Startup funding: key alternatives to VC money

2021 was a record year in terms of startup funding for regions such as Europe and North America. Startups achieved numbers that had never been reached before, in a year filled with mega deals and new unicorns.

Overall, VC funding gets a significant amount of attention in the media and business world. Yet, it isn’t always the best option depending on a startup’s maturity, sector and goals. VC funding should mainly be considered once pre-seed and seed funding has been achieved. Indeed, VC firms are looking for companies with a track record, traction and a proven product-market fit. As such, younger startups would benefit from looking into alternatives.

In this article we’ll look at some of the most commonly used alternatives to VC funding for startups, detailing some of the benefits and challenges that come with each one.

2021 in numbers

Before we delve into the different sources of funding available to entrepreneurs, let’s look at some of the numbers illustrating just how game-changing 2021 was for the European startup ecosystem.

For the first time ever, European startups raised over $100 billion in 2021. Indeed, according to Pitchbook data, $100.4 billion was raised across 9,419 deals as of December 20, 2021. This represented a 115% increase in the funding amount from 2020, and a 6% increase in the number of deals closed.

Venture capital was at the centre of these jaw-dropping numbers. However, while VC funding arguably receives the most media attention and is seen as a sign of a startup’s success, entrepreneurs should fully weigh all their options before deciding to opt for this strategy.

Indeed, the drawbacks of VC funding include giving up a potentially significant amount of equity in your company. Furthermore, depending on the deal and the investors, you could lose full control over how your business evolves. It's also a typically long and tedious process to secure VC funding, which might not be ideal if you're looking to secure funding fast.

An overview of alternatives to VC funding

Friends and family / Love money

Friends and family loans can be a great first step in funding your startup if they have the means to support you. It typically doesn’t involve giving up any equity and it provides the benefit of working with people you trust.

Typically an early-stage source of funding, friends and family are investing in an idea. They trust you and, because of their relationship with you, are willing to help kickstart your business.

Nevertheless, friends and family won’t usually be strategic investors. They often won't be able to provide you with advice on your business plan or overall strategy. Furthermore, mixing business with your personal life can quickly strain relationships if things don’t go as planned.

Business loans

Business loans are a go-to solution for startups to fund their activity. Unlike VC funding, it enables you to retain ownership of your company. It also presents the opportunity to build solid business credit, which can be useful in the future.

Nevertheless, startup loans are notoriously challenging to qualify for. Furthermore, the need to invest your profits into paying back your loan can present challenges in growing your company. This strategy might not be ideal for very young startups who lack enough historical data and have not built up any credit yet.

Banks will expect a solid business plan and a significant amount of documentation to be comfortable providing you with a loan. Furthermore, you'll need to do a significant amount of research and shopping around to ensure you’re picking a deal that will truly be beneficial to your company. Lastly, whether your business is successful or not, you will need to repay your business loan.

Flexible business financing from Karmen

Karmen, a partner of ScaleX Invest, has emerged as the alternative financing solution for startups, with a focus on providing customised financing tailored to the needs of each type of business.

Karmen offers Revenue Based Financing (RBF), an innovative form of financing based on the future revenues of project owners. This fast, non-dilutive financing is aimed at growing businesses. Entrepreneurs don't have to cede any of their equity, so they can enjoy a comfortable cash flow, finance their growth or give themselves a few extra months of runway. Take the test to find out if you're eligible!

Since it's a loan, there is certainly some compensation to be paid. However, this is not bank interest. The consideration is an annual percentage, generally around 6 to 10%, on the company's future income. The company that received the cash repays the investor monthly over six, nine or twelve months.

Rewards-based crowdfunding

Rewards-based crowdfunding is a popular funding strategy for startups, especially those in the B2C space. Platforms like Kickstarter and Indiegogo have arguably revolutionised the startup space. Indeed, they've made it easier for entrepreneurs to fund the launch of their projects. By presenting their idea/project online and offering rewards for investments, countless successful startups have emerged in the market.

This source of startup funding presents the benefit of not requiring any repayments or relinquishing any shares of the company. However, the market has become rather saturated and it can be difficult to stand out from the crowd to secure enough funding.

A successful crowdfunding campaign in the early days of a startup’s life can also increase its appeal to investors in the future. The marketing and media coverage that can come from such a campaign can also prove to be incredibly beneficial to an up-and-coming startup.

However, it’s important to look into the platform you use for your crowdfunding campaign. Many will only let you withdraw the money if you meet your goal and it’s common practice for these platforms to take a percentage of your earnings.

Typically, startups that succeed on crowdfunding platforms have a project that will appeal to a mass amount of individual investors, meaning not all projects are suitable for this funding method (e.g. B2B software).

Equity crowdfunding

Similarly to VC investments, equity crowdfunding involves exchanging funding for securities like shares, debt or a portion of revenue. But since equity crowdfunding involves raising funding from a large number of small investors, you avoid the issue of one shareholder having too much control over your business.

Furthermore, you have full control over setting your company's valuation and the price of shares. This is a significant benefit when compared to VC funding.

It's worth noting that equity crowdfunding does come with significant legal aspects and fees. Due diligence will also be a must, although many platforms assist entrepreneurs in that process. Lastly, as with most equity fundraising, you might need to provide your new investors with voting rights or other rights within the company. Nevertheless, it can still be more entrepreneur-friendly than VC funding for early stage projects.

Grants

Public funding isn’t necessarily the most popular source of funding, yet it can be a valuable option for startups of all maturity stages. Grants are a non-dilutive way of funding your project. They're essentially free money, which is something of significant value for any entrepreneur.

Furthermore, once you've received one grant, it will usually be easier to receive more in the future, as you'll have proven yourself a worthy candidate and thus increased your credibility. This also means receiving grants can help you later on if you do choose to raise funds from VC investors.

However, most grants come with restrictions and conditions regarding the use of funds (e.g. market research, product development, etc.). You must abide by these conditions no matter what. Moreover, grant eligibility is subject to several criteria like a startup’s industry, its size, its currently available funding, how many years it’s been in existence, etc. As such, it can sometimes be tricky to find a grant for which you fit all the criteria. Lastly, grant application and due diligence processes can be lengthy and complicated.

Business angels

Business angel funding is often the last step before a startup moves towards VC investors. Angel investors tend to be individuals with a surplus of money that they are willing to spend on potentially risky investments. They are often retired company executives, former entrepreneurs or leaders in their own field. As such, they can contribute a significant amount of expertise to a young startup. These investors can be key for early-stage startups that might not have the option to secure a loan. Their penchant for high-risk ventures makes them an ideal candidate.

These investors also help provide credibility to a startup. Many of them often have entrepreneurial experience or invest in companies that work in an area they have expertise in. Angel investors often leverage their business network for the project they've invested in. This means helping secure introductions to key prospects or potential partners. Their experience and mentorship can prove invaluable to your company's growth.

However, they often expect to be involved in defining the company’s strategy in order to secure their ROI. This can involve providing them with a seat on the board of directors or giving them an assurance of transparency. Furthermore, because of the risk incurred, business angels are likely to ask for a significant amount of equity in exchange for their investment. This, in turn, reduces your profits in the future.

Weighing the pros and cons

No matter what, having a solid business plan and a team of talented individuals is key to securing startup funding. Those are, in fact, key criteria in Early Metrics' startup rating process. Once you've checked those boxes, it'll be time to weigh the pros and cons of your options. VC money has considerable appeal, but you should ask yourself these questions:

• Is VC funding really adapted to your company today?
• Are you ready to lose equity and control in your business?
• Do you have the time and resources to invest in the lengthy VC process?
• Does your startup have a strong enough track record for a VC to be interested?

This isn't to say that VC funding is a bad choice, as that fully depends on your project and its needs. However, all these questions and more are important to consider before making a final decision.