One of the largest challenges a startup faces is securing the funding it needs to get off the ground. Most startups require some amount of seed money to get started, but without any history of credit or revenue, they can face difficulties securing a loan.
Fortunately, there are several funding options for startup founders who need cash to see their entrepreneurial ideas realized. Here’s a guide to financing for startups at all stages.
Options for Your Initial Funding
Friends and Family Loans
An alternative way to find the money for a startup is to reach out to friends and family. While many founders hesitate to approach friends and family (because of the potential for emotional and relational conflict), it’s one of the most successful ways for early-stage entrepreneurs to find capital.
The business owner can enjoy the benefits of a low- or no-interest loan, while the family member or friend is using their cash to foster a dream and support a vision. Depending upon the relationships, it can be easier for an early-stage entrepreneur to obtain a loan from a family member or friend compared to a traditional business loan. However, it’s still recommended to have a contract and terms of agreement for both parties.
This option is especially nice for any startup owner who has access to influential contacts or family and friends that have money available for investing. As long as the business owner can prove his or her idea as a viable business and show a plan to generate revenue, a loan from friends or family members is usually without any pre-qualifications. For more information on friends and family loans, check out our Guide to Family and Friends Financing.
Crowdfunding has helped launch hundreds of businesses. While other types of funding require a certain number of years in business or a minimum amount of profit, crowdfunding allows a startup founder with a great idea to often bypass all of those requirements.
What is crowdfunding? Essentially a startup develops a well-thought-out business plan prototype of their idea or service. They then pitch these ideas to the public through an online crowdfunding portal. The ideas are funded by crowds of people who are willing to invest in exchange for an exclusive gift, pre-orders, or just because they want to help. In recent years, some crowdfunding platforms (because of changes in the law) allow a business owner to offer equity in exchange for investment as well.
For more information on crowdfunding, including how to make your campaign successful, check out our Guide to Crowdfunding.
An angel investor is an individual with private money to invest in a company in anticipation of an exit (or equity event) in the future. Most angel investors are interested in the next generation of ideas and are willing to fund startup ideas they believe in. As a consequence, they tend to focus heavily on technology startups.
The process to receive funding from an angel is relatively straightforward, although finding the right angel can be a challenge. There are online communities where angels congregate and your local university is another good place to look. A Google search in your area for angel investors will likely reveal groups closer to your business. The business owner raises capital by selling equity in the company. Typical shares granted to angels range from 10-50% of the business.
This funding option can be a good fit for technology-focused businesses that are established beyond the beginning startup stages, but still, need guidance with marketing and product creation. An angel investor may not only provide money, but also mentorship for a startup owner who’s looking for more experienced partners or guidance.
The Small Business Administration (SBA) offers loan guarantee programs available through participating banks and other financial institutions. Some advantages of an SBA loan could include attractive payment terms, better repayment options, and smaller down payment when compared to other traditional financing options-all of which are designed to lead to better cash flow for a startup.
- 7(a) small business loan program. This is the most common type of SBA funding for startups. To be eligible a business startup must be for-profit and fall within the “small business” standards of the SBA. There are usually lower collateral requirements and longer terms in comparison to conventional funding. For more info on SBA loans, check out our Guide to SBA Loans.
- Microloans. Microloans are a type of SBA loan given to startups to use as working capital for inventory, supplies, machinery, equipment, and furniture. The average microloan is about $13,000, and the maximum is $50,000. Funds from a microloan cannot be used to pay off past debts or to purchase real estate.
Both programs are best for startups that are two years of age or older and in a good revenue-generating cycle. Traditional SBA loans generally take anywhere from 60-90 days for approval and processing to finalize, with amounts of $150,00 or more being distributed at one time.
Home Equity Loans
For business owners with equity in their homes, it’s not uncommon for an entrepreneur to seek a home equity loan for funding a startup. Granted, while this plan can provide needed capital, it does put a homeowner’s place of residence at risk.
The amount of money that a startup could potentially use for funding from a home equity loan varies, and is based on the difference between the value of the home and how much is owed on the current mortgage.
With this type of loan, the business owner will receive the entire amount of the funds all at once. Though the terms vary, it’s likely a homeowner will be required to pay back the home equity loan based on a 15-year term.
Retirement Loans from a 401k
A 401K loan is a specific type of loan that involves a unique legal structure, which is managed by a third party. The money comes from the borrower’s personal retirement funds, taken from an IRA or other investing account, and put into a “new investment” (the new business). This type of loan probably shouldn’t be the first on any startup founder’s list because it puts the small business owner’s retirement savings at risk.
If the business plan is solid, the return on investment could be much higher than a traditional investment account or retirement fund. 401k financing is relatively new, and requires a unique legal structure – if you go this route, make sure you are working with a reputable firm, and have everything reviewed by your attorney.