What does it take to raise capital for a successful early-stage startup? Is it all about having a great idea? Of course not. Any seasoned investor can tell you that great ideas are a dime a dozen.
Is it all about sacrifice? Working around the clock in your garage, surviving on nothing but ramen noodles? Nope. You likely will sacrifice a lot, and you might eat a ton of ramen noodles, but these don’t guarantee your success.
The biggest thing that separates successful startups from the huge field of failed startups is that the successful startups avoided running out of money long enough to turn their ideas into reality.
What it takes to create a successful startup, more than anything else, is a founder who is acutely aware of their finances, proactive about managing them, and creative about making sure the money keeps flowing in.
Venture capital is the most commonly talked about source of startup capital. But in reality, only a very small percentage of startups get the opportunity to work with a venture fund. The rest need to rely on that creativity we mentioned earlier.
This post focuses on nine alternative funding options that founders can consider when they’re raising capital for an early-stage startup.
Table of Contents
- #1 Revenue-Based Funding
- #2 Venture Debt
- #3 Grants
- #4 Equity Crowdfunding
- #5 Angel Syndicates
- #6 Convertible Notes
- #7 SAFEs
- #8 Peer-to-Peer Lending
- #9 Extensions
What About VC Funding?
Relatively few founders succeed in attracting the interest of big VC funds. According to Forbes, the number of startups that get investment capital is less than 1%.
That’s not to say you won’t find an angel who loves your mission or a big VC fund that’s looking for opportunities in your niche. It’s not impossible. But it is improbable.
If you plan to go after the big money, you’re going to have to work for it. You’ll need a captivating pitch, impressive performance metrics, and a rock-solid financial model. If that sounds like your game, Forecastr is here to help you and you should look for our next webinar on LinkedIn.
This post is geared more towards founders who aren’t looking for VC money right now.
So, if you’ve been told that you’re too early, that your metrics don’t meet industry benchmarks, or you’re just tired of searching for an investor who sees your vision, this post is for you.
Let’s dive in.
9 Alternative Funding Options for Raising Startup Capital
Just because VC funding is tough doesn’t mean you can’t find the funds you need for your startup to succeed. Entrepreneurs have a large and growing number of options to raise capital for their businesses.
These 9 options are worth your consideration.
#1 Revenue-Based Funding
Revenue-based funding is a great alternative for SaaS startups, tech products, or any business with recurring invoice-based revenue. It allows you to leverage your projected revenue to secure funding for continued growth. You then pay back what you borrowed, with interest, over the projected period.
Pros of Revenue-Based Funding
- This is a great alternative funding option for bootstrapping founders who want to retain their equity.
- The process is typically quick and simple. You can share some financial data with companies like Arc or Lighter Capital and get approved in days. This is much faster than raising a VC round, which can take several months.
- The terms are typically flexible. With some lenders, you pay a percentage of topline revenue each month. If you outpace your projection, your payments go up and your term is shortened. If you miss your targets, your payments go down but your term is extended.
- An undiluted cap table will make you more attractive to future VC investors.
Cons of Revenue-Based Funding
- You need to demonstrate predictable recurring revenue. If you can’t do that, you may not qualify.
- The amount of funding available is limited by your MRR, so you can only borrow as much as you can quickly pay back. This could be a pro or a con depending on your situation.
- If the repayment period gets too long, revenue-based funding can become less economical than a fixed-rate bank loan.
#2 Venture Debt
Venture debt may be a good alternative for startups with few assets and low cash flow. However, it’s only available to businesses that have already obtained some venture capital.
If it’s available, venture debt can be a good solution to raise quick funds to harness an unexpected opportunity, or to bridge the gap between fundraising rounds.
Pros of Venture Debt
- Venture debt can be much less expensive than equity financing because it doesn’t typically dilute your ownership.
- You don’t typically need to provide any collateral. Instead, you leverage the capital and valuation you obtained through fundraising to validate your ability to repay the loan.
Cons of Venture Debt
- Lenders can issue a default if the startup is unable to repay the loan.
- Lenders may add additional covenants to mitigate their risk.
- Expect lenders to add warrants on common equity, typically between 5-20% of the principal amount.
For some startups, grants are an excellent source of alternative funding. The problem is that they’re notoriously hard to get. To obtain a government-issued grant, you typically have to meet a range of qualifications set by various federal, state, and local government organizations, and the application process is often strict.
Grants are also available from other sources. Banks and businesses sometimes provide grants to develop their communities and markets. NGOs also provide grants to businesses that align with their missions and objectives.
Pros of Grants
- Money that is awarded does not need to be repaid!
- There’s no need to put up collateral or dilute your equity.
- If you meet the criteria for a government grant, you likely also qualify for many other grants.
- There are a huge number of grants available from a wide range of sources.
Cons of Grants
- You’re often competing with a very large pool of applicants.
- The paperwork is complex and time-consuming.
- Some grants require a significant investment in research, documentation, and presentation.
- The review process can take several months or longer.
#4 Equity Crowdfunding
Like traditional VC financing, equity crowdfunding allows you to trade equity for capital while taking much smaller sums of investment money from a much larger pool of investors.
Equity crowdfunding platforms allow anyone to invest in startups – they’re not limited to accredited investment funds. Some platforms let investors contribute as little as $100 for a small stake in an early-stage company.
Pros of Equity Crowdfunding
- You trade equity for capital, so there’s nothing to repay.
- You can structure your campaign to limit the amount of equity you give up.
- If your business appeals to a large audience, you have the potential to raise a lot of capital.
- Dilution is spread across a large number of stakeholders, so you typically avoid drastic changes in the percentages of ownership in your cap table.
Cons of Equity Crowdfunding
- Equity dilution.
- SEC requires public disclosure of company financials.
- Results of the campaign are publicly available. If you raise a lot, or very little, everyone will have access to that information.
- Crowdfunding platforms charge a fee, typically 5% to 10% of the money you raise.
#5 Angel Syndicates
Angel syndicates are groups of individual angel investors who team up to fund projects together. Syndicates are typically led by a notable lead investor who speaks for the group, manages the due diligence process, and serves as the intermediary between the startup and the syndicate.
Syndicates sometimes pool their assets in “Angel Funds” that allow them to invest in larger projects and diversify their investments.
Pros of Angel Syndicates
- Syndicates can often invest higher amounts than individual angel investors.
- Syndicates help startups gain access to higher numbers of high-net-worth individuals.
- Well-structured processes for due diligence and transactions.
Cons of Angel Syndicates
- Founders pay fees as high as 5% to 10% of the capital raised.
- The time to complete a deal can extend up to 6 months or more, including due diligence and term sheet negotiation.
- Some syndicates only schedule meetings for new opportunities during monthly or quarterly pitch events.
#6 Convertible Notes
Convertible notes are short-term debt that converts into equity during a later financing round. Although the debt does carry interest, it often converts to equity at a discount to valuation. Getting early equity at a pre-money valuation incentivizes the investor with a higher percentage of ownership.
For a better understanding of how the discount rate and valuation caps work, check out our guide to convertible notes or watch this video for a quick deep dive:
Pros of Convertible Notes
- Convertible notes are simple to execute.
- The capital is relatively fast and inexpensive compared to some other alternatives.
Cons of Convertible Notes
- Leaving a convertible note uncapped can put the investor at odds with the startup. The company wants a high valuation, while the investor wants the opposite.
- Diminished control for investors. Compared to a shareholder, who often gets voting rights on crucial business matters, a noteholder has limited input on company decisions.
- As a founder, if you have trouble raising capital in a subsequent financing round, you may not be able to repay the loan. Investors will likely offset this risk by setting terms to make the note automatically convert to equity at maturity.
SAFE stands for Simple Agreement for Future Equity. Like a convertible note, a SAFE is an agreement between an investor and a startup where the startup receives capital upfront in exchange for future equity triggered by an upcoming event.
SAFEs were developed by Silicon Valley startups who wanted
SAFEs were developed by Y Combinator as an alternative to convertible notes. Early SAFEs were designed to raise small amounts of capital quickly. Today they’re commonly used to raise large amounts of capital.
Pros of SAFEs
- SAFE fundraising can be easier and faster than convertible notes and equity financing.
- SAFEs typically have lower transactional and legal costs.
- SAFEs eliminate interest payouts.
- Founders retain full control until the SAFE converts to equity.
Cons of SAFEs
- Investors have no guarantee that the instrument will convert.
- If the company does not perform well, investors are not entitled to the company’s assets.
- Founders’ equity is diluted when the qualifying round is complete.
#8 Peer-to-Peer Lending
Peer-to-peer lending was developed in response to the Great Recession when other funding sources for small businesses collapsed. To solve this problem, new software was created to connect startups and small businesses with investors willing to fund them.
P2P lending has since expanded to become a popular online alternative funding option to raise capital for early-stage startups.
Pros of Peer-to-Peer Lending
- No collateral is required and you can repay the loan early without prepayment penalties.
- Online tools provide quick approval with minimal paperwork and the convenience of digital signatures.
- P2P loans aren’t subject to all of the rules and regulations of traditional bank loans. They can also provide lower interest rates.
- Some P2P lenders allow you to tap into additional funding once your original loan has been repaid.
Cons of Peer-to-peer Lending
- P2P loans are prohibited in certain states, so check to ensure that the loans are legal in the state where your startup is located.
- With very few regulations, P2P loans are less stable and slightly riskier than traditional bank loans.
If you need to extend your runway, but you’re not ready for a full fundraising round, you can ask your existing investors for an extension. This is often a great approach for early-stage startups with investors who have already written you a check.
In recent years, seed extensions have become very popular. As the bar for raising a Series A continues to climb, seed extensions provide a great solution for startups that aren’t quite ready. They’re also referred to as “Seed 2,” “Seed Prime,” and “Seed to A” rounds.
Pros of Extensions
- Sometimes an extension allows you to buy time without overhauling the dynamics of your cap table.
- Avoids the fixed repayment requirements of debt-based instruments.
- Bringing new investors into an extension round can add a valuable source of fresh insight and advice from an experienced advisor.
Cons of Extensions
- Equity financing requires a fresh valuation, which can work against you if you haven’t built a steady stream of revenue or assets.
- Additional dilution means you retain less control and ownership of your business.
Keep an Open Mind About Alternative Funding
Early-stage fundraising has been glamorized by TV shows like Shark Tank and Silicon Valley. But 99% of founders have a much different experience. If you find yourself in this majority, you’re in good company. You just need to evaluate your options and find the funding that works best for you.
These nine alternative funding options should provide a good starting point as you set out to raise the capital you need to grow your business.
If you’re not certain which strategy will work best for your goals and objectives, a good financial model might be the perfect tool for you. With a solid financial model, you can evaluate different funding options and visualize how they will impact your cap table and operations in the future.
Reach out today to talk to Forecastr about getting a great financial model, along with the support you need to make the most of it.