Venture capital (VC) is an important source of funding for startup founders. While VC funding can provide crucial fuel for startups looking to scale, it’s not suitable for every business. Fortunately, there are alternative routes to funding. In this article, we will explore the pros and cons of VC funding for startups and alternative streams of funding to consider.
The value of venture capital
As a founder of a VC-backable business, there are several benefits to working with this type of investor. VCs can provide substantial funding, strategic guidance, and valuable connections, accelerating your startup’s growth. Additionally, having a reputable VC as an investor enhances your startup’s credibility and attractiveness to other investors and customers.
However, securing VC funding is resource-intensive, requiring extensive preparation while running your business and meeting metrics. Raising investment generally involves selling equity and diluting the founding team’s ownership, potentially leading to changes in management and loss of control over business decisions.
VCs seek rapid growth and high returns, often prioritizing short-term gains over long-term stability. They invest in high-risk startups with the potential to deliver significant returns, as the majority of startups fail. Therefore, if your startup doesn’t aim to become a multi-million or billion-dollar business, VC funding might not be suitable.
In today’s competitive startup environment, VCs are more selective, focusing on startups with the potential for outsized returns. So, if you’re not building a moonshot business, what are your options – where do you go for alternative sources of startup financing?
Alternatives to VC funding for startups
Thankfully, for startups where VC isn’t an applicable route for funding, there are lots of alternatives. Each option has its benefits and risks. As with any business relationship, think about how each option aligns with your long-term vision, value and goals before deciding which financing route is best for you and your business.
1. Grow with Cash Flow/ Revenue aka Bootstrapping:
Relying on revenues to fund a startup offers several advantages. It allows you to retain full ownership and control of your business (by avoiding dilution). This method promotes financial discipline and sustainability, as growth is funded by and directly tied to your company’s profitability. It also permits you to avoid the pressures and expectations that come with raising external funding so you can focus on achieving your goals at your own pace.
For startups developing products requiring substantial upfront investment, consider alternative revenue streams or phased product launches to generate early cash flow. Do what you can to be efficient with what resources you have, and look to potential strategic partnerships to minimise your costs to allow you to accelerate growth. Maintaining a lean operational structure and focusing on high-value activities can help you optimise productivity and preserve resources. Lastly, always be learning – continuous market research and customer feedback loops are vital in helping you to refine your products and ensure what you’re building and selling aligns with what your target market needs (and is willing to pay for).
But if you’re being careful with cashflow, and still struggling with freeing up enough cash to build your next new thing, there are other options.
2. Startup business loans:
I started my first startup with a startup loan. Startup loans can provide you with an injection of capital to help launch and or scale your operations. In my case, it was a £5,000 loan that allowed me to survive between quitting my job and landing our first paying users. Depending on where you are based, loans may be offered by government sources, banks, or private lending platforms. This approach also allows you to avoid equity dilution, helping you to maintain full ownership and control of your startup. If managed responsibly, this method can help to build the business’s credit history, facilitating future financing options.
Keep in mind that startup business loans do carry risks, including the burden of debt obligations and the pressure of fixed repayments, regardless of your startup’s performance. In my case, I was also personally liable for repaying the loan – effectively taking the debt on personally until the loan was repaid. High interest rates can also put pressure on cash flow and reduce your profitability, making it harder to sustain or grow your operations. Most importantly, defaulting on the loan could damage your credit score or result in legal issues.
You need to have solid business and financial plans outlining realistic projections of your startup’s expected revenue and expenses. Maintaining a detailed budget, which will give you a clear picture of your financial situation and ensure that loan repayments can be met without compromising your business operations, is crucial. It’s also best to start with smaller loans to build creditworthiness and gradually take on more significant financing as the business grows.
3. Grants:
A grant is a non-repayable financial award provided by governments, organisations, or foundations to support specific projects or initiatives. They are probably the closest thing to free money you can get as a startup.
Grants often focus on specific industries or projects, providing funding towards relevant resources – and occasionally guidance and other forms of support as well. They typically do not need to be repaid, reducing your financial burden. They also allow you to retain full ownership and control over your business. Further, receiving a grant can enhance your startup’s credibility and attract further opportunities.
On the downside, grants usually provide little upfront capital – requiring you to pay for project fees to then claim back the value of what you’ve spent. On top of financing spending up front, securing a grant is a resource-intensive and (usually) competitive process. Lastly, grants can come with stringent eligibility criteria, usage restrictions, and reporting obligations.
To mitigate these risks, diversify your funding sources, ensure meticulous grant application preparation, and maintain compliance with grant conditions!
4. Family, friends & fools:
Many startup founders first turn to family and friends for funding. Those closest to you or who share your vision may be willing to invest despite the high risks. These investors often provide financial support based on trust and personal connections, offering favourable terms and flexibility compared to traditional financing sources.
However, this type of funding has its risks. These investors may lack business experience and may not provide the advice or strategic guidance that professional investors can. The informal nature of these investments can lead to misunderstandings about repayment terms, equity stakes, and business involvement. Most importantly, financial strain or business failure can damage personal relationships.
Clear communication and documentation can mitigate these risks. Be transparent about the risks of investing in startups and set realistic expectations to prevent misunderstandings. Create formal agreements outlining investment terms, repayment schedules, and the role of each stakeholder. Treat these investments professionally by providing regular updates and maintaining open communication to preserve trust and manage expectations.
5. Business Angels
If you’re unsure whether your business is VC-backable and you’ve exhausted startup loans, grants, and funds from family and friends, consider business angels as a funding source.
Angel investors provide capital and mentorship to early-stage startups in exchange for equity. They bring valuable industry experience, business acumen, and strategic advice. Additionally, they can introduce startups to a network of industry contacts, potential partners, and other investors. Angels often offer more flexible terms than VCs, including smaller investment amounts, longer investment horizons, and lower return expectations, reducing immediate pressure for rapid growth.
However, like VCs, angels require equity in return for their investment. They typically invest smaller amounts than VCs, which may not suffice if you have extensive capital needs. Since they invest their own money, angels can make investment decisions more quickly. While their expertise and support can be beneficial, the level of involvement and expertise of angel investors can vary significantly, with some providing little support beyond the initial investment. Differences in expectations, vision, or strategy can also lead to conflicts.
Clear communication and alignment of vision and expectations are crucial. Conduct due diligence to assess the angel’s experience and background to ensure they are the right fit for your business. Document investment agreements detailing the terms and roles of both parties. Maintain transparency provide regular updates on your business’s progress, and hold the angel accountable for their commitments.
Final Tips & Takeaways
Venture capital is the right tool for the job if you’re building a startup that is suitable for VC financing. If you’re not, that’s no bad thing – there are many alternatives to venture capital available to you.
When deciding which option – or options – are most suitable for you and your startup, be sure to:
- Think about your business needs and your appetite for growth (and risk);
- Evaluate the pros and cons of each funding option;
- Where possible, diversify your funding sources; and
- If possible, seek professional advice to align your investment (and broader financial) strategy with your long-term vision and operational goals.
