The different types of funding for startups

A big part of building your startup is having sufficient funds to support your goals. You may need money to buy equipment, to hire people, get important advice, or even simply to live whilst you’re kicking things off. There are many funding routes you can take and we explore some of them here.

This post consolidates my takeaways from the Funding (delivered by the insightful Katherine Broadhurst) and Alternative Routes to Funding (delivered by Gareth I. Jones, the founder of many successful ventures) masterclasses from Accelerator Wales. We’re sharing what we learn to help you on your startup journey.

The key types of funding most people will encounter are:

  • Revenue — actual money from customers
  • Equity investment — a stake in the business in return for cash with the expectation of returns later
  • Debt — some sort of loan that will involve repayment over time
  • Others — grants, awards, personal funds etc
Photo by CloudyPixel on Unsplash

Revenue

Actually earning money is the best source of funding you can have because it’s actual customers willing to give you money in exchange for value. Any income you gain from customers enables you to be in a better position to secure equity investment or debt if you need a larger sum of cash to achieve an important growth goal meaning further funds will cost you less longer term.

Structuring your startup to be revenue generating as soon as possible is, therefore, A GOOD THING. It’s not always going to be feasible as some ideas will take a lot of investment to bring to a point a customer can spend money, but if you can offer a slice of benefits early and get some sort of revenue, then you should definitely aim for it.

Equity investment

Equity investment is someone taking shares in your business in exchange for an upfront investment with the expectation of some return on investment (ROI) in future.

This needs a little unpacking!

Shares

First of all, a share is a unit of ownership in the company. You may set up your company and create 100 shares which you will entirely hold. These will probably be called ordinary or common shares. These represent basic ownership rights and make the holder the of the share eligible for profits, known as dividends, and can additionally be sold with the price typically linked to how much the company is perceived to be worth. Over and above ordinary shares you can create other variants or vary how shareholders can interact with the company and how they can manage their shares by having a shareholder’s agreement.

If you have co-founders then a shareholder’s agreement is another GOOD THING to get.

Investors

The someone who can take a stake in your business could be:

  • collectively known as the 3Fs: a family member, a friend, or someone else who believes in your organisation (their name in the 3Fs is fools)
  • a single person with money they are looking to invest, typically referred to as an angel investor
  • a group of individual investors, referred to as a syndicate
  • venture capital (VC) companies, companies specialising in making investments in companies in exchange for equity
  • larger organisations or companies who make larger equity investments are called institutions
  • others like accelerator programs, suppliers, and customers

Process

When you give someone a stake in your company, you will create a number of new shares that this person will now own. Who owns what shares and therefore how much stake in the company is most commonly shown in a cap table. This simply (early on anyways!) shows who owns shares and specifies the percentage of overall shares. Over time this will show changes like additional investors and ownership changes and gets more complicated.

The expectations of angel and VC investors is to typically get back at least 3 times their original investment amount within three to five years. For early stage startups, this figure could be 15x. This often means they will need some way of extracting this amount from the company after the agreed period. The ways you’ll most likely encounter for your company are:

  • another organisation buys the shares either by acquiring the company as a whole or by replacing the investor
  • the management team buys the shares
  • the company becomes publicly listed and shares become sellable to the public
  • the option you hopefully won’t need to take is the company wrapping up and the shareholders getting residual money

Debt

Instead of an investment tied to the company, you can take out some form of debt that is secured against a company asset or is unsecured. This means you will get a lump sum if taking a cash loan or something like a car if you’re leasing, and you will make regular repayments that include interest.

Due to the high rate of failure in startups, the interest rates aren’t as low as consumer debt types like mortgages which are secured against a property. You will be expecting at least a 6% APR but as this does not usually impact your equity and will have a known repayment schedule this can be a transparent way of funding your business.

Other

You can also fund your business through things like grants, awards, crowdfunding, and government incentives.

Grants will allow you to apply for money to deliver something, whether it’s a business, a project, or something else. There is usually significant paperwork and competition involved with applying for grants but if you can meet the requirements and obligations then it can be a useful way to grow your business without needing to give away chunks of your business or commit to regular repayments.

There are many crowdfunding platforms that can allow you to gain direct investment for your business idea. Some platforms like Kickstarter are particularly good if you need to raise investment to deliver a product to market. Others like Crowdcube are for getting equity investment from many individuals with smaller amounts of investable income. Crowdfunding platforms have different requirements and different models so you will need to find the right platform to meet your goals.

Conclusion

There are many ways you can fund your business goals and there is no single answer that is correct for everyone. You need to think about what you want to achieve, over what sort of timescale, what the risks are for you and investors, and how many people you want to engage in the decision making of your business.

If you’re a startup in (South) Wales you should totally be looking at the AGP and Accelerator Wales as ways to help boost your odds of success with your new venture.