Business Funding 101: 5 Types Every Start-Up Must Know

Business funding is any financial resources a company utilizes to launch or support a business. It can be used to cover costs for daily operations, inventory and equipment, marketing, expansion projects, and seasonal spikes in activity.

For start-ups, business funding is a big step toward business growth. However, there are a myriad of funding options, which may be confusing and overwhelming for most new businesses. 

It’s crucial start-ups choose the right type of funding that aligns with their goals. To help them with this, here are the most common types of business funding options every business should know. 

Self-Funding

Thirty-nine percent of start-ups are self-funded. This means they independently funded their business, usually with personal funds. It’s an excellent way to avoid the rigorous process of borrowing funds, paying for high-interest loans, and giving equity up to investors. 

However, self-funding does not come without risks. With personal funds, business owners may run their start-ups on a tight budget. If they’re using personal savings, they may use it up and likely not get it back, leaving them with no safety net in case of emergencies. 

Crowdfunding

Start-ups can quickly raise money online through online platforms without paying interest. This is called “crowdfunding”. On a crowdfunding site, investors can select from hundreds of projects and start-ups and invest as little as $10. 

These investors are paid back when a project or company starts earning profits. Crowdfunding sites, in contrast, generate revenue from rewards, a percentage of the funds raised, or equity (more of this later). 

Crowdfunding usually requires start-ups to build their own following with their own promotional strategy to raise funds. This is a low-commitment way for them to access funds and support and, at the same time, build early interest and reach an audience. 

Loans

Taking out loans is usually recommended when start-ups have already exhausted all of their non-loan funding sources. This is because loans can be expensive for most start-ups, especially those without stable income. If they’re not repaid, their business can be at risk. 

Fortunately, loan options are now tailored to suit the various financial capabilities and needs of start-ups and even other small and midsize enterprises (SMEs). These include the following: 

1. Term loans – for funding expansion
2. SBA-backed microloan – for refinancing existing debt or funding expansion
3. Business lines of credit – for seasonal businesses
4. Equipment loans – for owning equipment outright
5. Invoice factoring – for companies with unpaid invoices and need fast cash but have reliable customers on long payment terms (30, 60, or 90 days)
6. Invoice financing – where companies borrow against their outstanding invoices 
7. Merchant cash advances – for companies that can’t get financing anywhere else but can handle frequent repayments
8. Personal online loans – for start-ups with stellar personal credit
9. Business credit cards – for funding ongoing business expenses
10. Microloan – for companies in disadvantaged communities that seek only a small amount of financing

Grants

Grants are financial awards provided by governments, corporations, or nonprofit entities. Unlike loans, they’re considered “gifts,” so they don’t need to be repaid. However, they’re often mission-driven investments, so the competition is fierce. 

The good news is that there are many grants out there. Just in the US, around 19 small business grants are available for start-ups. Here are three of them: 

1. State Trade Expansion Program (STEP) – federal and state-sponsored 
2. FedEx Small Business Grant Contest – corporate-sponsored
3. Operation Hope – nonprofit-sponsored

Another example is the SBA-backed microloan mentioned earlier. The SBA, or Small Business Administration, is an independent agency in the United States (US). They specifically support small companies and help them start, grow, and build resilient businesses.

Private Equity Firms

For high-growth start-ups, private equity is recommended. Two of the most common examples of these are angel investors and venture capitalists (VC). Both invest in and support start-ups but demand business equity in return to gain a healthy return on investment (ROI). 

The difference between the two is that angel investors take more risks and would fund start-ups with no track record. This can be attributed to their lower return expectations, usually 20-25% of a company’s equity, and lower borrowing amounts, averaging $330,000. 

VCs, on the other hand, are pretty stringent. They focus on technology-driven start-ups with long-term growth potential and are about to commercialize their ideas to avoid the risk of losing investments. The process of seeking their investment can be rigorous, but the good part is that they invest up to $25 million. 

Incubators and Accelerators

Incubators and accelerators are great options for start-ups who don’t prefer and have no access to private equity, loans, or grants. They typically focus on start-ups run by those with marginalized identities, such as:

• People of color
• People with disabilities
• Women
• The LGBTQI+ community
• Veterans

Like private equity firms, both offer capital, mentorship, and networking in exchange for equity. The only difference between the two is that incubators focus more on helping start-ups build their businesses, while accelerators are mentor-based programs offering guidance and support to start-ups. 

Final Thoughts

Business funding can make or break a start-up. Hence, it’s essential to do extensive research to see if a funding option is the most ideal for a business. More importantly, ensure strategic planning and cash management to ensure business funds won’t be wasted on initiatives with a poor ROI.

*This is a collaborative post.