Funding Sources
Funding Sources
Introduction:
The startup entrepreneur has a wide spectrum of options for where to source capital and who will provide it. Each source brings pros and cons, including varying levels of investor accountability and dilution.
(1) Bootstrapping
(2) Family & Friends
(3) Small Business Administration
(4) Crowdfunding
(5) Incubators & Accelerators
(6) Angel Investors
(7) Venture Capital
1. Bootstrapping:
Bootstrapping is the process of funding your own start-up without any external resources. This typically takes the form of the entrepreneur funding the business through savings, credit cards, and/or the business’ cash flows. While this approach results in the entrepreneur maintaining 100% ownership of the business, it could also impede the company’s growth over time given limited resources available to re-invest in the business.
2. Friends & Family:
Many entrepreneurs seek their first external capital from friends and family. A “friends & family” round typically allows the entrepreneur to secure funds quickly and with less formality than other sources of capital. While there are advantages to raising capital this way, there are also downsides to the entrepreneur which include potentially unwanted involvement of family & friend investors in the business and damaged relationships if some or all of the investment is lost as a result of a failed venture.
3. Small Business Administration:
Created in 1953, the U.S. Small Business Administration (SBA) continues to help small business owners and entrepreneurs pursue the American dream. The SBA has multiple funding programs to support entrepreneurs and small business owners including Loans, Investment Capital, Disaster Assistance, Surety Bonds, and Grants. More info on the SBA’s funding programs can be found below and in the “Funding Types” section of this site.
4. Crowdfunding:
Crowdfunding is a way to raise capital by collecting funds from multiple non-institutional sources. Whereas more conventional means of raising capital typically garner a large amount of funds from a small amount of investors/lenders, crowdfunding relies on the collective impact of many funders who are each making smaller investments. Crowdfunding has become more popular in recent years driven by social media and online platforms which are equipped to reach wide audiences.
Donation-Based Crowdfunding:
Donation-based crowdfunding is a way to source money for a project or charitable need. There is not typically an expectation of financial returns or rewards to the donor aside from the feeling they get from backing causes they support.
Resources:
Reward-Based Crowdfunding:
Reward-based crowdfunding is a way for startups to source capital by offering products or services in exchange for funds from funders. This is one of the most common forms of crowdfunding. Because the exchange of value between the startup and investors is in the form of products/services, this form of crowdfunding does not result in the startup founders giving up any equity ownership in the company.
Resources:
Equity-Based Crowdfunding:
Equity-based crowdfunding allows startups to source capital from funders in the form of many small investments from multiple funders. Equity-based contributors to this type of crowdfunding campaign become part owners in the company – receiving equity shares in exchange for capital provided. The equity holdings entitle the contributor to any potential upside in the growth of equity value in the company over time, as well as any share of profits for the share class in the form of dividends or capital distributions. As described above, this form of crowdfunding resulting the startup founders giving up equity ownership in the company.
5. Incubators & Accelerators:
Startup incubators & accelerators are organizations that exist to support the startup and tend to do so at its earliest stages.
Incubators
An incubator provides the startup with a collaborative workspace which creates an atmosphere for creativity and provides mentorship and training to the entrepreneurs. Incubators benefit the entrepreneurs by providing the space, equipment, internet and other free or discounted professional services that may be needed early in the lifecycle of the startup. One example of a startup incubator affiliated with Penn State is the LaunchBox.
Accelerators
While the incubator is commonly associated with the physical space for the entrepreneurs to work over time, Startup Accelerators offer short-term intensive and highly-structured programs with the goal of accelerating the growth of the business, enabling it to go to market quicker and raise more capital sooner. Some of the most widely known accelerator programs in the tech space include Techstars, Y Combinator, 500 Startups, and SOSV.
6. Angel Investors
An angel is a high net-worth individual who invests his or her own money in start-up companies in exchange for an equity share of the businesses. ACA recommends that entrepreneurs work with investors who are accredited investors (who meet requirements of the Securities and Exchange Commission) and who can add value to the company via high quality mentoring and advice. Other important things to know about angels include:
- Many angels are former entrepreneurs themselves.
- They make investments in order to gain a return on their money, to participate in the entrepreneurial process, and often to give back to their communities by catalyzing economic growth.
- Angels make a return on their investment when the entrepreneur successfully grows the business and exits it, generally through a sale or merger.
- Angels tend to invest in companies that are located near them regionally (or to co-invest in a wider geography if a local investor they know and trust is involved).
Angel investment typically comes at the earliest stages of the start up life cycle (i..e, pre-seed and seed rounds).
7. Venture Capital:
Venture Capital, or VC, is a form of private investment which provides capital to startup companies that have prospects of significant long-term growth potential. Venture Capital investors typically seek to invest in earlier-stage high-growth industries and companies compared to traditional private equity investors. The goal of the VC fund is to achieve significant returns on the investment upon an exit event which would take the form of an IPO, going public through alternative routes (i.e. SPACs), M&A among other financial investors, or being acquired through a strategic acquisition).
Venture Capital typically invests in the startup once the company has evidenced product market fit, differentiated growth potential, “disruptor” status, and scalability. In practice, the larger and more traditional venture funds get involved with a startup from Series B through the growth equity phase to an IPO. However, in some cases, venture funds have invested in startups at their earliest stages.