Different Types of Early Stage Funding
In order to grow your company, you'll need access to capital. Even if you don't need capital infusion today, you will in the future in order to operate and grow your business. This infusion can come in the way of Equity Financing, Traditional Debt, and other forms of Non-Dilutive Capital.
The most talked about capital infusion strategy now days is Venture Capital (private investment in exchange for ownership in your company). While Venture Capital (VC) is useful for some companies, it's not for everyone. In fact less than 1% of companies ever raise VC and, of all the capital invested, only 3% goes to companies led by women. Yeah, we know 😑. (Watch Erika's Trillion Dollar Blindspot Ted Talk where she explains why so little funding goes to women entrepreneurs and what we can do about it.)
Many entrepreneurs, particularly women and BIPOC, start believing that in order to build a highly profitable company they either have to be venture backed or go home. But that is not at all the case! Just ask legend Sarah Blakely, Founder of SPANX.
Choice equals power. So it's important for you to know what options are available so you can pick the best one for you and your company.
Here are the most common types of funding available to entrepreneurs:
Community Development Financial Institutions (CDFIs): Typically, nonprofit loan funds and/or grants that provide capital, mentoring and financial advice to small businesses.
For-Profit Accelerators, Angel Investors and Venture Capital: This form of private investment equity includes individuals and firms typically looking to invest in startup companies with long-term growth potential. For more information on when and how to approach this type of investment watch our Video Tutorial on our Fundraising Track. You should also check out our Podcast where we interview Angel and VC Investors.
Grants: Awards given by the government, foundations, corporations, or individuals, which, under most conditions ,do not require repayment.
Loan Funds: Secured and unsecured term loans and lines of credit from non-bank corporations, investment funds, nonprofit organizations, and other non-bank institutions. We have several relationships with local and national bankers that can provide additional support. If you are looking at traditional debt as your source of funding we highly recommend you become familiar with all the programs and loans the U.S. Small Business Administration (SBA) has to offer, particularly for women. We also recommend that you look into becoming a Certified Women Owned Business, particularly if your business is looking to do contracting with government entities or with large corporations who contract with the government.
Crowdfunds: The use of small amounts of capital from a large number of individuals to finance a new business venture, made accessible through social media and crowdfunding websites. Crowdfunds help expand the pool of investors beyond the traditional circle of owners, relatives, and venture capitalists. If you are looking to crowdfund, take a look at crowdfunding companies like Republic.
Other Non-Dilutive Capital Options include:
Tax Credits. Tax credits are deducted from the taxes your company owes, yet requires the business to spend funds up front. Qualified companies can secure either refundable or nonrefundable credits. The former allows owners to receive a cash refund after paying all the tax they owe while the latter is applied to income tax with a direct cash infusion. Check out your local State Government Economic Development Agency to learn more.
Revenue-based financing (RBF). RBFs are agreements between business owners and investors, where investors provide companies with capital in exchange for a percentage of the monthly revenue as a return on the investment. The returns only continue until the initial capital amount plus any accrued multiple is repaid; most RBF investors expect to be repaid within four to five years of the investment, depending on the loan size. Check out Lighter Capital for an example of an RBF Capital Provider.
Venture Debt. Venture debt is a form of debt financing that is only available to venture-backed startups. Small companies that aren’t in a position to give up equity or secure financing from banks turn to venture debt, allowing the company to take on debt rather than give up shares. Importantly, this capital isn’t issued through venture capital firms. Instead, a specialized venture debt lender, such as a bank, hedge fund, private equity firm or business development company, provides financing. Extremely successful companies, such as Uber and AirBnB, have a long history of accruing venture debt. The loans are structured similarly to medium-term business loans in that they are paid off within three to five years. Companies leverage venture debt to increase their own growth without requiring additional rounds of equity financing.
Venture debt is considered a great complement to equity; it’s especially helpful for those that want to extend the runway between funding rounds, finance a specific project, purchase equipment, or limit dilution. However, any company taking on debt should have the means to repay the loan since lenders can force the guarantor into bankruptcy in order to recoup.
Annual Recurring Revenue, or ARR, refers to the value of a company’s subscriber base or the yearly value of a single subscription. Software companies, such as Spotify, Adobe’s Creative Cloud or Netflix, rely on the measure in order to evaluate their profits. Alternative lending sources often evaluate SaaS companies based upon their ARR. In combination with the customer renewal rate, the ARR helps the lender determine whether or not they’d like to enter into a long term relationship with the company.
ARR lending is very similar to venture debt, allowing subscription-based services to maximize their returns without losing company ownership. Stripe for example offers capital to its users basing limits on the transaction and ARR they currently produce through their platform.