Introduction

There are many occasions when businesses require funding,  especially for new businesses such as startups, who will have to identify suitable funding sources. In principle, there are two main startup funding types: Self-funded and funded by third parties such as investors or banks. However, this view falls short of capturing the many nuances in how startups get funding. Often, leaders will have to become creative to organize the capital they need to grow their businesses. This article goes beyond traditional financing sources and will explain 12 potential funding sources for businesses and startups. Of course, not all of them will be suitable for any startup but there are many times more potential funding sources available than just the obvious ones. The task here is to open the eyes towards all potential alternatives to obtain funding sources for Startups to start a new business.

Bootstrapping

When we look for Bootstrapping meaning, we can define it as starting a new business with little to no capital and reinvesting first profits into the business to grow it. As such, Startups who use bootstrapping do not take on external financing sources and rely on their means to achieve growth. Bootstrapping puts the entrepreneurs in a very tough spot as such startups typically are cash-strapped, and they have to turn every penny carefully before spending it. The good thing is, this incentivizes the entrepreneurs to find innovative and cost-effective solutions because such is needed to survive. Another plus is that bootstrapped businesses are not dependent on external financing providers. Therefore the founder will remain in complete control of their Startup.

A famous bootstrapping example is Mailchimp, a side-business founded in 2001, which 20 years later resulted in the largest bootstrap exit ever with the sale to Intuit of $12 Billion in November 2021. This example shows that especially in industries that do not require a lot of capital and rather rely on the know-how and talents of the founders, bootstrapping can be a very successful strategy and means to get funding for startups. As seen in this bootstrapping example, it is inherently complex, costly, and requires a lot of time. Therefore in many cases, like this bootstrapping example, it is a more suitable option when started as a side business first.

Another aspect of bootstrapping meaning requires a business concept that is profitable from the start. Growth is slower as the financial resources are much limited to the profits obtained, which means time and patience are required to grow the business. Compared to using third-party financing, bootstrapped businesses usually grow slower. Founders need to be ready with a lot of cash flow with bootstrapping, meaning they need to prepare funds to allocate properly before they execute their startup.

Family, Friends, and Fools Funding (3Fs)

When considering external financing sources, most startups face the main problem of nobody knowing or trusting the founders since there is zero credibility at the beginning. As they don’t have any credibility, the potential circle of potentially interested investors will be limited. One way to enhance credibility is to take on first investors.

The first natural step to obtain funding for a startup will generally be to check with Family, Friends, and Fools Funding called the 3 Fs, and ask them for funding. The main advantage here is that Family and Friends know the founders already and are ready to trust them. Family and Friends might not be sophisticated investors. In reality, they are not investing in the business idea itself; they are investing in the founder(s) because they like and wish to support them. One famous example of taking on the family as investors are Jeff Bezos’s parents, who invested in Amazon early on. That investment was very successful as Amazon became one of today’s most valuable companies.

One main topic of taking on family and friends as investors are personal and business affairs. Especially if a startup should not be successful and loses its funds, this can lead to ugly conflicts and disputes. Friendships quickly can end over such things. Therefore, the actual cost is the risk of losing those friendships.

The Fools are another investor category because they usually are the people the founders get to know when they start pitching their idea. Significantly investing in Startups in the Seed stage is inherently risky since many variables are in motion, ranging from the quality of the startup business idea, the founders’ commitment, the ability to execute, and the flexibility to adjust a business plan as needed. So, any reasonable person would have a large number of reasons why not to invest. Therefore, only the fools will be left to invest at the very early stage. Nevertheless, fools are very valuable as they are the followers who can bring an idea to life. The bottom line is that this investor category strongly believes in the founders for personal reasons. Family, Friends, and Fools Funding (3Fs) are the most accessible investors to deal with.

Crowdfunding

Crowdfunding is another option that Startups can consider to get funding for startups. The main idea here is to offer an alternative way of getting financing by using a pool of interested investors. There are different participation schemes how crowdfunding can work in principle:

• Equity
• Debt
• Products
• Donations

Raising equity and debt from a large pool of private investors usually is subject to applicable capital market laws to protect those investors. These laws add a lot of administration and compliance requirements to the process or even can be prohibited in certain countries. Therefore, these two participation schemes are more difficult to implement and less common.

What has become quite common on today’s Crowdfunding marketplaces is raising funding to develop or produce new products. These are usually new and innovative products that today are not yet available on the market. Creative entrepreneurs have developed concepts, designs, prototypes and need funding to bring those projects to life. Funding products also lower the ticket items, so that investment can turn into a purchase for a $100 product. The advantage here is that investors become customers in exchange for the funding raised, and they receive a product in exchange. Surprisingly, many people are ready to support the innovative ideas of creators as they like to stay at the forefront of the latest technologies and products. For the entrepreneurs, there are two main advantages to raising funding via a product-based crowdfunding approach:

1. No Equity: Entrepreneurs do not have to give away their shares and equity in the company. They avoid becoming diluted.
2. Attracting Customers: They can build up an audience and first customer base. Building audiences can be very helpful for the marketing of such products.

Another variation of crowdfunding is to use a donation approach. Donating is a bit vaguer and may be more suitable for artists or concepts with a less precise output definition.

For getting a Startup off the ground, it can be a good idea to start with launching a new product. Famous Crowdfunding platforms are Kickstarter,  Indiegogo, and GoFundme, among many others.

Angel Investors

What Are Angel investors? Angel investors – or business angels – are private individuals, often wealthy and many times possess an entrepreneurial background. They usually possess a higher risk tolerance than other investors as they are more familiar with the entrepreneurial journey and the typical pitfalls. They invest either for personal reasons, like the excitement of being part of innovative ideas, witnessing entrepreneurial journeys, or targeting abnormal returns in exchange for participating in higher-risk investments.

Angel investors typically provide funding for startups in their early stages and therefore face

high-risk plays. Angel investing is demanding as every investment comes with a lot of risk and many unknowns. Therefore, the experience and investment know-how make an angel investor successful.

How much can an angel investor invest in a startup? The calculation goes like this. Investing in Startups is inherently risky. Therefore, an angel investor can only invest a small part of his net worth in startups, estimated maybe 5% to 10% as an example. They can expect only 1 out of 10 startups to succeed, as a rule of thumb. The others might fail in the worst case.

Furthermore, a startup might need additional funding rounds in the future, so an angel investor might also want to reserve some of his capital for an add-on investment to avoid becoming diluted. Let’s say an angel investor has a net worth of $ 100 Million. How much can he invest in a single Startup?

• Net worth $100 Million
• Only 5% of the Net Worth to be invested in a portfolio of Startups: $ 5 Million
• 40% of Funds ($2 Million) will be reserved for future financing rounds, 60% to be invested in new startups ($3 Million)
• The Business Angel targets to invest in a diversified portfolio of 20 Startups
• $3 Million divided by 20 is $150,000, which the business angel can invest in a single Startup

This calculation shows how a business angel might tick and how he calculates the size of a possible investment ticket ($150,000). The calculation also means that many times a Startup will have to approach several business angels as the required funding many times will exceed the financial means of a single angel investor.

Therefore, many times, angel investors will team up with other business angels in so-called business angel clubs. Apart from the social and networking aspects, the advantage here is the sharing of deal flow, research, opinions, and know-how become easier. Furthermore, it is a more practical thing to do since a Startup will have to find multiple angel investors anyway. Sharing know-how, opinions, and research about startups with fellow other angel investors make the whole investment process easier for Angel Investors.

The Bottom line is that securing Angel investors are an attractive option for Startups. To add to what are angel investors, are individuals also driven by emotion, are ready to invest early on, and usually are entrepreneurs themselves to best understand the situation of the founders and the Startup. The downside is that ticket sizes might be small, and it might require taking several Angel investors to reach the desired funding level.

Startup Grants for Small Businesses

Another funding source many times are available is Startup grants for small businesses. The main benefit is that a grant does not need to be paid back. Grants usually are available from endowment funds, governments, or other organizations seeking to support a particular purpose. Therefore, using a grant requires typically strict compliance with the grant’s criteria and reporting requirements to ensure the funds are spent in an intended manner.

As grants are not profit-oriented, they usually do not use bank-like lending criteria and can be easier to obtain. One advantage is that grants can already be available in the early phase of a startup, the seed phase. Another advantage is that a grant is a “gift” that does not need to be paid back and will not dilute the equity ownership of the startup’s founders.

Therefore, if startups can access a grant and comply with the grant requirements, a startup business should use the available grant funding options.

We can differentiate startup grants by the party that provides them. Here is a list of where to look for grants from which parties:

• Government Grants: Governments often offer grants to support projects that provide certain desired benefits to the public. There are government grants available at the federal, state, or community level, not in the US but also other countries. Examples of such grants are to support the development of new technologies leading to cleaner air, less pollution, solving traffic problems, increasing the water quality, or reforestation. We can find examples of such grants grants.gov, Small Business Innovation Research (SBIR),  FONAFIFO, among many others.
• Cryptocurrency Grants: These are grants provided by promoting specific crypto-currencies aiming to develop the ecosystems of their currencies with more apps and use cases. Here the aim is to increase demand for the parent cryptocurrency and make the ecosystem more attractive. Many major blockchains have their grants as they need to incentivize developers to develop apps with more use cases for their ecosystems.  They also seek to increase demand and market adoption for the leading cryptocurrency. Such grants can drive significant value to blockchains, e.g., Ethereum, Cardano, Algorand, Chainlink, etc. There are many examples such as the Web3.0 Foundation, Chainlink Grants to develop integrations and applications for Chainlink, ETHPrize. which supports projects to make Ethereum better, Algo Grants, which is focused on developing projects for Algorand, among many more.  
• Corporate Grants: There are also grants available from more giant corporations., E.g. FedEx Small Business Grants, Walmart Local Community Grants among others.
• Private Endowment Funds: There are also grants to available from private endowments funds to support specific purposes, e.g., AmberGrants seeks to support Women, various Scholarship funds to support students, and many more.

Using startup grants for small businesses can be very attractive for startups or small or medium-sized businesses. Startup Grants for small businesses are definitively something that needs to be checked.

Family Offices

Another investor type potentially interested in investing in a Startup is a family office. Family offices are – same as business angels – are private individuals or members of a family who need to manage their wealth and systematically protect their interests. The origins of a family office typically date back to a successful entrepreneur. As parents may have several kids, the family grows over a generation, and the individual member’s interest could potentially conflict with the interests of the business they own. Some family members might want to sell; others want to run a company. Many times, the goal of the family office is to put in place family rules on how to keep and manage the wealth and ensure they can transfer wealth to the next generation to protect the legacy of the founder.

We differentiate between two types of family offices:

• Multi-Family Office
• Single Family Office

A multi-family office is a team of investment professionals that manages and invests the capital of several families. These usually are smaller fortunes, therefore require only a minor investment team, and there is a cost advantage when sharing the office expenses with other families.

Single Family Office is typically a more exclusive service and used by families with a more considerable net worth who can afford a dedicated team of investment professionals.

Sometimes, the wealth management tasks are not purely return-oriented but go into philanthropy. A family office may or may not decide to set up a set of investment criteria that defines in which asset classes how much of the wealth can be invested.

The main characteristics of family offices are that financial decisions are not purely rational but also consider other objectives. Some family offices might be interested in investing in a Startup, while others might not. Family offices are approached frequently for funding. Therefore they usually keep a low profile and rely on a trusted network of advisors and partners for deal-flow.

The main difference between a Family Office investor and a Venture Capital investor is that family office investors usually are not exit-driven. They follow a long-term investment strategy to build wealth over generation and do not need to chase short-term returns. Securing such a long-term investor typically makes the life of a Startup much more accessible than dealing with an exit-driven investor such as a Venture Capital firm. However, family offices willing to invest in Startups are challenging to identify, and usually, only a few of them will invest directly in Startups.

Venture Capital

Venture capital (VC) investors are a particular type of private equity that focuses on investing in startups instead of in established businesses. Same as Private Equity Funds, Venture Capital firms normally create investment funds funded by Limited Partners (LPs), which they manage as a General Partner (GP). Such a fund typically lasts 7-10 years and includes a performance scheme to reward the General Partner for outstanding financial returns. Important to note here is that the realization of financial returns will require an exit event where the VCs can sell the startup so that the VC can realize a financial return. Return expectations typically range between 20% – 35% Internal Rate of Return on the invested capital by the fund.

The Investment Criteria of Venture Capital Firms

Venture capital firms are set up following an institutional organization. Normally, the investment criteria will be defined upfront. Here is an example:

• Investment ticket USD           $500,000 – $2,000,000 per Startup
• Minimum Equity Stake:          Minority Stakes, starting as of 5%
• Industry:                                 eCommerce, SaaS, Marketplaces, Social Networks
• Stage:                                      Series A, B, C
• Team:                                      Qualified Management Team
• Product Stage:                        First Traction
• Target IRR:                             35%
• Exit route:                               Trade sale or IPO within 5-7 years

A venture capital fund typically targets a fund size north of $10 Million up to even billions of Dollars and will seek to invest in a diversified portfolio of Startups. Some of these startups will succeed, while others might fail. Therefore, the returns of the successful ones need to cover the costs of the failed investments. The goal is to invest the funds within 3-4 years as per pre-agreed criteria in promising Startups, which VCs can exit again within 7-10 years. Upon successful exit, the funds will be returned to the Limited Partner investors.

What Startups need to know about VCs

For startups, it is essential to understand that Venture Capitalists are exit-driven and need to create superior returns. They intend to invest in high-growth startups, leading to a successful exit at a much higher valuation. Therefore, VCs are under pressure to deliver those high returns to satisfy the financial performance promises they make to their Limited Partners. Therefore, Venture capitalists usually look at investing in Startups from a purely financial perspective. They will also base their investment decision on whether the expected Internal Rate of Return (IRR) of their investment case meets their minimum return targets or not.

The implications for Startups are that they need to be aware of this and prepare thoroughly for a discussion with VCs. The best is if Startups prepare their business and financial plans to show VCs how they generate their return, making funding discussions easier and showing the VC that the startup founders understand their situation.

VCs are professional investors who possess significant know-how and experience investing in Startups. In exchange, they might expect significant shareholder participation and protection rights and are exit-driven. Startups will need to meet the predefined investment criteria set out by the VC firm.

Corporate Venture Funds

A Special type of Venture Capital is Corporate Venture Funds. Here a giant corporation reserves its funds to be invested in Startups, commonly in minority stakes. The approach is pretty similar to Venture Capital; each deal targets a financial return, but on top of that, a Corporate Venture Fund may add additional investment criteria as per the parent company’s goals.

Why do Corporates set up their own Corporate Venture Funds?

The primary motivation for giant corporations to set up separate Corporate Venture Funds is to obtain access to the following, which otherwise is not available within the larger organization itself. Here is a list of the motivations why a large corporation would be interested in investing in risky startups:

• Access to Innovation,
• New markets
• New customers
• New technologies
• New processes
• Talented People

These are all problematic items to acquire once a sizeable multinational company reaches a specific size and operates as standardized processes. Putting Startups into such a large corporate setup often kills their initiatives, and they get burdened with paperwork, compliance, and reporting requirements. The solution to this problem is to offer Startups a particular vehicle through which a giant corporation can participate until a Startup is mature and could be better integrated into the structure of a giant corporation.

An additional aspect is that typically there is a lot of industry know-how inside a large corporation. Therefore, this can significantly reduce the risk of investing in specific industries since the team of the Corporate Venture Fund is more familiar with the industry and even contribute with their know-how to the businesses of Startups.

For Startups, there is a benefit as well as it will be much easier to interact with the team of a separate Corporate Venture Fund where they receive better attention and are viewed as a priority.

How does Corporate Venture Investing work?

Corporate Venture funds typically aim to participate through a minority stake. Investment criteria may be very similar to those of a Venture Capital investor. Still, they usually come with tweaks as the giant corporation seeks to achieve its own goals. Investment criteria should specify the following aspects:

• Minimum Investment ticket size
• Minimum Equity Stake
• Industries of Interest
• Stage
• Team requirements
• Minimum target Internal Rate of Return (IRR)
• Exit Route

It is important to note here that Corporate Venture Capital will require an attractive financial return, simply as they carry many risks that need to be compensated. They will also require an exit event – or if a startup is booming – many times will offer to invest additional capital to grow it further. In some cases, the parent corporate might also be interested in fully acquiring the startup later. However, this should typically not be the base case scenario upon which an investment decision is made, simply as there are too many unknowns yet, and things typically do change over time.

What are Examples of Corporate Venture Capital?

Today’s examples of Corporate Venture Funds include Corporate Venture Funds such as Intel Ventures, NOVA by St. Gobain, Googles Corporate Venture Funds GV, CapitalG, Gradient Ventures, Danone Ventures, among many others. Corporate Venture Investing has been done nearly since the industrialized age. One famous example is Du Pont which invested already 1914 in General Motors, which could accelerate its growth in the automotive industry. Apart from the financial returns, DuPont created a new customer as demands for its products increased, creating an actual win-win situation.

When looking for Venture Capital, Startups usually go hand in hand to also approach Corporate Venture Funds as they operate very similar to normal VCs. It can be much better to partner with a Corporate Venture Fund in some cases. They usually possess a lot of industry know-how that otherwise is not accessible to a startup and might be willing to invest in earlier stages than a VC. Apart from this, Corporate Venture Funds typically also have other motivations to invest in startups rather than pure financial returns, making the discussion easier. They also require a fit with their investment criteria and may expect significant shareholder participation and protection rights.

Private Equity

Private Equity (PE) firms invest equity capital into private businesses. They are considered an alternative Asset Class towards investing in the stock market. Therefore, the businesses that Private Equity firms are investing in are not publicly quoted and are quite attractive for institutional investors. The presence of non-publicly quoted firms allows them to diversify their portfolios better and benefit from typically higher returns than what can be achieved on the stock market (at least, this would be the idea). This investing is called “Private” Equity or abbreviated PE.

What is Private Equity?

Private Equity is the parent category of venture capital. A General Partner puts an investment fund together and takes on Limited Partners, which generally invest in the fund for a commitment period of 7-10 years. The General Partner is responsible for selecting and managing the investment opportunities until exit. The General Partner usually will receive an annual management fee (ca. 1% – 2% of the Funds under management) and a performance fee that depends on the actual financial success achieved upon exit. Like Venture Capital firms, Private Equity investors will also seek to exit their investments within 3-7 years as they will need to pay back the funds to their Limited Partner investors.

Private Equity funds are profit-oriented investment vehicles that usually will target a 20% IRR by investing in mature, stable businesses that can take on financial debt to improve their returns.

Investing in private businesses is inherently risky as there is no easy way to sell the investment in case of need. Investments are illiquid, and the Private Equity firm will be stuck with the invested business until it can be sold, generally through a private trade sale. Therefore, the Private Equity fund manager (the General Partner) is crucial for the firm’s success. Private Equity Management teams typically consist of experienced industry veterans who possess years of investment and industry know-how. Private Equity firms usually will have to prefer industries they are comfortable investing in, which their investment criteria will reflect. In addition, they will seek to structure their deals in a manner that gives them more control about their exit and will demand investor participation rights to protect their investment. There is a range of sophisticated strategies applied to protect their investment.

What are the Types of Private Equity?

The Private Equity investment category comes in different flavors and has several subclasses of Private Equity investor types. Here we list the main ones:

• Distressed/Turnaround: These are Private Equity investors specializing in distressed opportunities. These usually are firms going through a bankruptcy process and are looking for a white knight. Such opportunities come very cheaply, but they require some investment and specialized know-how to turn them around, as this is one of the riskiest investment categories of Private Equity firms but potentially can lead to a lot of upsides. There are many cases, e.g., in the automotive supplier industry, where Private Equity investors picked up distressed companies and turned them around, including successful exit.
• Succession (Management Buy-In): These are investments in owner-led firms and where the current owner has no successor and seeks to retire. With no successor, the Private Equity firm will have to bring in a new management team to manage the company. Offering such succession solutions adds quite a lot of value as many times it is not easy to find a qualified new owner. Private Equity firms specialized in succession solutions can offer an attractive alternative here.
• Management Buy-Out (MBO): This type of Private Equity investment seeks to work together with an already existing management team of a private company that feels that their current owners either limit them or cannot support them in their further growth. So, the management team will look to partner with a Private Equity firm. The management team will bring the know-how, while the PE will bring the capital.
• Leveraged Buy-Out (LBO): This investing focuses on acquiring businesses with stable cash flows entitled to receive a high amount of debt financing. This process is called leveraging: The company’s cash flows are used to pay for its acquisition, minimizing the required equity investment and leading to quite attractive returns. However, in this form of investing, there is an additional risk to be considered, the risk of defaulting on the debt payment. LBOs can be combined with other forms of private equity investing whenever the use of debt exceeds the average level.
• Real Estate: Some private equity funds will invest in real estate, e.g., commercial and/or residential real estate assets. Real Estate is considered a particular form of private equity investing as here the topic is managing a building and not a company anymore.
• Venture Capital: As mentioned before, Venture Capital is a unique form of Private Equity investing which specifically targets investing in Startups or new Ventures. Venture Capital comes with additional risk and requires unique know-how to manage this type of risk.
• Fund of Funds: Fund of funds investing means that this type of Private Equity investor will seek to invest in other Private Equity funds. The idea here is that only select Private Equity investors can deliver exceptional returns, and the selection of Private Equity funds is critical. Therefore, outsourcing fund of funds investment to a specialized team familiar with analyzing Private Equity funds. The downside here is an additional fee layer introduced, making this more expensive.
• Buy and Hold: This would be another form of Private Equity investing mentioned here. In this case, investors would agree not to seek an immediate exit but rather stay invested over a an extended period. Vehicles like this typically will get listed on a stock exchange so that the limited partners can exit beforehand while allowing new investors to come in at any time.

So as you can see their many sub-types of Private Equity investors might be worth it for businesses seeking investors to know about those.

What are typical Investment Criteria of Private Equity Investors?

The goal of Private Equity firms is to generate attractive returns, as reflected in the selection of suitable investment opportunities which need to meet specific criteria:

• Target Company Size
• Minimum Equity Stake
• Industries of Interest
• Business Situation
• Qualified Management Team
• Minimum target Internal Rate of Return (IRR)
• Exit Route

Please note, in contrast to Venture Capital, Private Equity Funds typically target to obtain a significant minority stake with investor participation rights (e.g., 33%) or even a controlling stake (>51%). The reason is that they will need more control over their exit and, in many cases, will be the only investor, also as there are no additional funding rounds are expected. The other aspect is that it takes the same amount of work to do the due diligence for one business to be invested in, and the rewards are immense when investing a larger ticket size.

How do Private Equity Investors Exit?

Private Equity firms typically need to clarify their likely exit routes before investing in a new firm. They will need comfort that at least one of these following exit routes will be realistic:

• Trade Sale: Refers to the sale of the company to a new owner.
• IPO: Refers to the listing of the company on a stock exchange, whereas the stock, later on, can be sold
• Leveraged Refinancing: In this case, there is no actual exit. The Private Equity firm will seek to obtain additional debt financing (leverage) from a bank and use those proceeds to pay out an extraordinary dividend.

What do Startups need to know about Private Equity?

It is essential to know that the typical Private Equity investor will not even invest in startups. Only specialized types of funds or Private Equity funds targeting certain situations can offer a viable funding solution. Therefore, it is worthwhile to ask for and carefully analyze the investment criteria of the Private Equity fund.

Another essential topic to analyze is the amount of debt financing a Private Equity firm plans to use. Taking on debt on a company’s balance sheet requires service later on. Servicing debt draws funds away from the free cash flows that otherwise can be invested in new growth initiatives. Using high amounts of debt financing will put a lot of pressure on the company to service that debt.

Private Equity investors also are exit-driven which raises the question of who will become the following company’s owner. Choosing the successor leaves significant power in the hands of the Private Equity investors. Any business or startup looking to raise funds from these funding sources for a startup might want to include such considerations when selecting suitable investors.

Overall Private Equity firms are professional investors who typically possess significant investment know-how and experience. However, only very few Private Equity firms will invest in a startup.

DEX Offerings

A new alternative to startup funding has been developed in the cryptocurrency space. DEX refers to “decentralized exchange”, which are automatic market makers such as Uniswap, Sushi Swap, PancakeSwap, TraderJoe, and many more in development. It works here is that a new cryptocurrency creates its digital coins or tokens and lists them on decentralized exchanges. The main idea here is to make those coins liquid upon issuance to be traded as digital tokens and allow investors the flexibility to sell them provided there is sufficient liquidity in the market.

The initial listing process is called initial dex offering (IDO), where typically, investors need to apply and fulfill specific criteria to get whitelisted and benefit from attractive entry prices. The initial Dex Offering is similar to crowdfunding because there need to be many investors, and their money needs to be pooled together to create a new cryptocurrency. Ideally, the funds raised will go to the project, but many times will end up in the hands of the founders.

DEX offerings have a reputation for being pump and dump schemes. Typically, upon offering, the price pumps, and then when it goes up, the investors take profit, and the price dumps again. Sophisticated marketing campaigns commonly accompany Dex Offerings via Social Media, which aim to create hype to manipulate the price, and many times there is suspicion of insider trading.

There is also a question about regulatory compliance with current security laws pending, as many of these cryptocurrencies potentially fulfill the securities criteria. Therefore such DEX offerings would be subject to the applicable local security laws. Currently, many projects simply are ignoring these questions as this is a bit of a grey space at the moment. Furthermore, regulators have not followed up on many of these cryptocurrency projects and left it to the market to decide. We can expect that more clarity will become available in the following years on how regulators will treat these kinds of projects.

Raising Startup funding via an initial DEX offering might not be a suitable alternative for many startups and appears to be more of an option for those with projects in the cryptocurrency space that will provide utility. There is also a pending question if such an offering might not violate local security laws.

Equipment Leasing

Another kind of funding source for startups to consider is Equipment Suppliers. Many times, equipment suppliers selling Trucks, Agriculture Equipment, Injection Molding Machines, or other types of Equipment will offer two possibilities to purchase the equipment:

• Purchase
• Leasing

The outright purchase option is the traditional way of paying for the equipment by cash. The alternative is if the equipment supplier can offer a leasing arrangement. The way it works is that the equipment can be paid in installments during a leasing period of typically 2-7 years (depending on the type of equipment). In this case, the equipment supplier will carry the risk if a startup cannot pay.

The equipment supplier can carry such risk because they know their equipment very well, and if something goes wrong could take the machinery back and sell it to somebody else. Often there will be a second-hand market for such machinery, and the equipment supplier has access to a pool of alternative buyers if needed. In addition, this can be a very lucrative business opportunity for an equipment supplier. The startup will often be obliged also to purchase the maintenance service and a service level agreement from the equipment supplier, leading to stable revenues. Many times, equipment suppliers have relationships with financing providers themselves so that leased equipment can be re-financed in a back-to-back agreement with a bank or a specialized leasing financing firm. In addition, the equipment suppliers can adjust the equipment price for the risk reflected by an interest rate included when calculating the monthly or quarterly leasing rates. The adjustments can lead to higher profit margins than a cash sale. So overall, offering equipment financing can be an appealing additional business opportunity for an equipment supplier.

However, this still requires that the startup passes the due diligence of the equipment supplier. Possible due diligence criteria for equipment leasing might be the following ones:

• Evidence of a source of revenue (e.g., a contract for producing certain parts which would require the use of the machinery)
• Know-how and ability of the lender to operate the machines
• Financial projections can demonstrate that the startup will have the financial ability to service the lease as per the agreed period (typically 2-7 years leasing period)

For equipment leasing or financing, the machinery will remain in possession of the equipment supplier until the end of the leasing period. The startup can often buy machinery at a remaining pre-agreed price.

Equipment leasing will only be feasible for a particular type of startup. The typical characteristics are the following ones:

• The Prospect of Revenues – Startup facing prospects or even have secured their first revenues (e.g., via an off-take agreement)
• Standard Equipment could also be used by another company when sold in a secondary market. Equipment leasing typically wouldn’t work if the startup requires specific equipment with many complex customizations that this startup can only use.
• Knowledgeable Workforce with the ability to operate the equipment
• Immediate start of production with all prior development work already done and the machinery can be put in place and will start operating from day one onward.

So overall, using equipment financing can be an attractive additional funding source for a startup. Leasing costs are typically cheaper than having offered an equity stake, so it’s a cheaper form of financing than equity capital. The downside is that servicing the leases reduces free cash flows, and equipment financing is not available for every type of equipment.

Bank Financing

The last funding option for startups we consider in this article is bank financing. Bank Financing is usually a very challenging source of funding compared to all other startup funding types as startups do not precisely meet the preferred lending criteria many banks will use. Here is a reminder of what kind of standard lending criteria banks typically have:

Bank Lending Criteria

• Established business model
• Track-record with many years of profitability
• Business plan available which clearly outlines how to service a loan
• Stable cash flows and profits
• Available Assets which can be used as collateral
• Availability of equity financing which can absorb risk

Startups and Bank Lending Criteria

As you can see in the list above, startups usually have difficulties meeting those criteria.

• Startups typically do not have an established business model. They are in the process of launching a product or service to the market and will first require validation and traction. Therefore, there is always a risk that insufficient demand for such a type of service or product in the market.
• There is no historical track record or evidence of profitability.
• Startups usually will prepare a business plan. Here the question is how credible this business plan will be, which typically depends on the team’s profiles, their track record, and how well prepared the business plan and feasibility study will be. However, even the best business plan alone might not be sufficient to meet the bank’s lending criteria.
• Startups typically do not yet have businesses with stable profits and cash flows. Often, first profits will need to be reinvested to grow the business further. Paying interest on a loan can be a real obstacle to achieving such growth as the cash will be diverted away from funding growth initiatives to servicing a loan.
• Assets that often serve as collateral are rare or non-existent. Therefore, many times startups simply won’t have sufficient collateral to offer to a bank.
• Many times, equity financing for startups will need to cover the initial costs to set up the business and cover operating losses at the beginning. So available equity financing might disappear quite quickly or even become negative in the case of loss-making startups.

As you can see, startups typically will have a tough time satisfying the lending criteria of bank financing providers. Now the question is, are there ways to overcome these obstacles?

Ways to obtain Bank Financing for Startups

Let’s consider some examples of exceptional cases where startups can obtain bank financing.

• Properties / Mortgages: When buying a property, the property has value and serves as collateral. Therefore, banks might accept offering a mortgage to a startup when a startup will purchase a tangble property. Furthermore, banks also can set a Loan-to-Value (LTV) ratio typically in the range of 65% (commercial properties) to 80% (residential properties) to a lower limit if they deem the risk to be higher. If  something goes wrong, the bank can claim the property in a foreclosure process and auction it off on the market to recover its money.
• Guarantees from credible third parties: The prominent problem startups face their lack of credibility and track record. For this reason, banks typically avoid this risk. However, it will be a different story if credible third-party steps in here and guarantee this risk. An example would be Loan Guarantee Funds from IFAD or public guarantees for bank lending in response to the Covid pandemic. Please note that every guarantee provider will have additional criteria a startup needs to meet and will do his due diligence on top of this.
• Guarantees from a parent company: If a startup is owned or invested by an already established company with a solid relationship and track record with bank financing, it would also be possible that such an investor could provide a guarantee to the startup to cover an eventual loss. Typically, the way to go here is to first negotiate with the investor and introduce the idea of providing an additional guarantee to obtain bank financing (a so-called recourse loan). However, not all investors will accept this as this will add up to their risk. Investors  will only do this if they strongly believe in the startup or have additional motives to require a product for themselves. For the investors, this can be super risky.

As you can see there sometimes exist creative ways to obtain bank financing by a startup. However, this will typically require meeting additional criteria, and the funding process becomes more complex. In addition, the consequence is also that there will be more reporting work to be done as every lender will ask for regular updates, and typically will want to be kept in the loop. The number of stakeholders in the company will increase which will absorb more time by the company’s founders – time which otherwise could be spent on developing the business. For the startup, this means spending more time on admin and paperwork and having to service the debt will also eat up a significant part of the cash flows early on. For these reasons, it can be a bad idea to fund startups with debt and should only be considered a last resort.

Overall, many times bank financing will not be available for a Startup. If it should be available, using debt financing from a bank typically is much cheaper than using equity financing.

Conclusion: Available Funding Sources for business depend on the Type of Startup

In this article, we have reviewed 12 potential funding sources for Startups. With some creativity, the point here is that there are many more funding sources for business available than just using venture capital. Each startup might want to carefully analyze its situation and seek all available financing options from this list as the availability of funding sources for business strongly depend on the type of Startup.

Below we have listed the pros and cons for each startup funding type to consider for startups and small businesses.

The Pros and Cons of the different Investor Types for Startups

Unlike other funding sources, bootstrapping doesn’t need to be externally sourced but is actually from the savings of the investors. The problem with bootstrapping is that the risks are solely shouldered by the founders. It might be faster to use other funding sources vs bootstrapping, meaning that patience will be required and profits, if any, would need to be reinvested to continue to grow the company.

While it is convenient to borrow from family, friends, and fools, it is not wise to take their belief in the founders for granted. Since they are also part of the founders’ professional circle, personal relationships may also be affected when things do not go so well for the startup. If you’re up for large-scale reporting to many customers, you can also opt for crowdfunding. Crowdfunding is appealing to individuals who are willing to fund your inventory so that you can create the product you are offering.

To answer what are angel investors, while they may invest in you early, Angel investors alone aren’t enough to fund startups. The founders need the support of other funding sources of startups to jumpstart their business idea. The Good thing about angel investors is that they are also entrepreneurs, and they may be as enterprising as the founders, if not more.

For free investments, the founders can apply for startup grants, which are too specific in terms of criteria. Startup grants are also strict with requirements since grants are given to further a cause that is aligned to the entities that give the grant. Another type of funding source is the family offices. While they’re not as common, it would be very beneficial to the founders to get a family office on board. Family offices are not exit-driven, which means that they will hold on to their investments for a very long time. They are very conservative investors, though, so it would be difficult to get them to invest in a startup.

For professional investors, we have 3 kinds, first, is the most popular called venture capital. Venture capital is professionals investing in startups and they also guide the founders. The problem with venture capital firms is that they are exit-driven, and they would want a bigger piece of the pie because they believe in the value they bring to the table. The same is true with corporate venture funds, the only difference is that corporate venture funds also look at the alignment of direction between the startup and the corporation planning to invest. Lastly, we have private equity firms. Private equity firms are relatively conservative, and might not invest in startups because of the nature of startups.

While cryptocurrency is a fledgling industry, we can also consider the IDO or the Initial DEX offering as another form of funding for startups. DEX is short for decentralized exchange, and while it would also be suitable for cryptocurrency projects, IDOs can easily accumulate funds through marketing and online channels. Current problems include regulatory requirements and that this can only be used by cryptocurrency projects.

Another form of funding is from equipment leasing. With this, you don’t need to dilute your investment to get funding. Leasing equipment is also cheaper than equity financing, the only problem here is that it limits cash flow, and is also limited to whatever equipment can be leased. Finally, we have the banks, and while banks can technically finance your startup, the riskiness of the project will most likely discourage banks from lending.

With all these funding sources of business available to startup founders, they must evaluate the best combination of funding sources to tap, based on their current situation.