Traditional financing often involves applying for a loan at a bank and having your credit and finances reviewed. However, getting financing as a startup company can be challenging as you may not have a sufficient track record of these items. Fortunately, there are options for alternative funding for startups, which utilize a different set of eligibility criteria.
If you have been unable to get financing from traditional sources or find that those financing options don’t meet your company’s needs, here are five places to get alternative financing for startup businesses:
- Friends and family: Best for borrowers who have 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
If you have friends or family with the financial resources available to provide you with the funding you need, you can ask them to support your business. We recommend writing a business plan and making a pitch deck to better inform them of how your company operates. This will help make them aware of the potential risks and benefits involved with investing in your company.
Financial assistance can be provided in one of three ways, and each has its own set of advantages and disadvantages:
- Loans: Compared to getting a loan from a bank, getting financing from friends or family carries the benefit of being able to negotiate an interest rate, repayment terms, and other loan terms more easily, such as fees and prepayment penalties. However, the IRS does set minimum interest rates that must be charged. The IRS’s Applicable Federal Rates are published monthly on its website.
- 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, we 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.
Where & How To Get Funding
Funding from friends and family can be obtained from your network of personal and professional connections.
For information on how you can get started, you can read our in-depth guide on how to ask friends or family for funding. There, we cover topics such as how to develop a business plan, how to pitch your business idea, steps to determine the funding amount you should ask for, instructions for negotiating a business agreement, and more.
2. Small Business Grant
How It Works & Who It’s For
Small business grants provide funding with no repayment required. 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 difficult to get because there are typically a large number of businesses competing for a small number of grants.
Even if you are selected for a grant, downsides include smaller funding amounts compared to loans and slower funding speeds. As a result, we 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 and 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. If you’re unsure where to start looking for grants, you can check out our list of the best small business grants. There, you’ll also find 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 is the process wherein you can raise a small amount of money from many different people. With it, your company can offer goods, services, and even equity in the business in exchange for funding. It is usually done through online platforms that help facilitate this exchange.
Due to the low rate of success for most crowdfunding campaigns, it’s important to have a product or service that potential investors can understand quickly and easily. You can view our crowdfunding statistics article for more details on this and other important data points.
We 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
With angel funding, you agree to give up a percentage of ownership interest in exchange for funding. 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. You’ll also most likely need to follow many of the same steps, 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 angel investor, you’ll need to negotiate terms, such as 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, we recommend viewing our alternatives to unsecured startup loans.
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, you can consider some popular online platforms to get matched with one. Some of these include AngelList, FundersClub, and Gust.
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.
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-growth companies. 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 to 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 suited better for your business needs. Before you give up on traditional financing, however, 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, without an established track record of profitability, banks may consider your company to be too high risk to lend money to. 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
If traditional methods of financing are not an option for your startup, you can still get money from the alternative funding sources we mentioned above. These carry a different set of eligibility criteria that can improve your chances of getting funding if you’re unable to meet a bank’s qualification requirements. The rates and terms you get could also be better suited to your business needs and goals.
