This article looks at the best 6 potential funding sources for startups. Of course, not all of them will be suitable for every startup since each business is different. Some people start with money they have been saving for a long time while others prefer to reinvest funds from other business ventures. However, most entrepreneurs do not have the money to start and grow their business. Therefore, the goal is to show all possible alternatives for finding the best sources of startup funding in 2022.
Funds received by borrowing money from family, relatives, and friends are known as family loans. This option is best suited to those who have close acquaintances with a high level of wealth willing to invest in a promising business.
Friends and family are the ones who always support us in making our dreams come true. So it makes sense that they are typically the first people to borrow money from in order to launch a startup.
The main advantage here is that family and friends already know the founder, so they can easily understand what a novice entrepreneur wants to implement and how much money is needed to cover it.
Legal side of family borrowings
You should document loans and monetary investments you have received from friends and relatives. This will ensure accountability and also help avoid unpleasant confusions in the future.
Some friends and relatives, especially spouses, might be willing to give you some money to grow your business as a gift. In some countries’ legislation, you will have to pay gift taxes, so it would be better for these people to consider this money as a loan or to get into your business as an investor. Still, be advised that less business-savvy folks may find it easier to borrow funds rather than buying a stake in the business.
This is essential to note that this source of funds should not be treated as incidental, but should be given proper importance and legal protection. Get a lawyer to draw up documents to show that you have received money from relatives or friends and the payment conditions.
Downsides of family loans
Receiving money from friends or relatives seems to be the easiest and perhaps most obvious way to get some financial help for a new startup. Nevertheless, it is essential to be aware of some possible difficulties that may arise as a result of such agreements:
- Even if you have received a loan from your friends or relatives, there is the problem of the interest rate. If your loved ones are not experienced investors, it can be difficult to determine a rate and agree on repayment terms.
- After you take their money, your family and friends might think they can give you uninvited advice or have a say in how you run your business. Unfortunately, this can damage relationships with your loved ones.
- Conversely, they can easily be approached again when you need to put more money into growing and upscaling your business. A face-to-face acquaintance also makes it more probable that they will lend you another credit.
P2P personal loan
A P2P loan is when an investor lends to another person or business through a special online service (P2P platform). This is an intermediary company that sets up rules for users and connects borrowers directly with investors so that they can view the loan offers on the website and choose the one they want to support.
P2P loans are often personal. Borrowers can use the funds for different purposes.
Almost all P2P platforms use their own algorithms to check the borrower’s passport details, property and car ownership, and so on. They also promise attractive terms for both investors and debtors alike, as they are ready to help in recovering money in case of delayed payments.
What you need to know about P2P loans
There are some P2P platforms that are open to loans for small businesses, but most of them are aimed at more established companies.
You can access a P2P loan without any specific credit rating. Unless you’ve got a particularly remarkable credit history, you are still welcome to opt for P2P.
These loans come with an average term of 1–5 years, and they have similar credit card interest rates. The crucial difference is that P2P provides you with a lump sum payment.
How to apply for a P2P loan
The process of applying for a P2P loan begins by filling out an application form through one of the various peer-to-peer websites that are available on the Internet. These platforms assess risk, analyze your credit rating, and calculate the interest rate you are eligible for.
As soon as you fill out an application form on the website, you instantly receive loan offers. You can evaluate the loan options and choose the one that suits you best.
After that you need to provide your social security number and address, as well as details of your employment and income. You may also need to provide proof of your identity.
Then the service platform will consider your application submitted along with the required documents. You will then be put in touch with an investor who is interested in financing your business. Once approved, the funds will be transferred directly into your bank account. This whole process can take 7 to 45 days.
Angel investors are individuals interested in young startup business ideas. They are usually more patient with risk than other investors because they are more familiar with the entrepreneurial path full of twists and turns. In return, they ask for a fixed share in a company’s venture capital. They tend to invest in startups because they receive various low-risk tax breaks from their national governments. They can be great business partners when it comes to providing valuable advice and creating opportunities for growth.
If you’re willing to give up a significant share of your business in exchange for a life-saving amount of capital, angel investors are worth considering.
Most often, companies looking for angel investors want to
- get funding to build their first product,
- gain visibility and build a customer base,
- and scale up their operations.
You will have to look for potential angel investors through networking, such as angel investor organizations, startup events, recommendations from your fellow colleagues in the industry, and so on. To strike a deal with an angel investor, come up with a story or an elevator pitch to sell your business. It must be compelling enough to make them want to invest in your startup.
Also, you can structure a loan from an angel investor into a convertible note that pays interest and can be converted into shares. Working with this financing model makes the process easier and requires less legal fees compared to an equity investment.
If you earn the trust of angel investors, they are more likely to invest more money in your business in the future. On the other hand, these investors are usually looking for businesses that require a significant amount of capital. It means it might be harder to sell a small business to them. Finally, of course, it takes time to find an angel investor and convince them to get involved.
Crowdfunding is a fairly new method of collecting money for different causes with the group support of the people around you.
In crowdfunding, money for a startup is raised through an online crowdfunding website. The working concept is that you set up a crowdfunding company on one of the many existing platforms and identify the purpose of the funding. After that contributors donate money to your cause, and as soon as the target has been reached, you will have access to the money required for your startup.
This is one of the safest and fastest methods of raising funds for your startup, as you will not need to be worried about sky-high interests and a limited repayment period.The downside is that your campaign needs to go viral, i.e. gain certain hype and traction in order to reach the donation goal quickly.
This method of funding for startups is suitable if you already have a ready-to-go startup with a revenue flow. It is great for entrepreneurs who are looking for extra capital to test/launch a new product or simply raise awareness of the business.
Most common types of crowdfunding
There are different participation schemes of crowdfunding:
There are two most popular types of crowdfunding for small business entrepreneurs - reward-based crowdfunding and equity-based crowdfunding.
- Crowdfunding platforms based on rewards is a popular crowdfunding model on most platforms that involves offering an incentive to attract contributors. This often means giving them rewards. Rewards can be to acknowledge donors who have contributed a certain amount to your business or to offer them a discount on their purchases. It can also be a share in your business if they are willing to contribute a significant amount to your venture. Crowdfunding platforms based on rewards: Kickstarter, Indiegogo.
- Crowdfunding based on equity shares. In this type of crowdfunding, investors get shares of the company, but the amount of shares is based on the amount of the donation. Investors prefer to invest in companies that they feel will be successful down the road, as the success of the company has a direct effect on the donors' return on investing.This crowdfunding method is well suited to small businesses with solid growth plans. You will stay with investors in your company, which can lead to potential hitches, including increased regulatory scrutiny. Equity-based crowdfunding platforms: Republic, CircleUp, Crowdfunder.
Disadvantages of crowdfunding
Obviously, crowdfunding has disadvantages to it as well.
- Crowdfunding may take a lot of time. You have to structure your product in such a way as to motivate people to finance it. After that, you have to stay in touch with your funders and regularly inform them about the progress of your business.
- The majority of crowdfunding platforms charge a fee of 5 to 10% of the total amount collected. A number of platforms will not allow you to access the money collected if you have not met your financing targets.
- You will as well have to cover the cost of the rewards you give to donors.
The other way to fund your startup is to submit an application to government grants for small businesses. It is always worth investigating the grants that are specific to your business.
The main advantage is that there is no need to repay the grant. Grants are usually provided by governments or other organizations striving to support a specific purpose. Therefore, using a grant usually requires a rigorous strict compliance with grant criteria and reporting in order to ensure that the funds are spent as intended.
Also, grants can be available at an early stage of a startup.
Each grant offered by the government has different requirements and terms. For example, grants may be allocated for businesses in underserved and/or ecologically fragile areas. Sometimes funds are offered to local jurisdictions to enhance economic development; they are available to businesses in the form of business startup grants.
The process of applying for government loans is usually exhausting, with a long processing period. Finding grants to launch a business can also be a time-consuming and frustrating task. The Small Business Association provides an excellent starting point by offering an online tool to assess whether a business is eligible for a grant or loan. To find out if grant funds are available in the local area, a business owner can contact the department of economic development, representatives of a city council, or any other similar instance of authority.
So, if you are looking for financing that does not require equity capital in return, government funding for startups would be the best option for you. But it may take a significant amount of time to get the funds, so make sure that you apply several months in advance of launching your startup.
Among other startup funding sources, this one is aimed at investments in machinery, vehicles, and other equipment. They are suitable for businesses that rely heavily on specialized machinery or equipment for their operations, such as factories and trucking companies.
There are two common ways to finance equipment: a loan or a lease. Although both have the same goal of giving you access to the equipment you need to run your business, there are many differences between the two.
- An equipment loan is a loan that is taken for the direct purpose of purchasing equipment. As a rule, the equipment is secured by the loan. When you cannot afford to repay the loan any longer, the equipment is taken away as collateral.
- Equipment leasing allows the business owner to use the equipment, but ownership still remains with the creditor. Also, the business owner pays a monthly fee for leasing the equipment.
More on equipment loans
Such loans are beneficial to business owners who require the use of equipment for a long-term basis, but who cannot yet afford to make the purchase outright. The downside is that such an agreement will cost more in the long-term than if they just bought the equipment to own.
Interests on equipment credits are quite substantial, ranging from 6% to 16%. Generally, startups receive more approvals for equipment credits compared to unsecured business loans.
More on leasing
Leasing is good for companies that change equipment frequently. This is also more likely to help cover the additional expenses. Rather than borrowing money to buy the equipment, you would pay to rent it. The lessor (leasing company) technically keeps the ownership of the equipment, but gives you permission to use it. Leasing conditions can differ according to your business's needs.
There is also a $1 buyback model, in which you will pay the cost of the equipment and the interest for the duration of the rent. Eventually, you will only owe just $1. After the balance is paid off, it is no longer a formality, and you will become the rightful owner of the equipment.
Another model is lease with 10% option. This leasing is similar to a $1 leasing, although by the end of the period you will have the opportunity to buy the equipment for 10% of its cost. Here, the monthly payment is usually smaller than in a buyout leasing for $1.
Overall, leasing is usually cheaper than offering an equity share, so it is a more budget-friendly form of financing than equity. The strong disadvantage, on the other hand, is that leasing reduces free cash flow.
Hopefully, this article helped you find the most efficient sources of startup financing. No matter which source of financing you choose, read the contract thoroughly and research the Internet for useful tips to make sure the terms are right for your business.