Startups needing funding often have to source financing by untraditional means. This is because getting a traditional business loan often involves a hard credit pull and close review of finances—and since many startups have limited resources, they may have difficulty qualifying for various lending products.
Sourcing alternatives has become a more common way for startups to grow their businesses. So, if you have been unable to get financing from traditional lenders or find that those financing options don’t meet your company’s needs, here are five sources of alternative financing for startup businesses:
- Friends and family: Best for borrowers with friends and family willing and able to invest in the company
- Small business grant: Best for business owners looking for funding that does not require repayment
- Crowdfunding: Best for startups with a strong brand or dedicated customer following but low revenue
- Angel funding: Best for startups willing to trade equity in exchange for funding from nonprofessional investors
- Venture capital: Best for startups willing to trade equity in exchange for funding from professional investment firms
1. Friends and Family
How It Works & Who It’s For
Friends and family may be a solid financing option if they have the means to provide the funding you’re looking to acquire. You’ll need to make a case for how the funds given will be used toward your business, so I recommend writing a business plan and making a pitch deck to better inform them of how your company operates and allow them to evaluate the potential risks and benefits involved with investing in your company.
Financial assistance can be provided in one of three ways with this route, and each has its own set of advantages and drawbacks to consider.
- Loans: Compared with getting a loan from a bank, getting financing from friends or family is a less formal way of entering into a debt agreement. Generally, it’s easier to negotiate an interest rate, repayment terms, and other loan terms, such as fees and prepayment penalties. However, the IRS does set minimum interest rates that must be charged.
- Gifts: While receiving funds in the form of a gift can be great as it requires no repayment, the IRS may still view it as taxable income. Since tax circumstances can vary greatly, I recommend consulting a tax professional if you’re concerned about being left with an unexpected tax liability as the result of a gift. If you’re in need of tax advice, check out our guide on how to find an accountant.
- Equity: Receiving equity has the benefit of not requiring any loan repayments. However, be aware that accepting funds in exchange for ownership interest in the company can result in unwanted advice from the new stakeholders and could potentially strain your relationships in the long run.
Where & How to Get Funding
Funding from friends and family can be obtained from your network of personal and professional connections.
2. Small Business Grant
How It Works & Who It’s For
Small business grants provide alternative financing for small businesses without debt obligations. Since there’s no negative impact on your cash flow, it’s a great option if you’re unable or unwilling to deal with loan repayments.
This type of funding, however, can be quite competitive because there are typically a large number of businesses competing for a small number of grants. Also, grants may only be available during certain times of the year, or on a limited basis.
You’ll likely have to prepare a business plan and submit an application that involves various characteristics of your business and your intended use of funds. Even when selected, downsides include smaller funding amounts compared with loans and slower funding speeds. As a result, I recommend considering this type of funding year-round, well in advance of when you think you might need additional money.
Grant eligibility criteria varies, but some examples of how grant winners are selected can include:
- Quality of responses to question on the grant application
- Alignment with grant branding
- Quality and types of business products/services offered
- Intended use and anticipated impact of funds
- Business need
- Originality of business history
Where & How to Get Funding
Small business grants are issued by different types of organizations, including federal and privately owned companies. Check out our list of the best small business grants for a jumping off point. It also contains information on different eligibility criteria, details on how winners are selected, and where to go to submit an application.
3. Crowdfunding
How It Works & Who It’s For
Crowdfunding involves raising money from various types of investors, usually through donations. With it, your company can offer goods, services, and even equity in the business in exchange for funding. It’s commonly hosted by online platforms in which you can run your campaign, and that will facilitate the exchange of funds.
It’s worth noting that crowdfunding can be more difficult to obtain since it is often oversaturated and results in a low success rate. That said, it’s important to have a product or service that stands out and that potential investors can quickly and easily understand. You can view our crowdfunding statistics article for more important data points.
I also recommend that the incentives you offer in exchange for funding are enough to attract a sufficient number of investors. Incentives are commonly reward-based or equity-based.
Where & How to Get Funding
Crowdfunding is most commonly accomplished through various online platforms. You can view our list of the best crowdfunding sites to find the one best suited for you. Each crowdfunding site varies in terms of things like fee structure, target audience, industry, and how long your crowdfunding campaign can run.
4. Angel Funding
How It Works & Who It’s For
Angel funding allows you to get access to capital by agreeing to give up a percentage of ownership interest in exchange for funding to potential interested investors. Funds are often provided in the form of a convertible note, which is a loan that can then be converted to equity once the company reaches a specified valuation.
Similar to getting funding from friends and family, your ability to successfully find an angel investor will be dependent on your network of personal and professional connections—although it’s possible you may find a suitable investor through an online platform. You’ll also most likely need to follow many of the same steps as the other options above, such as preparing a business plan and a pitch deck to educate and convince angel investors to fund your product or service.
Once you’ve found an investor, you’ll need to negotiate terms, like how much funding you’ll receive, how the funding will be structured, and the percentage of ownership interest that will be provided. You can also discuss other terms, such as whether collateral will be required, and the valuation cap at which the convertible note will convert to equity.
If you don’t want to provide collateral, I recommend viewing our guide on how to get an unsecured startup business loan.
Where & How to Get Funding
If you don’t have any existing connections in your network willing or able to provide funding as an angel investor, consider popular online platforms—such as AngelList, FundersClub, and Gust—to get matched with one.
5. Venture Capital
How It Works & Who It’s For
Although venture capital shares some similarities with angel funding, it is a more formal process. Venture capital partners can provide funding in exchange for ownership interest in your company. Additionally, they’ll typically want to have a spot on your company’s board of directors and have a say in the decisions regarding your operations. This is usually to ensure a return on their investment and to offer guidance to help grow your business.
While this can come with the benefit of having a partner truly invested in your success and the additional networking and resources they possess, it can also reduce the amount of control you have over certain areas of your company.
Venture capital funding is typically best for high potential companies aiming for exponential growth. Two main types of investments exist:
- Equity Venture Capital Investments: These are settled with company equity. When a company is acquired or starts trading on a public exchange, venture capital firms liquidate some of their holdings in the company to make a profit. The startup business owner makes no payments in this scenario.
- Convertible Venture Capital Investments: Convertible debt is repaid at either a future funding or liquidity event. The investor can receive payment in the form of cash or equity in the company. A liquidity event can be an acquisition, an initial public offering (IPO), or another fundraising event.
Where & How to Get Funding
Venture capital funding can be obtained by tapping your network of professional connections. You can expand your network by attending industry events, such as business competitions and hackathons. Venture capital websites, such as Crunchbase, can also provide information on which firms offer this type of funding.
Frequently Asked Questions (FAQs)
You can consider getting funds from friends and family, crowdfunding, angel funding, and venture capital or applying for small business grants. Each has its advantages and disadvantages as well as varying eligibility criteria.
Alternative funding methods use different eligibility criteria compared with traditional loans, so you can potentially get funding with bad credit or a short history of being in business. Rates and terms can also be more flexible, which may be better-suited for your business needs. Before you give up on traditional financing, though, consider the approval tips in our guide on how to get a small business loan.
Yes, it can be difficult to get funding as a startup. While you can consider our list of the best startup business loans, banks may consider your company to be too high risk to lend money to without an established track record of profitability. Alternative funding for startups can also be difficult to get as they can involve a heavy amount of documentation to show investors that your business has a high chance of succeeding.
Bottom Line
While seeking sources of alternative financing for startup businesses may require more effort on your part, it can be worth it to secure the necessary financing to grow your operations. While you’ll still need to factor in your qualifications and aim to meet various eligibility criteria to improve your chances of getting funding, there are a variety of options to consider. Choosing the best one for your business will depend on the amount of funding and terms you need.
