The Role Of Alternative Funding In Startups

Funding a startup can be challenging, especially if you’re new to the game. There’s lots of competition. Interest rates fluctuate depending on the current economic conditions and policies. Many seek an alternative route as traditional funding doesn’t always work out. What are the options, benefits, and risks of alternative financing for a startup?

What is Alternative Funding?

Alternative financing is any kind of financing that does not involve a traditional bank. Less common bank loans, such as those offered by credit unions or Community Development Financial Institutions (CDFI), may also fall into this category.

Why Do People Seek Alternative Funding?

Startups may seek alternatives to bank loans for several reasons.

• They are turned down for a traditional loan. This could be due to a lack of collateral, bad credit, or a nonviable business plan.
• They may seek alternative funding as a supplement to traditional financing.
• The process of applying for a loan is too complicated and drawn out. Some people prefer to deal with smaller, scaled-down options rather than go through the long process of seeking a bank loan.

How Alternative Funding is Changing the World for Startups

In the past, if you needed money to start a business, you had to go to a bank. Today, there are many more options, a development that has opened the doors to more startups.

• This gives more people access to funding. Alternative methods allow new entrepreneurs to get started even without the credentials they’d need to get a bank loan.
• Faster access to capital. Even when bank loans are approved, it’s usually a long process. Alternatives often give people funding much faster.
• Entrepreneurs can build a community and get feedback. Funding methods like crowdfunding and campaigns are good ways to test a concept before releasing a product. Based on early results, founders can make changes.

Major Types of Alternative Funding

Here are some of the most popular alternative funding methods for startups, along with their pros and cons.

Peer-to-Peer Lending

Peer-to-peer (P2P) funding is usually done through a P2P website such as LendingClub, Kiva, Funding Circle, or Zopa. Each service has its particular focus. Funding Circle specializes in smaller enterprises. LendingClub works with medical and dental companies. Kiva is a nonprofit that funds projects around the world. As with banks, loan interest rates depend on factors like credit history. Getting a loan on this kind of site requires a compelling pitch. When looking at P2P loans, you must also know the service’s transaction fees.

Pros

You can find investors from anywhere who are interested in your idea.

Cons

• It’s a very competitive field. You need a good pitch and must have (or develop) marketing skills.
• You may have trouble finding investors without good credit.

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Crowdfunding

Crowdfunding is a way to raise funds using websites like Kickstarter and GoFundMe. These websites offer funding for various projects, from album and book launches to inventions to more conventional startups.

While crowdfunding is similar in concept to P2P funding, there are a few differences. Crowdfunding works best for highlighting products, while P2P is often used for service-based and B2B models. Crowdfunding is also a better option for people with imperfect credit or little business history, as people are used to funding brand-new products.

Pros

• Suitable for people who are new to business or don’t have solid credit.

Cons

• Requires self-marketing. Your ability to get funding depends on your landing page and how well you publicize it.

Angel Investors

An angel investor invests in a business using their own money. They may also provide guidance and mentorship, while taking the firm’s equity in return for the investment. Angel investors can be accredited, meaning they must have a net worth of at least $1 million and an annual income of at least $200,000. A startup can also engage non-accredited investors who do not meet these requirements.

Pros

• You can get funding for startups that a bank would consider too risky.

Cons

• You have to give up equity in your business.

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Venture Capital

Venture capitalists are another funding option. They specialize in high-risk projects that often don’t qualify for traditional loans. Like angel investors, venture capitalists take an equity stake in the company.

While angel investors are individuals, venture capitalists work as a team or company.

The pros and cons of working with venture capitalists are similar to those that accompany angel investors. They may fund new and risky endeavors, but you must give up equity.

Startup Incubators and Accelerators

Startup incubators and accelerators are relatively recent innovations that can help new businesses get off the ground. Incubators, often locally based, offer guidance, mentorship, legal advice, and funding. Accelerators are a faster and scaled-down version of incubators, offering short and intensive mentorship programs and funding.

Pros

• Both startup incubators and accelerators can provide many valuable educational resources and funding to startups.

Cons

• Like venture capitalists and angel investors, you must give up a stake in your company in exchange for funding.

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Government Loans and Grants

Small Business Administration (SBA) loans are among the best-known types. However, not everyone knows that the SBA funds existing businesses and startups. The SBA offers possibilities such as micro-loans and 7 (a) loans for startups. In addition to loans, startups can apply for several government grants and subsidies. These are available in numerous categories, including grants for firms in a particular location, minority-owned, rural firms, and others.

Pros

 There are a wide variety of programs to apply for.

Cons

• Not all businesses are eligible for funding. Grants are often quite competitive.

Bootstrapping

Bootstrapping refers to raising capital without using investors or financial institutions. Capital can come from various sources.

• Savings
• Loans from friends and family.
• Personal credit.
• Selling assets such as real estate or an existing business. You may need to research what your assets are worth. For example, a real estate professional can advise you on a property’s value. If you manage merchant accounts, a merchant services portfolio evaluation can tell you their value.

Pros

You don’t have to give up equity in your company.

There’s no need for formal pitches or marketing.

Cons

• Your personal savings and credit are harmed if the business doesn’t succeed.

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What to Consider when Seeking the Best Kind of Funding

Let’s look at the main factors when you need financing.

Credit Rating and Collateral

Financial history often matters for alternative funding as much as traditional. In particular, investors on P2P platforms either prefer working with founders with a strong credit history. No matter what type of funding you are applying for, you must carefully consider before putting up collateral such as a home as there’s a real risk of losing it if the business doesn’t succeed.

Reach and Marketing Savvy

Success is often related to how healthy projects are marketed when using a method such as crowdfunding. Someone with a large social media following or email list has a significant edge. You must be ready to sell your campaign from scratch without an existing following or network. This may require paid advertising or intense content marketing.

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Amount of Capital Needed

The investment capital required for your startup is one of the first points to consider when applying for funding. It’s always more challenging to raise larger amounts.

Giving Up Equity

If you get financed by an angel investor or venture capital firm, you’ll have to give up a percentage of your company. While accepting funding offers when you need them may be tempting, you may regret it later if you’ve given up a large amount of equity if the business becomes profitable.

Creating a Good Business Plan, Pitch and Educational Material

A business plan is a basic necessity for traditional funding. Having a business plan for alternative funding is always a good idea, but you’ll also need other ways to communicate your message. On P2P and crowdfunding platforms, you’ll need a solid pitch or landing page. How you deliver the message is as important as the product or service. It’s worth putting lots of effort into developing a compelling pitch and marketing material such as videos, beta versions, product demos, or whatever is needed to demonstrate the quality of the product.

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Alternative Funding Offers Many Opportunities

Finding sufficient funding can be the difference between getting a startup off the ground and scraping or postponing the project. There are currently more funding options than ever before. Alternative funding can be used in place of or in addition to conventional loans. Many startups are funded with multiple sources, both traditional and alternative. Every business needs to find a solution that fits their needs.

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