There are more funding and financing options for startups today than there ever have been before.
There’s also been an explosion in debate and transparency about navigating startup funding and financing. Bootstrapping vs VC, debt vs equity, profitability vs hyper-growth, sustainability vs substantial exits, the list goes on.
Let’s explore the funding and financing options for your startup.
Funding Your Startup
The truth is that funding options aren’t all that different from one another. Viewing it as a binary option — to get funding or not to get funding — is not an accurate reflection of reality.
Every business is funded, it’s just a matter of how it’s funded.
- Company A was funded by some of the founders’ savings, a small line of credit from the local bank, and profits from customers.
- Company B was funded by a small grant, a loan from the founder’s parents, a seed round, Series A, Series B, and then profits from customers.
- Company C was funded by pre-orders from customers, a friends and family round, and then through revenue-based financing for a period of time.
For Companies A, B, and C, they all exchanged equity for capital, leveraged debt, and used profits from customers to fund their startup.
How To Evaluate Funding Options
Stray away from absolutes.
“I would never raise funding” and conversely “I would never bootstrap” are both equally ignorant positions for a founder to hold.
Every business, every founder, and every market is different and requires a unique approach.
I guess what we’re trying to say is: Do what’s best for you, your business, and your customers.
Choosing the right combination of funding for your business is just as fundamental as choosing the right co-founders (or not), the right market, the right product, and the right team.
To get started in finding the right funding options, answer these two questions as thoroughly and honestly as possible:
- What do I value?
- What do I need funding for?
For each funding option, ask: “Is this funding option aligned with my values and goals for the business?”
It’s quite possible, maybe even probable, that you need to sit down and do some critical thinking about what your values and goals are, so that you can compare them with every funding option you consider.
Incentives are frequently misaligned, and the wrong funding option can be disastrous for your business.
While not disastrous, these startups demonstrate the significance of choosing the right funding for your business. Buffer spent $3.3 million – about half of all the cash they had on hand – to buy out their main venture capital investors after eight years since founding. After seriously considering an acquisition offer, Wistia decided to take on $17.3M in debt to buy out investors to focus on independence and profitability. Gumroad floundered, restructured, and then re-focused on profitability after failing to build a billion-dollar company. And don’t forget about Tettra’s journey from nearly failing to profitability and the nitty gritty of their seed round.
Now let’s explore the vast variety of startup funding and financing options out there in more detail.
Dictionaries and founders alike can’t agree on the definition of what it means to bootstrap a business. The best representation of what bootstrapping means today is starting and growing a business with minimal resources.
Bootstrapping purists insist on only using revenue from customers to fund the business. Taking pre-orders from customers, encouraging annual subscriptions, and even offering lifetime deals are just a few ways to make it work as a bootstrapping purist.
Others maintain that bootstrapping can also include other self-funding options, which could also include personal savings, loans, credit cards, and income from a job, consulting, or extraneous product. Whether founders want to admit it or not, less-than-ideal funding sources like personal savings and credit cards are more popular than you’d think.
More recently, the concept of “fund-strapping,” aka taking outside investment or external funding options with the intention of not having to raise any more funding again, has become another viable option for businesses. TinySeed, Earnest Capital, and Indie.vc are pioneering the way for new funding options for bootstrappers.
While bootstrapping has a couple different interpretations, it’s evolved more into an ethos rather than a technical definition.
“Don’t wait for someone to give you permission. If you are a writer you should write (don’t ask a publisher for permission). If you are a filmmaker you should make films (don’t ask a studio for permission). If you’re a founder you should build your product (don’t ask an investor for permission). Build your startup in a way that you don’t need investment. That way, if you decide to ask for it you’ll not only have no problem raising the money, but it will serve to add fuel to an already burning fire, rather than be consumed trying to start one.”Rob Walling of TinySeed
The benefits of bootstrapping center around prioritizing control, ownership, profitability, and building a “small” but lucrative business. While bootstrapping founders can take a much more calm approach to running a business, it can also be accompanied by slower growth and a long, slow ramp to reach where you want to be.
My company, which I classify as ‘bootstrapped’, has been funded from a combination of my personal severance from my last job, my personal consulting, and customer revenues. I had ~$30k in severance to begin with which I used to pay myself for a couple of months, during which time I got my company to ~$5k/mo in product revenue and also did multiple tens of thousands of consulting. To me, the biggest risk in not taking outside funding is not being able to pay yourself which can then lead to making short term (bad) decisions for your company. I was able to take that challenge off the table by consulting and severance, which enabled me to build the right product and business that became self-sustaining about a year later.John Doherty of Credo
Here’s a quick overview on some of the leading funding options for bootstrappers:
Started by Rob Walling and Einar Vollset, Tinyseed is “the first accelerator for bootstrappers” and is completely online. According to their terms, they invest $120,000 for your company’s first founder, then up to $20,000 per additional founder. The fund does take a permanent equity stake in your business of 8%-15%, although they do not take a board seat or hold any voting rights.
Earnest Capital is a fund by Tyler Tringas with SureSwift Capital that makes seed stage investments in “bootstrappers, indie hackers, makers, and real businesses.” Earnest Capital invests via a Shared Earnings Agreement, a new investment model developed transparently with the founder community with the intention to align with founders who want to run a profitable business and never be forced to raise follow-on financing or sell their business. A 3-5x return cap is agreed upon before investment, Earnest takes no equity, and Earnest is paid back over time through a percentage of “Founder Earnings.”
Indie.vc is a fund lead by Bryce Roberts with investments ranging anywhere from $100,000 to $1 million. With their V3 terms, founders typically pay 3%-7% of monthly revenue until they have repaid the fund 3x the amount invested. Each time a payment is made, the fund’s ownership stake is reduced with the founders’ ownership shares increasing since founders can repurchase up to 90% of the fund’s ownership stake through the recurring payments or even lump sum payments, while the fund maintains a minimum of 10% of the equity it was initially allocated.
The great thing about SaaS is that it’s a very cheap business to start. The primary investment is usually time. I started HostiFi 1 year ago with less than $500 of my own money invested, and about 2 months of work. It’s now generating over $5k MRR. I began working full time on HostiFi at around $2.5k MRR, and never required any additional investment. I applied to Earnest Capital, TinySeed, IndieVC, and HustleFund mainly for mentorship and ended up taking investment from Earnest. Having some capital has helped though, I am less stressed about month to month revenue now and able to focus my efforts on more long term growth strategies.Reilly Chase of HostiFi
If you’re interested in learning more about these options and how they compare, Matt Wensing of SimSaaS has written a great quant analysis between TinySeed, Earnest, and Indie.vc, although keep in mind that longer time-spans do need to be taken into consideration and, of course, do your own due diligence as well.
At the end of the day, bring it back to values and incentives to choose the best option for you and your business.
Particularly because there are now a few types of funding that can be broadly grouped into ‘funding, but not VC’ there is a temptation to micro-analyze the ‘cost’ of each of them. The question is framed as: ‘If I am exactly as successful as I think I’m going to be, which of these forms of capital will cost the least?’ I’m happy for founders to do this all day—there is a reason I surveyed all the financing options available that could meet the criteria of ‘what kind of funding would I have taken’ and decided to create our own—but I also don’t think shaving a percentage point here or there is the top priority… particularly if you don’t plan to raise a Series A-F afterward. The real question to ask is: ‘Does this agreement align the investor and I toward the same shared goals and priorities? Are our incentives aligned?’Tyler Tringas of Earnest Capital
Equity financing is the process of raising capital by selling shares of stock in the business. Equity financing can take many different forms and shapes, depending on the business model and time of investment. Usually, equity financing is broken down into “rounds” of investment at different stages of the business, though the names for each round are mostly arbitrary.
The upside to exchanging equity for capital is that it can allow a startup the resources they need to get to market with a product, build the team necessary, and reduce risk for founders who would otherwise have to rely on self-funding otherwise. This capital can also greatly accelerate the progress and trajectory of the business with resources that others may not get for years down the road.
Spencer Fry, founder of Podia, bootstrapped his previous three companies and now has taken on venture capital for his latest startup Podia. In his post about bootstrapping vs raising money, he talks about how raising money has allowed more resources, faster, the ability to compete in a growing market, the ability to build a high-quality business without sacrificing certain areas, and having great accountability.
The downside of exchanging equity for capital is that the founder(s) give up ownership, and sometimes even control. It’s very unlikely that you’ll get that ownership back, or even have the opportunity to. Don’t forget that equity is ownership, and you want to bring on the right owners with the right goals and incentives.
Below is an explanation of different forms of equity financing at different stages of the business. A business may raise funding through equity financing multiple times, which are known as “funding rounds.”
Pre-seed: Friends, family, and angels
This is usually the first real stage of funding through equity. Though venture level investors and funds are beginning to test the waters and investigate this space more, it’s typically been a less formal round of fundraising reserved for friends, family, and angel investors.
Choose your investors wisely. While it might feel generous to give Aunt Carol a piece of your business in exchange for some capital, she may not be making a wise decision personally or be a valuable source of advice. AngelList is a great source for finding angel investors, and should be carefully considered as well.
Seed capital is typically the first formal investment round raised through accredited investors like angels, seed venture capitalists, incubators, and accelerators.
Incubators and accelerators generally provide groups of startups with workspace, business advice and training, and potential funding. Each startup gets support from the accelerator or incubator plus networking opportunities with the other startups. In exchange, the incubator or accelerator may take an equity stake, especially if they provide funding.
Notable investors, incubators, and accelerators for seed rounds include:
After seed funding, a business will often turn to venture capital to make the next stage of their business a reality.
Venture capitalists (aka VC) usually come in the form of experienced investors looking to make large returns by investing in business ideas. Rather than a loan, which a recipient is legally bound to pay back, a VC accepts a certain amount of risk that they won’t make the money back, in hopes that some of their investments pay off huge. Although there is acceptance of risk, they are very selective of who they support.
It’s worth noting that VC has traditionally been the primary financial vehicle for billion-dollar companies. And it’s not that VC helps a company eventually become worth over a billion dollars, but that VC can be the right instrument for companies who are on a billion-dollar trajectory. Going back to what founders value, ask: “Can I build this into a billion-dollar company in the long run?”
Venture capitalists usually operate in “late-stage” funding rounds for businesses who have an established business and are growing rapidly. These rounds can be accompanied by other types of investors and funding methods, but are usually lead by venture capitalists.
The Series A funding round is usually after a seed round with the purpose of optimizing and expanding on what’s already been done and proven to work. At this point in the business, Series A funding normally goes to two key areas: hiring and customer acquisition.
The Series B funding round is a demonstration that the business is successfully deploying capital and can continue and even improve on the results seen from Series A funding. Profits may still be scarce, though the startup should be firing on all cylinders and demonstrating traction and business model that works.
Series C and beyond
Every funding round after Series B is essentially another larger, Series B round to continue on deploying capital to expand and grow. From here it’s likely going to be a sprint to an exit event, either through acquisition or IPO. Every round is accompanied by even more demanding due diligence to verify traction and expectations in tight timelines.
Bridge financing is an interim financing option used by companies to solidify their short-term position until a long-term financing option can be arranged, often in the form of a loan or equity investment.
A bridge round “bridges” the gap between the time a company is set to run out of money or have to downsize resources and when it can expect to receive another infusion of funding or reach profitability.
Notable venture capital firms include:
To see a more comprehensive list, see this list of 1,000+ venture capital firms by Golden.
Convertible debt can also be called convertible loans or convertible notes, which can essentially all be used interchangeably. Convertible debt is when a company borrows money from an investor with the intention to convert the debt to equity at some later date.
It can be advantageous to the company if it believes its equity will be worth more at a later date, then it will dilute less by issuing debt and converting it later. The transaction costs, mostly legal fees, are also usually less when issuing debt vs equity.
But why would investors issue convertible debt? Sometimes they are so eager to get the opportunity to invest in a company that they will put their money into a convertible note and let the next round investors set the price, especially early on in the company’s lifetime when it’s difficult to calculate an adequate valuation. Sometimes investors believe that the compensation, in the form of a warrant or a discount, are valuable enough to make it worthwhile. Debt is also senior to equity in a liquidation so there is some additional security for an investor to take a debt position vs an equity position.
A SAFE is a similar alternative investment model pioneered by Y Combinator lawyer Carolynn Levy and open sourced. The “simple agreement for future equity” was created and published as a simple replacement for convertible notes. In practice a SAFE enables a startup company and an investor to accomplish the same general goal as a convertible note, though a SAFE is not a debt instrument. Investors invest money in the company using a SAFE. In exchange for the money, with a SAFE, the investor receives the right to purchase stock in a future equity round (when one occurs) subject to certain parameters set in advance in the SAFE.
We self-funded to $100K MRR, then we raised $435K on SAFEs at $20million/20% discount. A little less than a year later and around $250k MRR, we asked both SaaS Capital and Lighter Capital for a loan. Lighter Capital said yes nearly immediately, it was about 3 weeks from our ask to the wire (for $800k) hitting our account. The process was easy, the only unexpected bit was we had to get life insurance for $800k payable to lighter capital on myself. We borrowed the money because our return on capital is much higher than the cost of capital on the debt and there are no strings attached – no board seat, warrants etc.Aaron Rubin of ShipHero
Leveraging Debt and Revenue-Based Financing
Debt is capital you have to pay back. Many lenders mask terms and conditions to make their loans seem more attractive, but in the end, all debt must be repaid. There are also some alternative methods for deploying and collecting debt, but again, it all must be repaid.
The advantage of leveraging debt and revenue-based financing is that you don’t have to sacrifice equity. Debt allows you to maintain ownership and full control over the company. There are also many more lenders than there are investors, and it’s generally easier to secure loans than it is to secure investment, especially in a time crunch.
The disadvantage of leveraging debt is that it can introduce a lot of pressure and liabilities to a business. Unlike a traditional equity investment that doesn’t have to be repaid, not repaying debt will result in legal consequences that could shut down a business or even hold founders accountable for repayment. It’s also worth noting that debt can constrain the capital available to use to fuel growth because of the recurring repayments with interest, whereas you don’t have to pay any interest with equity financing.
Debt and loans
Savvy entrepreneurs can take advantage of programs such as the U.S. Government-backed Small Business Association (SBA) loan program.
If you’re looking for a more flexible source of financing for your new business, consider a business line of credit. Often described as a hybrid between a credit card and a traditional business loan, a line of credit is a pool of funds established by the lender with a maximum credit limit. You can draw from the line of credit for nearly any business purpose and in any amount, up to the credit limit.
The difficult part about taking a loan as a software or SaaS company is that the lender will often require collateral. Since SaaS companies usually don’t have physical assets to pledge as collateral. Traditional lenders may then require a personal guarantee in the form of a house, car, or another business, which introduces much more risk for the founder(s).
Both personal and business credit cards are also popular options for funding. Personal credit cards, while not ideal, may be more popular than most would like to admit. Business credit cards require more due diligence, but offer many benefits with rewards, higher credit limits, and limited-time low APR periods.
Lighter Capital provides “revenue based financing” to SaaS, tech services, or digital media companies based in the United States and have funded over 300 startups to date. They make investments of $50,000 to $3 million—up to ⅓ of a company’s annualized revenue run rate. The money borrowed is typically repaid over 3-5 years, with payments ranging between 2%-8% of your monthly revenue. Typically the money returned is between 1.35x-2x the amount borrowed.
Metcalfe Fund is a new financing option that “provides growth capital to online businesses using actual business data instead of a credit score.” Metcalfe is paid back over time using an agreed upon percentage of your future sales. Repayment occurs daily with a small fixed percentage of daily sales being automatically debited from your bank account—they refer to this investment model as a Structuralized Future Revenue Purchase, or SFRP. The company provides financing in the range of $10,000-$500,000, which is typically paid back within 6 months for a 6%-10% fee (12%-20% annualized).
Clearbanc is another innovative solution for the next generation of startups looking for alternative funding options. Here’s how Clearbanc’s new campaign, “The 20-Min Term Sheet,” works: Clearbanc invests $10,000 to $10 million in e-commerce businesses with positive ad spend and positive unit economics after Clearbanc’s algorithm has reviewed the startup’s marketing and revenue data. Clearbanc sends the cash within 48 hours, doesn’t take a board seat or require a personal guarantee and continually invests in the company as it scales, so long as those two key metrics — ad spend and unit economics — remain positive. Here’s the catch: Until the company has paid back 106 percent of Clearbanc’s investment, Clearbanc takes a percentage of the company’s revenue every month.
Taking a small revenue-based loan enabled us to test some sales & marketing tactics and prove their effectiveness. Armed with these metrics, we were able to raise a $3M round from VCs.Nicolas Vandenberghe of Chili Piper
Crowdfunding involves getting a large group of people to back your company with relatively small amounts of money each. These backers will not always get a say in how your business is operated, depending on the platform, and they collectively share a relatively small risk each, because together they enthusiastically want the project in question to exist.
It’s important to note that crowdfunding can vary wildly. It can come in the form of equity financing or pre-sales. Traditional crowdfunding allows you to pre-sell your product before the product even exists and therefore raise the capital you need to create and distribute the product. Equity crowdfunding is a newer option made possible under the Jumpstart Our Business Startups (JOBS) Act — which allows you to seek small investments from a large number of investors.
Notable crowdfunding options include:
Fundable, Republic, and CrowdCube are all equity crowdfunding platforms, which facilitate the online offering of private company securities to a group of people for investment and are still subject to securities and financial regulation. See how Trust & Will used Republic to raise over $200k in capital.
Kickstarter and IndieGoGo are traditional crowdfunding platforms that are largely used by businesses selling physical products to go from prototype to functioning product, kickstart marketing, or validate demand for a new product. See how the Oculus Rift used Kickstarter to raise almost $2.5M in capital.
Like all other funding options, crowdfunding has its advantages and disadvantages. Crowdfunding can help startups gain even more capital than they originally set out to raise capital that they were unable to raise from other sources, and main more control than other sources may provide. On the flipside, founders can lose valuable insight from investors and advisors, or not reach their goal and waste valuable time and resources.
Startup funding and financing is an incredibly sophisticated process. The good news is that there are more varied options for more businesses than ever before. The bad news is that you have to sift through more options than ever to find the right one for you.
A guide on startup funding and financing would be remiss without a couple Paul Graham essays, so consider his fundraising survival guide and extensive thoughts on how to raise money as mandatory homework.
Remember: Do what’s best for you, your business, and your customers.