cash. The disadvantage is that you may have to repay interest and capital over time, negatively affecting your cash flow in the early stage of your business. You’ll also have regular reporting requirements so that the lender or grant provider can make sure your business is on track and this can be cumbersome to manage, taking up your valuable time.
Angel investors are individuals or firms who invest in small businesses and start-ups. They are often prepared to fund businesses that are at a much earlier stage than are larger firms like venture capital operations. Because they are often entrepreneurs themselves, they can bring their experience and professional expertise as well as cash to help your business.
The advantage of angel investors is that they are more likely to invest in early-stage businesses. The disadvantage is that you can sometimes end up giving up too much equity in your company to an angel in return for finance.
Incubators are programmes organised by groups of professional investors who organise events designed to attract the brightest and best new entrepreneurs and great ideas. If you pitch to an incubator and you’re successful, you’ll not only attract cash but you can also get access to contacts and professional expertise to help you grow.
Venture Capital firms or ‘VCs’
These firms are groups of successful investors, and typically provide large sums of money in addition to the cachet of having them on board. If you succeed in attracting a VC to invest in your start-up, that’s a sign to the investment market that you’re a good bet. More and more VC firms are willing to provide investment for start-ups but you must demonstrate that you’re capable of delivering fast and good returns.
Early rounds of funding are known as series A rounds, and later rounds B, C and D. Which VC firm is best for you depends on their particular niche. This may be tied to geographical location, sector expertise or the stage of your start-up business.
Venture capital can be tricky to obtain, as VCs can afford to be selective. You’ll need a good pitch deck, Minimum Viable Product (MVP), and the funding process can be time consuming. They’ll also want a fair chunk of your company’s equity in return for their cash. Your company will need to be valued and they’ll want you to report to them regularly with business updates. They’ll also want to have their share of the company protected against ‘dilution’ in case you obtain further funding and offer shares to new investors in future funding rounds.
Venture capitalists are particularly keen to take advantage of government backed investment schemes that provide them with tax advantages. If your company is eligible for this type of investment, this can increase your attractiveness to VCs.
See our How to create the perfect pitch for investors guide for tips on how to become more attractive to Venture Capital investors.
More and more large institutions like companies, hedge funds, private equity and investment banks are providing investment for start-ups by creating incubator programmes. Large institutions can be good allies for start-ups, although there can be cultural differences between you and your funding organisation, and this type of investment can be complex and hard to manage. You may also need to provide regular reporting on your progress.
Funding rounds and the alphabet of series funding explained
Each series of funding round has different qualities and is appropriate for businesses at a certain stage of business growth. The basic principle of series funding is that investors offer cash in return for shares. Different funding rounds are designed for companies at different stages of growth, and investors at each type of round will make differing demands on the business seeking funding.
If your start-up business has started to generate healthy revenues, has an established base of users or other metric that demonstrates a company growing rapidly, Series A funding may be an option for you. Series A funding is designed to help a company grow and scale so that it can generate profit for the participants. Series A funders are looking for start-ups with brilliant ideas and a sound strategy for turning that idea into a money generating venture. You can expect to raise anything from £1,000,000 upwards.
Typical investors are VC firms and possibly angel investors too. Once you have succeeded in attracting a single investor, it’s easier to find additional investors to take part.
Series B funding rounds are designed for companies moving from start-up to scale-up stage. Generally, this round is all about increasing market share and attracting new users. You’ll need to show that you’ve a solid business and an experienced team around you that can help you grow. The processes for obtaining Series B funding are similar to those involved with series A, although investors will be more focussed on your business structure and the skills and other attributes of the key players. You’ll expect to be raising in the tens of millions.
If your company makes it to the Series C stage, you’ll already have demonstrated a track record of success, looking to scale further, move into new markets or even acquire a competitor to help you grow. Series C investors will want to achieve a substantial return in return for their capital. Typical investors include more risk-averse organisations like institutional investors since the company has shown it’s already successful.
Occasionally a company can move from A, B and C funding rounds through to series D and beyond. These rounds are generally for high-value companies who aren’t quite ready to become listed on a stock exchange via an IPO.
Business loans for start-ups
There are a variety of borrowing options open to start-up businesses providing different types of start-up funding.
For example, traditional banks may be prepared to offer your business an overdraft, depending on your relationship with the bank and what security or guarantee you’re prepared to offer in return. You may have to pay an ongoing overdraft fee, but you won’t pay interest until you go into the red.
Or, a bank could offer you a loan to fund your working capital or to purchase large items of equipment or stock. It’s also possible to get alternative financing to fund large purchases such as vehicles or large equipment. Peer-to-peer lending sites offer another financing option.
If you’re considering borrowing as a means to finance your business, you’ll need to make sure you understand the key terms of the deal and compare them with those offered by alternative sources of finance. Here are some of the things to watch out for:
- What’s the rate of interest?
- How often do you have to make interest payments?
- When is capital repaid and on what schedule?
- What arrangement and other fees are payable?
- Do you have to meet certain metrics in terms of your operating finances?
- What might constitute a default under the loan?
- Do you need to offer security or a guarantee of the loan?
- Will the lender insist that you use the loan for certain specific things?
- Can you repay the loan without penalty?
A possible option for back-up funding is a business credit card. Some credit cards are specifically designed for small business users, although eligibility may depend on your personal credit rating, and interest can be high in relation to loans. Be aware that if you default on a business credit card this might negatively affect your personal credit rating.
Angel investment in start-up businesses
Angel investors specialise in early stage businesses, offering investment and sometimes their expertise in return for funding. Generally, amounts of funding go from £25,000 upwards. Angels care most about the energy, passion and commitment of the founders, the potential market, a well-prepared and thought-out business plan coupled with a realistic valuation.
To find your angel, exploit your contacts, professional advisors, crowdfunding sites and specialist platforms set up to attract start-up investment. If you bag an angel, they can bring strategic vision, specialist advice, networking opportunities and access to high-value contacts including talent. They may also have particular experience in your market sector.
Equity crowdfunding for start-ups
Crowdfunding is an alternative type of start-up funding, especially for entrepreneurs that want to promote their business as well as raise finance. There are plenty of crowdfunding platforms out there, and it’s not too difficult to set up your campaign. You’ll need to tell a compelling story about your product and brand, and the more content you can produce the better your chances will be. As well as rewards-based crowdfunding (offering discounts or early-access to products), you can choose to give away equity in return for cash.
Because of the potential impact on your company of shares-based crowdfunding, we strongly advise you use a lawyer to help structure your crowdfunding offer and guide you through any regulations you’ll need to comply with. You may have to pay a fee to list. Our crowdfunding lawyers have helped many entrepreneurial businesses like yours achieve their goals. Get in contact with us today for a free initial consultation.
How to attract seed funding
The earliest stage of business start-up funding is seed funding or pre-seed funding. The most common form of seed funding is bootstrap funding. Seed funding comes before series A funding in the funding hierarchy. Many companies never get beyond seed stage.
Seed funding helps a start-up business get beyond its early stages and is generally used for product development and marketing. Apart from bootstrap funders, other potential seed funders are angels and VC firms. The best way to attract seed funding is to mine your network of contacts, research on the web for suitable angels or VC funders or apply to take part in an incubator project. You could also consider crowdfunding.
Attracting funding via an incubator
Incubators can be a great way to attract investment for your start-up, as they can help you find funding by:
- Allowing you to use their premises and other services in return for a stake in your investment. Their services can range from access to their network to hands-on mentoring.
- Helping you target the investors that are right for your business by reviewing your business plan and putting you in touch with those funders who are most likely to be a good fit.
- Help you finesse your business plan so it will attract high-quality investors.