Financing Methods for Startups

  • Friday 13th October 2017

There are numerous financing options and routes available for startups and small businesses. The viable options will differ from business to business but here we lay out the general options available for companies looking to raise money to help with the day to day running or for an injection of growth capital.

The main funding options include:

  • Personal savings or from family/friends
  • Loans
  • Venture Capital and Angel Investors
  • Crowdfunding
  • Grants

Personal savings

A common method of providing finance for new businesses is investing your personal savings in order to fund the setup of the company. Family and friends often provide additional financial support in the early stages of a company, when getting external funding can be particularly difficult.

Loans

A multitude of options for loans exist for small or expanding businesses and this is but a brief overview of the opportunities available.

The two main categories of loans are secured and unsecured loans. Secured loans use the company assets as security (i.e. a car or property based on the amount borrowed), which can be repossessed should you be unable to repay your loan. This provides more security for the lenders and hence interest rates are often lower. Unfortunately, many startups do not have the necessary assets in order to obtain this kind of loan. On the other hand, unsecured loans do not require a form of security but may require a personal guarantee based on your credit rating rather than collateral, which can be a lot higher risk for you should your business venture not succeed (i.e. credit cards).

Within these loan categories, you can acquire term loans where you borrow a fixed amount of money at a certain interest rate over an agreed time period. Short-term loans are similar but with a much shorter time period and often a higher interest rate.

Factoring, sometimes called invoice financing, can be a good option for companies who often have outstanding invoices such as retail businesses. Banks will loan up to approximately 85-90% the value of outstanding invoices which can then be paid back once you have received the payments. Some banks will suggest they make this transaction directly with your customer. Crowdcube partner, GapCap, is a company which specialises in providing invoice financing for SMEs.

Business cash advances are technically not a loan but involve businesses receiving advanced payment for future revenue. It is repaid by an agreed percentage of further card purchases being paid back to the lender. Cash advances are often unsecured and many don’t require a personal guarantee, although this varies between different lenders.

You may otherwise think about getting a business credit card, which works similar to a personal credit card but prevents personal and business finances from mixing - this can be helpful if you're self-employed when filing your accounts.

If you are looking for debt- related finance, some of Crowdcube partners could be a good place to look. Crowdcube partners with Virgin StartUp, a delivery partner of the government's startup loans scheme, which offers unsecured loans of up to £25,000 to individuals to be used for business purposes. Funding Options, on the other hand, acts as a marketplace for business finance and connects small business owners to different types of loan providers.

Venture Capital

You can pitch your business to Venture Capital firms to gain financial support in exchange for equity (shareholding) in your company. This brings the benefits of potentially gaining investors who can provide advice and expertise for your business. However one of the pitfalls of gaining venture capital is the competitive nature of the industry, which can make it difficult to convince firms to fund your company. VC’s mainly focus on fast-growing startups which appear to be stable and lower risk than less established new businesses. A large amount of time-consuming work and effort often goes into acquiring the backing you require and may not be feasible for smaller, riskier businesses.

Examples of VC-backed businesses include the likes of Monzo, Revolut, goHenry, Adzuna, eMoov and POD Point which have also raised on Crowdcube.

Other VC-backed businesses include the likes of Deliveroo and Skype which are both backed by Index Ventures.

Angel Investors

Angel investors are often known as high-net worth individuals who want to invest their personal money and make their own decisions about investment opportunities. They can often provide less finance than a venture capital firm but have the potential to back riskier undertakings. Angels can also bring valuable ideas and advice to your business. When looking for this type of financing, angel investment networks and syndicates are a good place to start. The UK Business Angel Association (UKBAA) states that in general angels invest between £10,000 and £500,000 in a single business, with £1.5 billion being invested in total in the UK by business angels each year.

Uber held an angel investment round in 2010 and raised £1.25 million for its’ seed stage company. YPlan, an event booking app, also gained angel investors in its; seed investment round which raised £1.06 million.

Corporate Investments

Similar to Angel Investors, large corporations can choose to invest in other businesses. They can often invest more than individual angels due to the higher worth of companies compared to individuals.

The two largest fundraises of Q1 and Q2 in 2017 involved corporate investment. A UK startup, Improbable, develops large scale virtual reality technology and raised £389 million over four fundraising rounds. The leading investor was a Japanese telecommunications company, SoftBank, which invested alongside two angel investors. FarFetch, an online fashion retail platform, raised £313 million from a single corporate investor, JD.com.

Crowdfunding

There are various forms of crowdfunding with the most relevant for funding small to medium-sized enterprises (SMEs)  including, peer-to-peer lending, peer-to-business lending, reward-based and equity crowdfunding.

Peer-to-peer lending involves investors lending money to an individual for a fixed interest rate.

Peer-to-business is similar to peer-to-peer lending but with loans for businesses, instead of individuals, via investors, companies and government institutions.

Reward-based crowdfunding allows you to receive funds in exchange for giving your investors a reward, such as a sample of your product or an event.

Equity crowdfunding is similar to rewards-based but instead of providing capital for rewards, you offer shares (equity) in your company in exchange for investment. Deciding which crowdfunding model is right for you is generally dependent on your business stage and how much you need to raise. Rewards-based is typically for very early-stage businesses looking to raise anything from £500-£50,000, although it is known for businesses to raise up to £1m. Equity crowdfunding generally starts from £50,000 up to £4m and beyond, with businesses that already have some traction.

Equity crowdfunding enables everyday investors to invest alongside professionals and venture capital firms with hope for a monetary return greater than that invested in the future. This would be through buying back the shares, selling your company, merger and acquisition (M&S) or Initial Public Offering (IPO). This route of finance can benefit your business in more ways than just providing financial support. Pitching your company to a crowd of investors provides valuable market validation and enables you to gain a large base of customers and brand advocates. You also do not need to pay any fees unless your company successfully hits its 100% target.

As an equity crowdfunding platform, Crowdcube has already raised up to £350 million for growing businesses with an investor crowd of over 440,000. Find out more about equity crowdfunding (link to raising finance).

For a more comprehensive insight into different crowdfunding methods, visit our blog post 'Crowdfunding Models Explained'.

Grants

Grants are available for businesses from the government and other institutions.

Within the UK these can be found on the government website. A good place to look for government-related grants is your Local Enterprise Partnership (LEP), whose main goal is the growth of businesses and as such offer many grants for their designated area. Each LEP covers one or more counties of the UK.

EU grants and loans are also on offer but the long-term prospects of these are currently unknown due to Brexit negotiations. However, there are currently schemes which can be found on the European Commission website such as COSME (Competitiveness of Enterprises and SME) which provides funding for small to medium enterprises (SMEs).

Similar to grants, competitions can also allow you to gain funding without acquiring debt or selling equity. VOOM Pitch is a competition run by Virgin Enterprise which gives startups the opportunity to pitch their business to Richard Branson and win a portion of £1 million.