Sources Of Startup Funding: The Pros And Cons

What is the right path when evaluating the pros and cons of different sources of startup funding for your venture?

There’s more than one way to fund your startup. Each has its own pros and cons. Which is right for you?

Bank Loans

Small business loans from banks used to be the first stop and go-to source for funding new companies.

The Pros

1. You won’t have to give up equity in our company
2. You don’t have to create a pitch deck
3. May find it easier to finance real estate assets and equipment
4. Good credit may help make up for what you lack in design skill and pitching ability

The Cons 

1. Rarely available for new startups
2. Lots of paperwork and lack of common sense underwriting
3. Poor customer service
4. Monthly debt service repayments required even if you aren’t making money

Equity Crowdfunding

Equity and debt crowdfunding and hybrid uses of convertible notes exploded in popularity with the passing of the JOBS Act. However, when you are thinking about the pros and cons of different sources of startup funding and considering this one as an option regulation can be a real hurdle. 

The Pros

1. Don’t need to add the pressure of monthly repayments and overhead
2. Ability to recruit more stakeholders who are invested in your success
3. Leveraging existing platforms and investor databases
4. Raising publicly can help create buzz and urgency among potential investors

The Cons 

1. Still requires a strong marketing strategy and a sizable marketing budget
2. Can require hefty legal fees and filing with the SEC
3. Platforms can be costly and take a big bite out of your raise
4. Success can rely on already having your round significantly subscribed to in advance

Donation-Based Crowdfunding

Donation-based crowdfunding predates equity crowdfunding and has been used to launch a variety of successful startups.

The Pros

1. No need to give up equity in your company or take on the burden of debt
2. Use it to gain early customer and users
3. Generate buzz, branding, and marketing while raising money for your startup
4. Lower regulatory and legal costs

The Cons 

1. It’s not as cool as it was. It’s a little too 2013
2. Platform fees and processing costs can take a big bite out of money raised
3. Your success or failure is all public online for the world to see forever
4. Can require a lot more marketing, strategy and investment than most founders expect

Friends & Family

No matter how big you go, raising money from friends and family will probably be one of your first steps as you are thinking about the pros and cons of different sources of startup funding. Other investors are going to question why they should trust and believe in you if these people who know you best haven’t.

The Pros

1. They may be far more forgiving if you fail or it takes longer to get results
2. You’ll love being able to share the rewards of your success with them
3. Low expectations for pitch decks and business plans
4. The low burden of meetings and pitching and negotiating terms

The Cons 

1. If it goes badly you could lose your most valued relationships and friendships
2. May not be experienced investors or advisors
3. Your initial circle and network may not have a lot of capital to invest
4. You could end up diluting your cap table without getting much capital in

Angel Investors

When evaluating the pros and cons of different sources of startup funding, keep in mind that angel investors are usually your next stop on the fundraising circuit after your friends and family round. 

The Pros

1. Will invest based on you as the founder and the idea versus financials
2. May provide connections to angel investment groups
3. More likely to play a passive role than venture capital firms
4. Can be a way to attract advisors and future introductions to other investors

The Cons 

1. Can require time pitching and nurturing these contacts
2. May be dealing with inexperienced investors with little structure
3. May not be experienced operators or qualified advisors
4. Can require giving up significant equity early on in your venture

Startup Accelerators

Startup accelerators and incubators can be a valuable vehicle for getting focused, speeding up your momentum, gaining early seed money and introductions during demo days. Keep in mind that in terms of the pros and cons of different sources of startup funding accelerators give little capital for a sizable chunk of equity. 

The Pros

1. Forced focus on your startup and making progress
2. Being surrounded by other founders and experienced entrepreneurs
3. The chance to present to a room full of qualified investors 
4. Branding and credibility if you have joined a well-known accelerator like Y Combinator

The Cons 

1. You may not get into your chosen accelerator on your first application
2. You will have to travel and stay there for several months 
3. It’s fast-paced with big expectations for producing tangible results
4. Funding amounts are typically very small, and equity taken can be significant in comparison

Venture Capital Firms

VCs are often the main target of entrepreneurs seeking funding. Yet, they often come to the table much later, after tapping these other sources of funding. As you are ranking the options and analyzing the pros and cons of different sources of startup funding I would probably say this is one of the most powerful options. 

The Pros

1. Large funding amounts from each of these firms
2. Organized due diligence and funding processes
3. Capable board members who can open lots of doors
4. Can add significant credibility, media attention and appeal to talent

The Cons 

1. No one wants to be the first lead investor
2. Exhausting months of pitching and investor meetings
3. Once you take their money you are working on their goals and timeline
4. The pressure to make choices that may not be best for the business or your customers

Credit Cards

Many entrepreneurs have started out financing their companies with their own personal credit cards. 

The Pros

1. Retain all control and decision-making authority without partners or co-owners
2. You can get started right away without a pitch deck or investor meetings
3. Save months of time and distraction, and just start doing business
4. Great flexibility if you need to pivot your startup or switch plans altogether

The Cons 

1. Very limited amount of funds available 
2. It’s very expensive money to use
3. Extreme pressure to pay back the money and stay on top of payments
4. Not as flexible as having cash in the bank 

Remember that storytelling plays a key role in fundraising. This is being able to capture the essence of the business in 15 to 20 slides. For a winning deck, take a look at the pitch deck template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

Remember to unlock the pitch deck template that is being used by founders around the world to raise millions below.

You may also find interesting the video below where I cover in detail the sources of funding for your business.

Still not after going through the pros and cons of different sources of startup funding? Check out this fundraising training where we help founders from A to Z with fundraising.

FULL TRANSCRIPTION OF THE VIDEO:

Hi, everyone. This is Alejandro Cremades, and today we’re going to be talking about the sources of funding for your business. Essentially, there are different sources of funding. You’re going to have the ones for businesses where they’re a little bit more mature, and then the ones that are a little bit better or more advantageous for those that are more on the earlier stages and the early days of building and scaling their business. So with that being said, let’s get into it.

The first source of funding is bank loans. Obviously, banks, as we know them, they’re at the worst numbers of issuing and financing to businesses since the 1940s. For that reason, I think that if you’re an early-stage business, where you don’t have any assets or things that you can put as collateral, I think it’s going to be very difficult for you to be able to secure any type of financing from a bank. And then also, the problem that comes with getting funding from a bank is that you are going to have to make those repayments, which really takes out from the cashflow of your business. That’s definitely one, but not the one that I would recommend the most.

The next source of funding is equity crowdfunding. Now, equity crowdfunding is when you are putting your venture up on one of those online platforms such as, for example, SeedInvest or maybe StartEngine or one of those other platforms that are connecting startups with accredited investors. 

Essentially, what you’re doing there is you’re just putting up your materials, you’re putting up your business, you’re putting a price tag on your business and a price-pre-share that you’re giving to the investors that are coming in and making an investment in your business. This is small investors that are putting small ticket sizes in your businesses, and those types of investments or financing rounds tend to be on the smaller end.

The next source is really donation-based crowdfunding or perhaps any type of crowed funding source that doesn’t require a contractual obligation, just like the one that you would find on equity crowdfunding. On the nation-based crowdfunding, which is the type that you would find on platforms like Kickstarter or Indiegogo, what you’re doing is you are creating a project, an initiative, and preselling your product or giving something in exchange for those people that are contributing something to you. Maybe you are giving them an item, or you’re basically giving them a product, or just to put something out there like a pair of shoes, or a book that you’re about to sell, or maybe something that is tangible.

On donation crowdfunding platforms, let’s say the tech type of projects don’t perform very well because what are you going to be giving them in a way for their contribution – early beta test to your service? It’s not really appealing, so typically on donation-based crowdfunding, what performs very well is when you have a tangible product that you can give in exchange, or perhaps there is a cause that is really capturing and inspiring people to contribute.

The next source of funding is friends and family. Maybe you have your cousins, your uncles, your parents, your friends. They also call it the Friends, Families, and Fools. But, again, I think that if you don’t want your Thanksgiving dinner to be a shareholder get-together, a shareholder meeting, where they’re going to be grilling you on: how is the evaluation? How has it been increasing over the last week? 

I would highly encourage you to avoid taking money from friends and family. In many cases, if things don’t pan out as promised or as expected, perhaps that relationship would go south. So, for that reason, I would highly, highly not recommend going with the friends and family source of financing.

Then you have the angel investors. The angel investors are not the ones that have on LinkedIn the angel investor title. Those are the ones that are going to waste your time, which are just going to be putting a $5,000 check in your business. Angel investors are those that are either senior executives that have an idea or have domain expertise on what you’re doing or perhaps successful entrepreneurs that just exited their business and that are now investing and using this as a way to pay it forward.

Next, you have the angel groups. In essence, angel groups are a way in which those angel investors are coming together and grouping their investments to invest in your business. Now, angel groups are investing in different ways nowadays. They’re either investing via a special purpose vehicle, which is a vehicle like an LLC that they use to group them all, and invest, and count as one in your cap table, which is that ledger that keeps track of who owns what part of the business – essentially, who owns what piece of the pie or what kind of equity.

Then, you’re going to have these types of investments in the form of, let’s say, direct investments where those investors, those angels who are members of that group, just making investments directly. Then, lastly, we’re starting to see that many angel groups are creating venture capital funds to make investments in those companies that they are excited about. 

Next, we have the startup accelerator programs. Those are like Y Combinator, Techstars – those are the best, and essentially, you’re getting a small amount of money. It typically ranges between $10,000 all the way to $100,000. What happens is that you’re giving them in exchange 5%-10% of equity in your business, and you’re committing to spending three months with them, perhaps in the Bay Area or in New York or wherever they are based to have them help you in scaling things up, in plugging in their networks, and in their making introductions to investors, which happens in the form of Demo Days. Essentially, that’s the way accelerators work.

Next, you have the venture capital firms. Venture capital firms tend to come in a little bit later. Venture capitals invest in people, and they are going to take the risk of coming in at the early stage of the business. But what they want is to see that there is a product/market fit that you’ve been able to have a product in the market and validate it somehow.

Venture capital firms typically start to invest bigger amounts. We’re looking at $500,000 and up, and they would continue to reinvest potentially all the way until your business does an IPO or until your business is acquired. Here, you’re talking with sophisticated people, people that are investing for a living, and then also people that have great networks that can really support you and take it to the next level.

The last source of funding is credit cards. But I would highly, highly not recommend that you do credit cards because it’s like the saying: once you pop, you can’t stop, and then it’s very hard to back-peddle from that. In many cases, what I see is founders that use credit cards, and then they get repaid back from the future investors that come in, but this is super risky, and I would not recommend going the credit card route – and also, because the interests are very high and probably don’t justify going via this way.

So, with that being said, hopefully, you liked this video. Remember to Like, to comment as well, and subscribe so that you don’t miss any of the future videos that we’re going to be rolling out. Also, don’t forget to check the fundraising training, which is the program where we help founders every step of the way from A to Z in the fundraising journey. We have live Q&As, templates, agreements, a community of founders all over the world helping each other, and I think you will find a lot of value from that. So, with that being said, thank you so much for watching.