Venture capital is usually touted as the be-all-end-all with regards to financing a startup. To be fair, you need to admit that wealthy investors showing up to rain treasure upon you because you have a great idea provides extensive appeal. That said, venture capital isn’t the only method to finance your new business and, in many cases, may not even be the best way to go.
So what now ? when investment capital isn’t a good match for the business plan? Below, we’ll look at some alternative funding sources if venture capital isn’t the right fit for the startup or small company. But first, let’s discuss investment capital a little to make sure we’re on a single page.
How Investment capital Works
There are lots of myths surrounding venture capital, however the concept is fairly easy and not especially glamorous used. Venture capital firms aggregate funds from the number of sources ranging from bored wealthy folks to pension funds. Once they’ve raised an agreed-upon amount, they’ll shop around for businesses to invest. What all these funding sources has in keeping is the need to recoup their cash, plus a tidy profit, once the business they committed to either A) goes public or B) is sold to a different company. A investment capital fund frequently disburses its funding during the period of several “rounds,” the very first which is known as the seed round.
Investing in unproven businesses, many of which will fail, can be risky. Typically, venture capitalists will hedge their bets by spreading their money out via a quantity of businesses to improve their likelihood of scoring a success. This model works mainly because the payoff from the successful company making an initial public offering (IPO) can generate returns orders of magnitude above what was invested. On average, a venture capital firm wants around a 20% return each year.
How much the firm receives is based on a valuation of the company done both before and after the money infusion. The difference in valuation is used to determine the percentage of stock the venture capitalists will own in the company. It may also determine the amount of influence the investors have inside a company’s decision-making processes prior to the company’s IPO/sale.
When You need to Look For Alternatives To Venture Capital
If you looked at the previous section and thought that arrangement sounds bad, then venture capital probably isn’t for you personally. For instance, if you’re not really a serial entrepreneur and would rather own and run your business indefinitely, this probably isn’t the funding source for you. Venture capitalists require that you come with an exit strategy.
It’s also quite possible that your type of business won’t easily fit in well with the venture capitalist model. For better or worse, “venture capital” is becoming almost symbolic of Silicon Valley. If you’re not a tech company creating some type of software, you may have some difficulty convincing a fund to help you out. They’ll be also searching for a quick return, so if your business plan doesn’t match that rate of return, you’ll be a poor match.
Keep in your mind, too, that most investment capital funds focus on a specific kind of business, so even when your profile is investment capital friendly, you might want to look around to find one that can work with your company at its current stage.
Finally, there’s a geographic component to investment capital investment culture. If you’re not in, or close to, hot spots like New York City, Bay area, Los Angeles, Atlanta, or Austin, you’ll have to work more difficult to wiggle your way right into a venture capitalist’s view.
8 Venture Capital Alternatives
If all new businesses required to rely on venture capital to get off the floor, we wouldn’t have very many businesses. The good news is there are numerous methods to finance your company’s early operations that don’t involve investment capital. Let’s take a look at a number of your choices.
1) Grants
When you’re talking about raising money, even a zero-interest loan just can’t contend with free money. Grants typically offer small-to-moderate-sized lump sums to companies that fit their criteria, and the best part is you don’t have to pay for that money back!
So why isn’t every startup running exclusively off grants? Well, understandably when you’re providing money, there’s going to be a lot of people in line to obtain some. Grants are highly competitive. Applying for them can be very involved and time-consuming, and there’s no guarantee that your effort will pay off. Still, should you target the right grants at the proper time, you are able to score a pleasant slice of money with no debt obligations.
2) Crowdfunding
You’ve probably heard of Kickstarter, but the crowdfunding industry is quite a bit larger and more specialized than you might think. In contrast to venture capital, traditional crowdfunding tends to work best when you’re attempting to raise money for any tangible, deliverable product–funders are essentially pre-purchasing your product (with some additional funders simply donating smaller levels of money in the interest of seeing any project succeed).
A newer type of crowdfunding, equity-based crowdfunding, allows investors to purchase equity inside your company. These services can be convenient if you’re not connected to the investor circuit but they are still searching for that kind of relationship. You need to be aware that this is still a fairly new realm of investing, with lots of investors still wary.
Keep in your mind, any type of crowdfunding will need a marketing blitz to obtain your name and product available, that will likely have its own costs both in money and time.
3) SBA Loans
The Small Business Administration’s loan guarantee programs are made to give smaller businesses access to quality rates and terms. In the case of startups, two of the most popular programs, 7(a) and 504, may not be the best fit because they usually require you to have been in business for 2 years.
The SBA microloan program, on the other hand, is much more geared toward startups. These loans can net you between $500 and $50,000. Rates of interest range from around 6% to 18%, with many borrowers falling approximately 8% and 13%. You’ll possess a while to pay them back too, with term lengths of up to 6 years. The rate you receive will be based upon your credit score and any collateral you’re able to set up.
If you need in addition to that, you’ll also want to check out SBA Community Advantage Loans, that the agency offers through community-based lenders. These financing options range from $50K to $250K, with terms lengths as high as Ten years. Interest rates are lower, usually falling between 7% – 9%.
4) Online Business Loans
Wait, why would you be here reading this if you could just go out and obtain a company loan? Fair point. It can be very challenging for startups to be eligible for a business loans because most business lenders need to determine a profitable business history before they open their purses.
That said, it’s not impossible. Many online lenders are willing to work with businesses with histories as short as 3 months. A few of the more creative ones may not care whatsoever. Just be prepared to pay rates of interest compared to the risk your business represents. Additionally, you can often find better terms if you can set up something valuable as collateral.
5) CDFI Loans
Community Development Banking institutions (CDFIs) are available in a variety of forms, ranging from banks, to credit unions, to–believe it or not–venture capitalists. What they have in keeping is certification through the federal CDFI Fund, which designates them to be dedicated to facilitating economic growth within low-income or historically disadvantaged areas.
CDFIs usually carry higher interest rates than comparable bank products, but less than the ones from a typical alternative lender. Best of all, most are startup-friendly.
6) Personal Loans
Your business might not have much history, but that doesn’t mean you don’t. Many unsecured loans are versatile enough that they'll be utilized for business expenses. And since you’re probably not taking a look at borrowing huge amounts of money, they may be sufficient to meet your financing needs.
Of course, because they are unsecured loans, you’ll lose whatever protections you would have had with loans, which typically differentiate between you and your business. Be sure you can continue to eliminate them even if your business fails.
7) Vendor Financing
Don’t feel bad if you haven’t heard about vendor financing so far. Vendor financing is an arrangement where a vendor essentially lends a seller the money to buy the vendor’s products. This can be useful if you’re launching a retail business of some kind or perhaps badly need what they’re selling for your own personel uses.
So exactly what do the vendors get free from the arrangement? Surprisingly, it may be easier to move product with risk these days move product at all. Additionally, the seller will often be prepared to earn interest on the loan or an equity stake in your company in exchange. Regardless of arrangement, you’ll probably need to be on good terms using the vendor to become a candidate.
8) Friends & Family
Depending on your social context, this might or might not be a practical option for you. Still, you might be surprised by how willing your family and friends may be to help out and assist you to succeed and probably at cheaper (if any) interest rates than the most benign lender.
Just make use of your judgment and don’t burn bridges.
Your Best VC Alternative Offers Funding That actually works With Your Terms
Don’t be worried about fitting the platonic ideal of an entrepreneur. The very best venture capital alternative for the startup will depend greatly on your circumstances and strategic business plan. Use the time and connections are looking for the funding you need to execute how well you see.
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