9 Great Alternative Funding Options Every Founder Should Know About
The process of acquiring venture capital can stir up quite a few emotions in an early-stage founder: Excitement. Fear. A sense of doing something incredibly important. The incredible degree of pressure in knowing that you need this money to be successful.
However, as many founders have discovered, chasing that venture capital funding can be incredibly time-consuming, expensive, and frustrating.
What if there was a better way to raise capital?
In today’s ever-changing marketplace of ideas, alternatives to traditional venture capital funding are rapidly emerging. This natural financial evolution enables founders to be more efficient while still getting the money they need.
Overview of the Traditional VC-Funded Round
The traditional VC-funded round is perhaps the most-traveled path for startup founders. When successful, founders sell a significant stake in their business to venture capital funds in exchange for a major investment in the company. The founders then use those dollars to grow revenue, hire staff, invest in technology, or simply keep the lights on.
The challenge? Getting funding from a VC fund can be very difficult. One study estimated that 1% of applications are actually funded. These are exceptionally long odds, meaning the chances of you getting your application funded are fairly small.
We don’t say this to discourage you — quite the opposite. Despite the long odds, countless businesses have still found a way to raise capital in an incredibly competitive financial environment. Fortunately, there are several good alternatives to the traditional VC fund.
Alternative Funding Options
There was once a time when VC funds and big banks monopolized funding startups, particularly tech startups.
Those days are long gone.
Ironically, the rise in technology has increased the chances of funders finding alternative funding options to raise the capital they need. This changing funding ecosystem allows founders to access various potential funding sources — including, but not limited to, traditional VC funds.
Let’s take a look at nine potential alternatives.
Gust will keep you updated with the latest fundraising experts on resources and how to raise capital.
Alternative #1: Revenue-Based Funding
The idea behind revenue-based funding is simple but incredibly powerful: As a startup business, you may have already developed some revenue streams. You can leverage that projected revenue for additional funding against these recurring revenue streams. Of course, you will pay this revenue funding back with interest. However, the advance revenue will give you the early funding you need, enabling you to continue operating and investing in your business.
Pros of revenue-based funding:
– As far as alternative funding options go, this one is perfect for subscription-based businesses or those that have some sort of recurring and predictable revenue stream.
– There is already an industry built around obtaining this funding. You can share your financial data with companies like Lighter Capital and Arc to begin receiving money quickly.
– The process is significantly less competitive and easier than venture capital.
– This alternative funding option comes with major flexibility. Depending on the specifics of your situation, you may be able to negotiate positive terms regarding interest and repayment time.
Cons of revenue-based funding:
– Any changes in your revenue stream will damage your ability to make repayments, get future funding, and even survive. As such, your revenue must be extremely predictable.
– Since this model depends on already existing revenue, it is not appropriate for businesses that don’t already have some sort of revenue stream or aren’t subscription-based.
– Monthly repayments are often required. This can be problematic for businesses that are short on cash.
Alternative #2: Venture Debt
In some cases, your firm may have already raised venture capital and may be ready to seek another funding round to extend your existing runway. In that case, venture debt may be a good option. Venture debt allows you to issue warrants on equity. These warrants enable you to get the funding you need, but on the promise of future equity.
Pros of venture debt:
– Unlike many other alternative funding options, venture debt involves future equity. This enables you to grow without having to worry about immediate financial constraints.
– You work with specific venture debt lenders who have experience in this area and can potentially work with you to limit financial burdens.
– Venture debt may be ideal if you need cash between funding rounds.
Cons of venture debt:
– The interest you will eventually pay with this alternative funding option is high, potentially reaching 20%.
– A lender may also require you to issue debt covenants on the debt. This is more common in higher-risk situations.
Alternative #3: Equity Crowdfunding
Equity crowdfunding is an alternative funding option that allows you to trade equity for capital. It operates similarly to peer-to-peer lending but requires you to repay equity instead of interest. Various third parties can help with equity crowdfunding, including Wefunder, StartEngine, and Fundify.
Pros of equity crowdfunding:
– Equity crowdfunding operates with relatively light administrative requirements.
– You don’t have to make any repayments on loans, allowing you to save limited capital.
– A properly designed pitch can dramatically increase the ability of your business to raise capital.
Cons of equity crowdfunding:
– You lose equity in your business.
– Using a third party can be expensive, potentially taking a portion of your capital when you need it most.
– There is no guarantee that anyone will invest in your business, meaning you could go through all the work of using a third-party platform without any guarantee of success.
Alternative #4: SAFEs
SAFE stands for Simple Agreement of Future Equity. As the name implies, a SAFE will allow an investor to get equity in the future. In exchange, the investor will provide a capital investment. The agreement that kicks in will enable investors to obtain their equity when a specific event occurs.
Pros of SAFEs:
– SAFEs can be extremely flexible for both the investor and the startup.
– The flexibility of SAFEs enables founders to concentrate on operating their business metrics instead of repaying loans.
– Reporting requirements and administrative requirements are low.
– SAFEs do not come with any interest payments.
Cons of SAFEs:
– While SAFEs can be great for the initial stages of a startup, the triggering event may cause a major equity dilution for founders.
– Business circumstances may change, making the deal less beneficial for founders.
Alternative #5: Convertible Notes
Convertible notes are alternative funding options that change over time. They start as short-term debt but convert to equity. This equity is usually converted at a discount, incentivizing investors to create such a note early and increase their stake in a company.
Pros of convertible notes:
– The funding mechanism incentivizes additional investment, thus making it easier to raise capital.
– Because this is such a commonly used mechanism, administrative burdens are low, allowing investors and startups to quickly move on with their investments.
Cons of convertible notes:
– Convertible notes can dilute equity for startups.
– Repaying the loan at a future date may not be possible.
– A convertible note can create conflict between an investor and a startup, depending on the situation. With so much at stake, an investor may seek specific controls or oversight of a startup.
Alternative #6: Grants
Grants represent large gifts of money from a government, nonprofit, or foundation. While the specifics behind each grant vary, they usually represent “free” money granted to an applicant. However, in most cases, this alternative funding option has major restrictions or reporting requirements.
Pros of grants:
– There may be nothing to repay, including equity or interest. A properly designed grant may be the best possible alternative funding option, as it may literally represent free money.
– If you meet the requirements, you can obtain a grant anytime without surrendering equity or ownership control.
– Grant amounts can be extremely high, depending on the specific circumstances of the grant.
Cons of grants:
– Grants often have extensive reporting requirements, placing a significant administrative burden on your business.
– They are often extremely competitive.
– Finding a grant that you can apply for will take time and money. You may need to pay a third party to help you find grants.
– There may be extensive public-facing reporting requirements, meaning you will have to spend time working with funders to explain the various benefits of your grant.
– You may open your business and books to public scrutiny if the grant is taxpayer-funded.
Alternative #7: Extensions
Many startups that obtain initial funding eventually need a longer runway and are forced to raise capital again. If you’re in this situation and aren’t ready to launch another fundraising round, you may find that asking for an extension is an easy way to proceed.
Pros of extensions:
– Extensions enable you to get the funding you need without pursuing a full round.
– Extensions can give you the full financing you need and potentially open the door to larger future rounds.
Cons of extensions:
– There is no guarantee that you’ll get your extension; if you don’t, you may be in real trouble.
– You may get the extension under less favorable terms, potentially creating additional reporting or financial burdens on your resource-constrained business.
– A full funding round may be preferable to an extension, as such a round may better position you for long-term success.
Alternative #8: Angel Syndicates
An angel syndicate is a group of investors who pool their money to fund a project. This operates similarly to a venture capital fund: angel syndicates represent pooled resources. However, there is a major difference: They are often pulled together by one lead funder to create a one-off funding stream.
Pros of angel syndicates:
– Angel syndicates offer a highly flexible method of funding projects. If you know an investor who wants to support you, they can take the lead in finding the funding you need.
– Individuals who participate in angel syndicates are usually highly wealthy and well-connected. This may open the door to future funding.
– Angel syndicates are often more flexible than venture capital. This makes it easier to obtain this funding.
Cons of angel syndicates:
– Many of the same challenges with venture capital exist with angel syndicates: They can be time-consuming and reporting-heavy and require you to sell equity.
– There may be extensive fees if you use a third party to find a network.
– The process may occur monthly or quarterly. If you need money now, you may be out of luck.
Alternative #9: Peer-to-Peer Lending
Peer-to-peer lending allows individuals to use a third-party service, such as Lending Club or Prosper, to get loans directly from other individuals. The process is relatively simple: Individuals upload a portfolio and apply for a loan. A diverse series of vendors from across the country can then invest in your business, receiving interest payments based on the risk that the third party has assigned you.
As far as alternative funding options go, this is a true “democratization” of funding. It allows individual investors — not major businesses or VC firms — to be your funders.
Pros of peer-to-peer lending:
– The process is usually very easy to set up, allowing you to start obtaining funding relatively quickly.
– You don’t give up any equity in your business in order to raise capital.
– You won’t have to worry about extensive reporting requirements or presentations to your funders.
Cons of peer-to-peer lending:
– Investing in P2P platforms isn’t legal in every state. This may limit your pool of investors.
– Caps may limit the funding you can acquire on the platform.
– There’s no guarantee you will obtain all the funding you need, and getting a second round of funding may be difficult.
– You are completely reliant on the risk profile assigned by the platform. A higher risk profile will mean you have heavier interest rates to repay.
– Interest rates tend to be very high, meaning you’ll lose more cash than usual by seeking this investment.
Alternative Funding Options Are Out There
As a startup founder, you have a ton on your plate, and getting the funding you need to survive is unquestionably one of your biggest issues. That being said, it’s vital to remember this fundamental truth: You have alternative funding options to raise the capital you need. The above nine options may fit your niche perfectly and present you with an alternative way to get your startup from idea to reality.
Gust will keep you updated with the latest fundraising experts on resources and how to raise capital.
This article is intended for informational purposes only, and doesn't constitute tax, accounting, or legal advice. Everyone's situation is different! For advice in light of your unique circumstances, consult a tax advisor, accountant, or lawyer.