Alternate financing options for startups
With VCs shying away from investing in startups, there are a host of other options open to entrepreneurs to raise the much-needed capital despite all the uncertainty and negative sentiment.
Funding is critical for most startups to survive, especially in the current turbulent environment. The global pandemic, while compelling several big companies to go for cost-cutting, has forced many small and new businesses to shut shop. Investor sentiment is also at an all-time low with several countries in the throes of a recession and the global economy continuing to be on a downward trajectory.
During economic downturns, it is usually difficult for new entrepreneurs and ideas to get funding, especially from venture capitalists (VCs). In the current scenario, VCs are wary of taking risk and the trend may continue for a while. However, startups can explore other avenues for funding. Some of these are:
1. Bootstrapping
Funding one’s own business or bootstrapping is the ideal route for any startup. The entrepreneur invests the seed capital, tapping either into personal savings or taking a loan from family or friends. There are many positives to this option. The entrepreneur can independently decide on how to operate without the strappings of any financial obligation.
The biggest challenge, however, is that the amount of capital is generally small, sufficient to cover just the initial costs.
2. Crowdfunding
An entrepreneur can draw outsiders to invest in his idea through the crowdfunding option. There are many crowdfunding platforms to help new-age entrepreneurs connect with like-minded investors.
Since this involves many people, the investment per person is fairly low, at times as less as USD 10. As the amount is small, investors do not really get monetary benefits. They may get free products or samples.
New gaming ideas, for instance, are usually funded through this route. The benefit for investors is that they generally get for free the first edition of the game when it is released. Not only is it an incentive for the investor but the entrepreneur also gets a chance to pilot test his product on potential customers.
Equity crowdfunding – Under this, individual investors invest in an early-stage unlisted company in exchange for shares in that company. Therefore, like any other equity investment, investors can gain if the company does well.
3. Initial Coin Offering (ICO)
A fairly new concept, ICO is intrinsic to the cryptocurrency industry, serving as an equivalent to an Initial Public Offering (IPO). Investors in an ICO generally receive a new cryptocurrency token issued by the company.
The token is either a key to using the company’s product or service or may just represent a stake in it or a project. A technology (in itself), this is an easy platform to raise funds. Technology firms largely take recourse to ICOs.
There are no set rules and regulations to govern ICOs due to which chances of fraud are very high. Therefore, investors must be cautious and do their due diligence before investing in ICOs.
4. Partner Financing
If a company takes interest in an idea or innovation by a startup and decides to fund it, it is known as partner financing. Apart from funding, larger companies may take the startup under their wings and help it in other aspects as well.
A collaborative tool, it is advantageous for a new company entering uncharted territories. On the flip side, it results in loss of control. All strategic and management decisions need to be approved by the funding company. Therefore, it is ideal to have an agreement if this option is chosen.
5. Accelerator/Incubator Programs
These programs are specifically run to aid startups in the initial stages. Accelerators are organisations that offer a focused program to startups pertaining to mentorship, education, and networking resources for a specified period. This readies a startup to present its case effectively to interested investors.
Incubators are similar in terms of concept, but they also take novice startups (that just have the idea, but no associated product based on it or setup to give shape to it) under their programs. As the name suggests, they help the startup in preparing or building upon its idea. Incubators pick up stake for their aid, but some are also government-funded.
While these avenues may not provide ample funds, they help startups to be investor-ready and enter the market.
6. Pitch Competition
This platform provides exposure and support. Entrepreneurs and innovators can unveil their products or solutions in front of seasoned judges.
Not only do winners get cash prizes and the opportunity to be guided by mentors but they can also leverage it to build network for obtaining funding in future.
However, competition is fierce. Plus, there is the risk of theft of idea due to the absence of any confidentiality clause to protect an entrepreneur’s ideas. Therefore, this is not a highly popular form of funding.
7. Venture Debt
A somewhat traditional form of funding, it is also known as venture lending. Under it, a diverse set of debt financing products is offered to early and growth-stage venture capital-backed companies. Usually banks and dedicated venture debt funds offer this form of funding.
While the interest rate on loans is high, adding to the costs for a young company, the plus point is that there is no loss of control and the entrepreneur can use the fund in line with his strategy.
8. Government Grants
Many countries encourage innovations and offer aid to new-age entrepreneurs. One of these steps is giving grants. The best part about a grant is that there is no financial obligation to repay it.
There are some limitations, though. Grants are few and, with many other startups in the fray, competition is tough. Also, guidelines on how the money can be used are stringent, not allowing for much flexibility to deploy funds.
VCs are not the only options for startups to get funding. Several alternatives have mushroomed in the current changing environment. Entrepreneurs can consider any of these, depending upon their requirement, to give the right boost to their idea.
Until the investment market turns positive and VCs are comfortable loosening their purse strings, these options may well provide the much-needed succour.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)