What are the different types of startup funding?

Fintech

Fintech, short for financial technology, is growing in popularity and is fast becoming one of the key sources of investment for startup businesses. Fintechs usually lend to businesses that might not qualify for a more traditional small business loan. To do this, they often use less traditional metrics for underwriting. For instance, one company looks at the number of UPS packages shipped and received.

Fintechs are causing banks to re-evaluate the business lending process, which benefits the industry.

Pros:

• Nontraditional: Fintechs can be a great way to access funds if your business is unique or it’s difficult to provide the traditional metrics that banks look for.
• Convenient: Often, you can apply for and access this money digitally. The process can feel smoother compared to other loan applications.

Cons:

• Terms: Many of these startup loans come with high interest rates or other fine print. Be sure to watch for amortization schedules, prepayment penalties and high premiums.
• Fewer regulations: These companies might not have the same oversight and government compliance programs as more established lenders.

Tips: Read the fine print. Make sure you understand the annual rate, the amortization schedule, prepayment penalties and more. These details can help you determine whether you can meet the terms.

Crowdsourcing

Transaction value in the crowdfunding market is projected to reach $1.27 billion by 2028, according to Statista. Fundraising is often done via a third–party website, and investors often expect sample products, recognition or equity in exchange for their donation.

While this type of fundraising is used for more than just business ventures, many popular fundraising campaigns have been for new products or businesses.

Pros:

• Wide net: Crowdfunding platforms put you in touch with a vast pool of would-be donors.
• Lower bar: Donors on a crowdfunding site may be more likely to look at your business from an investor's standpoint.

Cons:

• Regulations and fees: If you use a third–party platform to fundraise, expect to encounter fees. Plus, these sites aren’t subject to the same regulations as traditional capital sources.
• Idea theft: Without a trademark, there’s a chance that someone with more resources could steal your idea from a public site.

Tips: Read the fine print to understand the protections and liabilities before using these sites. While they can be a great and innovative source of funding for startups, they may come with unknown risks.

Friends and family

It can be tempting to take money from people you know rather than pursuing more formal channels. But there can be strings attached. Beyond any potential damage to personal relationships, it can also lead to complex tax implications and legal risks.

Pros:

• Less red tape: Your friends and family are unlikely to run a credit check or ask for revenue projections.
• Encouragement: It’s uplifting when those close to you offer more than just words of support.

Cons:

• Taxes: Gifts above a certain amount are taxable. If the money is considered a loan and no interest is charged, the IRS may calculate interest retroactively.
• Equity trap: Friends and family may ask for a share of the business, which could potentially limit your future funding options.

Tips: Have a frank conversation about terms and expectations before you borrow from friends and family. Talk about the amount, payment schedule and interest rate. Make sure to document what’s been agreed to before starting your business and seek legal advice.

Self-funding

As reported in a survey by Score, 66% of entrepreneurs use personal funds to start their business.  When you include personal credit cards, home equity loans and other forms of personal funding for startups, this number increases even more.

Pros:

• Autonomy: You maintain control over strategy and operations.
• Motivation: Using your personal savings might give you an added incentive to succeed.

Cons:

• Personal risk: If you use your own money, failing could result in personal debt or bankruptcy.

Tips: Legally registering your business with your state — as an LLC, simple partnership, S Corp or C Corp — can help limit some of your personal liability.

Create bank accounts and credit cards in your business’s name, even if you use personal savings to fund them. Lenders typically look for a credit history for the business itself, in its own name.

Next steps

If you’re ready for a small business loan, there are a few criteria that lenders will look for:

1. Time in business: This can vary by bank, but a minimum of six months is usually preferred.

2. Credit history: If you use one of the types of startup funding methods discussed here to get started, you can still build a credit history by using those funds to open a bank account and credit card for your business. If your business has no credit history, your qualification will depend entirely on your personal credit history.

3. Performance: Lenders are likely to review your balance sheet, focusing on overall profitability, as well as your cash flow cycles and ability to repay the loan.