Understanding The 6 Types of Business Funding

This post originally appeared on Capchase’s blog.

When you run a startup, securing the right types of funding at the right moments can feel like a never-ending game of chess. You have to think twenty moves in advance, and if you make just one mistake, you might end up sabotaging the whole game.

And plenty of founders do sabotage the game: It’s estimated that 80% of startups don’t make it past the first year, and 90% fail over the long run. And even those who do make it have their regrets: The average SaaS founder walks away with 20% equity in their company, with some hitting numbers as low as 1% or 5%—not much when you consider the overall emotional, financial, and spiritual investment founders make into their companies.

So, what can a startup founder do to ensure they’re navigating raising funds strategically? Keep reading to learn everything you need to know about how to raise funds for startups, including the different types of funding available, which growth stage is most appropriate for each, and what investors look for in a startup.

Why is startup funding important?

Funding is crucial for the success of any budding business, but it’s especially important for SaaS startups that may take months or years before they can generate a profit. Without outside funding for SaaS company growth, startups may not be able to build the teams and systems they need to develop their product and make their mark.

Startup funding has fueled some of the biggest businesses
Access to reliable capital has been a contributing factor to the success of many well-known startups that turned into multi-billion dollar companies, such as Airbnb, Uber, and Slack. These companies were able to secure funding early on, which allowed them to rapidly scale their businesses and outpace competitors. As a result, they have become household names and have created immense value for their investors.

For example, Airbnb got its official start in 2008, as a website created by two roommates who wanted to offer travelers the chance to stay at their apartment on an air mattress. Over the course of 8 years, the company raised billions of dollars in funding and managed to become a behemoth before finally becoming profitable in 2016. If it weren’t for outside investors, none of it would’ve been possible.

Considerations for how to raise funds for your startup
But simply getting funding isn’t a surefire method for startup success. How you go about raising funds for your startup and the types of startup funding you choose matter just as much, if not more, than securing funding by itself.

It’s important to weigh the pros and cons of each type of startup funding available to determine which option is best for your startup and the stage of growth it’s in. You should also question what you want to get out of the entire experience of raising funds for your startup. Is it important for you to walk away with maximum ownership? Or do you just care about getting the product out there, no matter what it takes? Do you really need $5 million, or will $2 million suffice for your expenses?

Asking these questions and more is important for ensuring you make the right decisions. Founders need to carefully consider their options and decide which type of funding aligns best with their goals and long-term vision.

Raising funds for startups: The top 6 types of startup funding

Securing the right type of funding is critical for the success of a startup. Here are the six most popular types of startup funding SaaS companies typically use, along with their biggest advantages and disadvantages.

Remember, these funding options aren’t mutually exclusive, and many startups use a mix of several throughout their funding journey. Many even use several at the same time.

1. Venture capital
Venture capital (VC) is one of the most popular types of startup funding out there, and almost all successful startups use VC at one point or another. VC is almost always used to raise big series rounds, like Series A or B, and makes up the bulk of funding a startup receives over its lifetime. A typical VC round of funding can be anywhere from $1M to $50M or more, depending on the size of the company and the series round.

Venture capital involves raising capital from institutional investors in exchange for equity in the company. Since VC investors take on a high risk by investing, they want a high reward and typically look for startups with high growth potential and a strong competitive advantage that could 10x or 100x in value.

Aside from the large amounts of money startups get from VCs, one of the key advantages of VC funding is the guidance and connections that come along with it. Venture capitalists often have a wealth of experience and connections within the industry, and can provide valuable advice on everything from product development to marketing strategies—which they’re motivated to give you since they’re personally invested in the company.

However, the strings attached to VC funding can also have downsides. If your vision for your company clashes with the vision your VCs have, you end up in a tricky situation that can result in losing control over your company—especially if the VCs own more of the company than you do. And, even if you do get along perfectly with all your VC funders, giving up huge chunks of equity just to keep your business afloat isn’t an ideal situation to be in.

2. Crowdfunding
Crowdfunding has emerged as a popular alternative to traditional methods for raising funds for startups. It involves reaching out to a large number of people, typically through social media or online platforms dedicated to crowdfunding like Kickstarter or IndieGoGo, to raise money for your business. Founders usually accomplish a successful crowdfunding campaign with a good viral marketing strategy and an incentive for investors, such as early access to the product, a discounted or free version of the product, t-shirts or other swag, or even equity in the company.

Crowdfunding can be a great way to validate your idea and generate interest in your product or service. If enough people are so interested in your product that they give money to create it, that can be a good sign that your product has real demand. It can even be used to pitch your product’s value to VC investors.

However, crowdfunding is a lot more difficult to pull off than it may seem. For one, it’s important to manage expectations and make sure that you can deliver on your promises—whether that’s providing early access by a certain date or printing 1,000 t-shirts. Failure to give your investors the incentive you promised can seriously damage your reputation and harm your chances of securing future funding. It can also be a sign that you’re not prepared to handle investor money properly—if you can’t estimate what’s realistically possible to accomplish with $50,000, you won’t fair any better handling $1 million.

Second, it’s extremely difficult to build the momentum necessary to get a meaningful amount of money from crowdfunding. Getting a small group of three or four investors to care about your product in real life is already challenging, so trying to get thousands of investors to give you money on the distraction-filled internet can be downright impossible. Between hundreds of other startups trying to do the same thing as you and the millions of other distractions people are faced with, just getting your message to the right audience can be a feat in itself.

Fortunately, there is a silver lining to this. Although initially grabbing people’s attention is difficult, once you have it, gaining traction becomes a lot easier. If you have a knack for viral marketing, a compelling pitch, and a solid product or service that’s easy to sell, crowdfunding can get you surprisingly far.

3. Angel investors
Angel investors are independently wealthy individuals who, much like venture capitalists, provide funding to startups in exchange for a share of ownership or equity in the company. They’re called angel investors because they tend to invest in businesses that can’t secure other types of funding, acting as angels to the founders. Because of this, angel investors are a great choice for startups that have a powerful, potential-filled idea, but don’t have proof of concept.

Angel investors can be a valuable source of capital, as well as guidance and connections. Because they are driven by passion and vision rather than profit alone, they’re often more flexible than venture capitalists and are more willing to act as personal business advisors to startup founders.

This can create amazing results when the founders and angel investors can act in synergy, but if they disagree on key aspects of the company’s values and trajectory, there could be serious problems. It’s important to choose investors who share your values and goals for the business, or else you risk ending up with someone who could transform your startup into something completely unrecognizable.

Additionally, as with VC, giving up equity in your company to an angel investor can be a difficult decision, as it dilutes your ownership and can limit your control over the direction of the company.

4. Bootstrapping
Bootstrapping involves self-funding your business or collecting funds from friends and family and can be a great option for entrepreneurs who want to start a business on a budget. By using their own savings or funds from friends and family (who will likely be laxer on interest and repayment than a regular investor), founders can avoid the high costs of traditional funding and maintain complete control over their company.

Bootstrapping is especially useful for young startups that are not yet generating revenue and cannot secure funds from venture capitalists, banks, or angel investors due to their lack of financial track record. Bootstrapping can also help founders create a lean business model that is focused on generating revenue as quickly as possible.

However, there are some downsides to bootstrapping as well. The primary risk of self-funding your startup is the financial burden it places on the founder. Without bootstrapped funding, there’s little to no safety net in case of unexpected expenses or downturns in the market, and all the consequences are placed on you, the founder. It’s essential to have a solid financial plan in place before starting a bootstrapped business and to be prepared to handle the ups and downs of running a startup on your own dime.

Despite the risks, bootstrapping can be a smart choice for entrepreneurs who are willing to take on the financial risk and put in the work required to make their business successful. By focusing on generating revenue and building a lean business model, bootstrapped startups can often achieve profitability faster than those relying on outside funding. And for founders who are successful and can keep their business running off of revenue and self-funding, the rewards can be substantial, as they maintain full control over their company and reap all the benefits of its success.

5. Debt funding
Debt funding is a traditional type of startup funding. Debt funding can include anything from bank loans and small business loans to microlending, but the key feature of debt funding is that a startup takes on debt to fund its growth.

Debt funding can be a good option for startups looking to fill up gaps in cash flow, get started, or make it to the next big round of VC funding. However, taking on debt if you’re not making enough money to pay it back can backfire. Failing to make payments on a loan can lead to serious consequences, such as defaulting on the loan, which can damage your credit score and limit your ability to secure future funding.

This is especially hazardous if your business suddenly takes a turn and doesn’t produce as much revenue as it used to, leaving you with negative cash flow and an inability to pay back debt.

A popular offshoot of debt funding is venture debt. Venture debt is given by venture capitalists or other specialized lenders to early-stage companies that may not have the revenue or financial history to secure regular debt funding. While typically has shorter repayment terms and higher interest rates, it also comes with the benefit of industry connections and guidance.

6. Revenue-based financing
Revenue-based financing (RBF) is a fairly new type of alternative startup funding that has gained popularity in recent years. It involves raising capital by selling a percentage of future revenue to investors.

One of the main benefits of revenue-based financing is that it creates a nice middle-ground between other funding options. It doesn’t require taking on debt or giving up equity, and it also tends to lend more than loans but less than venture capital. Most revenue-based financing providers also offer guidance and business help to founders, similar to a VC. This can make it a good sweet spot for startup founders who don’t quite need the massive capital or overbearing guidance of a VC or angel investor but need more than what a hands-off debt lender could provide.

Another advantage of revenue-based financing is that it can be a more sustainable funding option for startups. Unlike traditional venture capital funding, which often requires startups to focus on rapid growth and profitability, revenue-based financing allows companies to focus on generating sustainable revenue over time. This can lead to more stable growth and better long-term prospects for the business. It’s also a great option for startups who are in between funding rounds and need an extra boost to get to their next round.

If you’re wondering whether revenue-based financing could meet your financial needs, check out our runway calculator to see how much capital you could get approved for from Capchase Grow.

Understanding the 5 stages of startups

Most startups use a variety of different funding methods that are chosen for different reasons, including convenience, what they can get approved for, and the amount of money offered. One of the most important considerations on how to raise funds for startups is to accurately gauge your current growth stage.

Here’s a rough breakdown of each startup growth stage, and what kind of funding is most appropriate for each.

1. Pre-seed stage
At this stage, the focus is on getting the business off the ground and creating a minimum-viable product. Because your company has no track record of success, funding options are extremely limited. Most pre-seed founders have to rely on their personal funds, or benefactors who believe in their vision, despite the lack of proof of concept.

The most common sources of funding for pre-seed startups are bootstrapping, crowdfunding, and, less commonly, angel investors. Some dedicated venture capital funds may also invest in pre-seed startups, but this is even rarer.

2. Seed stage
Seed-stage startups have gotten past launching their business and are looking to validate their product and gain traction in the market. At the seed stage, you still don’t have much to prove your company will be successful, so bootstrapping and crowdfunding are still fairly common.

However, since seed-stage startups are a bit further along than pre-seed and have likely gained some level of reputation, Angel investors are a lot more likely to invest. VC funding also starts becoming an option at this stage, provided the startup has a well-defined product roadmap and clear growth strategy.

3. Early stage
The early stage typically means startups who are seeking a series A or series B round of funding. At this stage, the startup has found some initial success and is looking to scale its operations. They have a proven concept and a growing customer base and are ready to take it to the next level.

The most common funding choices for early-stage startups are venture capital and debt financing. It’s slightly too late for angel investors, bootstrapping, and crowdfunding since the company has already gotten off the ground. Revenue-based financing starts to become relevant too, as by now, the startup has established a financial track record.

4. Growth stage
The growth stage can be loosely defined as anything from series B to series C, and sometimes even further. Some even consider the growth stage to be everything that leads up to an IPO. Regardless of how you technically define it, the growth stage is all about rapid growth and expansion.

At this stage, the startup has proven itself as a successful, rapidly growing business, and has the revenue and market dominance to back it up. Venture capital is still sought out at the growth stage, but it starts to phase out in relevance as the company needs less outside cash and the founders run out of equity they’re willing to give up.

This stage is one of the best times to consider revenue-based financing, as the company has already established a track record of success, and the founders may not want to lose any more equity. Debt financing is also a common alternative, as a growth-stage startup is very likely to get approved for a loan.

5. Late stage
In the late stage, the startup is preparing for an exit, whether that be through an IPO or acquisition. At this stage, VC funding, angel investor funding, and other dilutive options are still sometimes used, but they’re generally avoided as they involve giving up too much control and equity, and most late-stage startups don’t need large sums of outside funding anyway.

The late stage is one of the best times to consider revenue-based financing and other forms of non-dilutive funding. These can act as the perfect way to close up temporary cash flow gaps without needing to sacrifice ownership or promise new exponential growth. Debt funding is also an additional option at this stage, for similar reasons.

What investors look for in a startup: How to make an impression

Regardless of which type of startup funding method you choose, at some point, you’re going to need to convince someone else to give you money. So, how do you convince investors that your startup is worth investing in? Here’s a checklist of questions you need to answer when pitching your company to a potential investor.

Does your product address a real pain point?
Investors want to see that your startup addresses a real pain point for customers that isn’t already being solved by someone else. They want to know that there is a clear need for your product or service in the market and that customers are willing to pay for it. This can be demonstrated through market research, customer feedback, and competitor analysis.

Is your target market clear?
It’s also important to have a clear understanding of your target market. Who are your customers? Where do they live? What are their interests and behaviors? Do you know how to reach them and speak their language? Investors want to see that you have a well-defined target market and a strategy for reaching them.

Is your business scalable?
One of the biggest things that differentiates a regular small business from a startup is how much potential your product has to scale. Investors (especially angel and VC investors) want to see that your startup has the potential to grow rapidly and generate significant returns on their investment. This can be demonstrated through a solid business plan, a scalable business model, and a clear strategy for growth. Proving customer demand also helps.

Can you sell your product?
Finally, investors want to see that your startup has a solid sales strategy in place. They want to know that you have a plan for acquiring customers and generating revenue and that this plan will actually work. This can be demonstrated through a well-defined sales process, a strong marketing strategy, and early sales traction.

Your pitch to your investors also acts as its own proof of sales strategy—if you can’t successfully explain why your product is worth investing in, you probably don’t know how to explain why it’s worth buying to your customers.

Finding a way forward: Grow with Capchase

If you’re looking for alternative financing options to kickstart a new phase of growth or to supplement your cash flow in between VC rounds, Capchase can help.

Capchase Grow’s revenue-based financing allows you to grow your business without giving up equity or taking on debt with financing that you can access quickly and easily—often within 72 hours or less. All you have to do is sync your business data into our streamlined application process, and you can receive a funding offer based on your ARR for up to $10 million.

Plus, Capchase also pairs you with a dedicated Growth Advisor who can help you navigate the funding process and give you tips on how to grow your business.

If you’re interested in learning more about how Capchase can help you extend your runway and meet your growth goals, try our runway calculator to see how much funding your startup can qualify for, or connect with our team directly sometime this week.

About Capchase

Capchase is a platform for recurring-revenue companies to secure non-dilutive capital. Founded in Boston, MA in 2020 and headquartered in New York City, the company provides financing by bringing future expected cash flows to the present day – thereby extending an immediate line of credit. Companies that work with Capchase are able to secure funding that is fast, flexible, and doesn’t dilute their ownership.