When most founders think about funding, their minds immediately go to a venture raise. However, in the current economic climate, venture funding is becoming harder to secure than it was a year ago. For startups that need outside funding to accelerate growth, that’s a problem.
3 Alternatives To Venture Financing
- Online lenders: These loans, usually under $100,000, use automation to analyze personal and business credit indicators.
- Equity crowdfunding platforms: Raise capital online from investors through a profile that includes your pitch, financial statements and other information.
- Revenue-based financing: It’s underwritten based on your company’s projected future revenue relative to past performance.
Alternative capital options have emerged in the last several years. Online lenders, crowdfunding and revenue-based financing all give you options when you may not have the high growth required today for VCs, the collateral or profitability required by traditional debt providers, or need to act faster than those options allow.
For those unfamiliar with these options, I’ll outline where to start and then give you the pros and cons of three types of alternative capital. Make the right choice for your business and you’ll still be able to hit those growth milestones and maximize future valuations, despite the current venture downturn.
Know What You’re Looking For
When thinking about an alternative funding partner, founders should consider the following:
- Does it match my needs? Determine the use of the capital and the return you will generate, then match that to the structure. Consider if the repayment terms are long enough to let you deploy the capital and see the returns, versus it coming in and your cash going back out the door because of short repayment terms that create high payments.
- Is it the right amount? Establish how much you need to act on your near-term goals and then what you will be able to secure. The amount has to be meaningful to execute on your strategic initiatives but also make sure that you are not overleveraging your business or getting too diluted.
- Will it grow as I go? If the amount isn’t enough to accomplish all your goals, check to see if your capital partner will allow you to access additional funding when certain growth milestones are hit, and if they can support your long-term growth goals.
- What is my cost for the capital? Beyond your fees or APR, when evaluating cost, you don’t want to pay for capital you are not using or are not ready to leverage. Many capital partners will require you to take larger sums (or all of it) upfront. This is typical when equity is involved, but the long-term costs need to be weighed here. Look for a partner that will allow you to draw what you need, when you need it. You’ll find uses for the additional capital as you grow, it just might not be in the next month.
Alternative Financing Options
Here’s a closer look at three types of alternative financing available to startups, plus benefits and drawbacks and how to prepare for them.
Online lenders offer an option for startups looking to secure capital without navigating traditional lending hurdles. These loans, which generally don’t exceed $100,000, use automation to analyze personal and business credit indicators.
In this case, the main benefit is speed. Partnering with a fintech lender can help businesses secure a minimal amount of capital in as little as one business day. This can be a solid option if all you need is quick, non-dilutive funding to solve short-term cash deficits.
But the speed at which this capital is delivered often comes with costs, including:
- Short repayment terms. Online loans may require full repayment in as little as three months, leaving little time to prove the ROI of the investment.
- Frequent payments. Lenders may require payments made on a weekly or even daily basis, which can restrict cash flow depending on the amount borrowed.
- Personal risk. Many of these online lenders require the founder to personally secure the loan and are dependent on their personal credit score.
The result? Limited impact on growth. The loan’s term and payment structure may limit the amount of capital you can deploy, resulting in paying back the loan before seeing any benefits from the capital financed.
How to prepare for this kind of funding: Because much of this funding relies on the personal credit of the founder, it’s recommended that you prepare for this type of capital the way you’d prepare for a mortgage but with some extra steps. Personally, knock out revolving debt, get your credit score up, have your paperwork in order and know what you’ll put up for collateral. For the business, decide what type of loan you want (do your research on the different types), document your business plan, and know when the right time is to apply as it’s possible you will have to start paying on this capital very quickly.
You will likely have personal financial and/or business accounts, so many sure you have access to those prior to applying.
Another alternative capital option for early-stage startups is equity crowdfunding. The term crowdfunding brings to mind Kickstarter and consumer goods, but a number of platforms are focused on equity-based crowdfunding for early-stage businesses.
Crowdfunding platforms allow you to raise capital online from investors through a profile that includes your pitch, financial statements and other information investors need to make an informed decision. Like traditional equity raises, you’re offering a piece of your business rather than a loan that needs to be repaid. Debt may be a part of the deal in some instances, but this varies based on platform and investors.
For first-time entrepreneurs or companies with a unique bend that wouldn’t be a good fit for traditional venture capital, crowdfunding is a great alternative to investigate.
As with any equity-based funding, there can be some downsides:
- An unpredictable amount of capital. Like traditional venture capital, you don’t know how much you’re going to be able to raise until you go through the whole process.
- You’re giving up a piece of your business. It’s not the right fit for everyone, especially if the investor requires operational oversight as a part of the investment.
- Fees. These platforms make their revenue by charging a percentage of funds raised for their services, through monthly listing fees or from additional payment processing fees.
- Additional expenses. Because this is an equity investment, you will likely need help from lawyers and accountants or other services to make sure everything is in order.
Even with these innovations in equity models, companies looking at crowdfunding should be aware that there are many laws that govern this type of investing to protect inexperienced investors. Seeking advice from legal counsel is recommended.
How to prepare for this kind of funding: Crowdfunding investors are looking for similar things as traditional venture investors. However, they’re primarily evaluating you online. Know what you’re willing to give in terms of equity and for what valuation. Have the numbers and performance to justify the valuation. Demonstrate a clear product market fit in a way that connects with investors. Make sure your pitch and financials tell the full story of who you are and what you do via the online profile. Consider creating a video about the company specifically for this purpose to increase the impact of your online story.
Revenue-based financing (RBF) offers a non-dilutive investment that provides the capital to maintain your growth trajectory. You apply online and sync your financial systems. Terms are generally simple, straightforward and aligned with how startups, especially SaaS companies, do business.
What makes revenue-based financing unique is that it’s underwritten based on your projected future revenue relative to past performance. Because access to capital is based on revenue growth, the amount you access can grow as your revenue grows. Neither personal credit score nor collateral are needed.
Another thing that differentiates revenue-based financing is that it is built for growth initiatives. If you’re looking to bridge to an equity round, smooth your seasonal cash flow, hire to support implementations or scale sales and marketing, this type of capital is likely a good fit.
Revenue-based financing isn’t for every business, though. If any of the following describe your business, another type of capital might work better:
- Stagnant growth. If your business is starting to flatline or is heading in the wrong direction, RBF is not a good fit because funding is based on predictable future growth.
- Burn is at a high rate. If your expenses relative to revenue are off balance, approval is unlikely. Burn needs to be under control and showing an eventual path to profitability for RBF to work.
- Seeking small amounts. Given the cost of capital compared to a traditional business loan or online lender, it may make more sense to pursue those options if you have good personal credit.
Every company that provides RBF financing can do things a little differently, so when evaluating this type of financing, compare not just payments and fees, but length of payback as well. Much like with online lenders, some can have quick payback terms (six to 12 months), meaning you’re essentially receiving the money and are paying it back before you have a chance to see the ROI.
How to prepare for this kind of funding: Start early. Many founders underestimate their true runway and try to apply when their numbers won’t give them the amount of funding they are looking for. Get burn under control, tighten up any numbers or financials and have a clear use case for the capital.
With regard to burn, predictability and scalability are king for RBF. Burn isn’t seen as inherently bad, so if your burn is driving growth, then it has an ROI. Be able to describe how those expenses are an investment in your growth. Know your numbers: understand how burn has an impact on customer acquisition costs, customer renewals and churn rates.
Evaluating Alternative Financing Providers
After you’ve found the funding partners you want to consider, you’ll need to look at the terms of your deal. Look for things like dilutive provisions, as warrants or success fees are costly. Anticipate if your business can meet financial covenants. Decide if the payback structure for debt will make sense for your business, and determine how much effort you will need to devote to reporting/engagement.
The best piece of advice I can give any entrepreneur, regardless of what type of funding they’re seeking, is that when you think you need capital is probably much later than when you should start looking for capital. Get ahead of it long before the need sets in.
At the end of the day, the retreat of venture capital dollars isn’t a death knell for your business. Those founders who are willing to embark upon a less traditional funding journey will find the means to continue to grow and maximize their valuations when VCs come knocking again.