The early stages of a startup are delicate, and the single largest destabilizing factor tends to be money. Even with a brilliant idea and hardworking team, a lack of funding can capsize small companies quickly. Crafty business owners looking to keep the momentum rolling have many options in front of them. They can seek angel investors such as friends and family, empty their personal savings accounts, or approach venture capital firms for seed money. The latter course was traditionally the most popular, but a more established method of funding is now staging a comeback.
Business loans are becoming more sought after by startups looking to continue their growth trajectory. While VC funding remains a path that many founders take, others are choosing business loans and realizing the same success. For those who are considering raising money, this makes it necessary to consider both options.
Loans Are Back, and Startups Love Them
Loans are an integral part of the economic infrastructure, helping millions get the funds they need, although small business loans have dropped 50 percent over the last 20 years.The technology boom of recent years, however, has led to venture capital replacing loans as startups’ main source of capital. Now, a tech revolution has brought the trend full circle. Achievements in fintech have made old-school business loans smarter and faster, thanks to powerful innovative technology and the support of financial regulators.
The mistrust in traditional financial services borne of the 2008 financial crisis saw the rise of several new industries, such as Lending-as-a-Service (LaaS). Instead of going to banks for loans, companies are turning to online lenders and LaaS providers. End-to-end automated finance solutions provider ezbob, for example, lets businesses find financing tailored to their needs. The savings these lenders gain from streamlined process are passed on to borrowers, and many are taking advantage.
According to Tomer Guriel, the company’s CEO, the decision to move to lending was part of developing an understanding on how banks operate.
“The idea of being a technology provider was born in 2012. At the time, we teamed with Accenture in order to sell our platform to banks. Unfortunately, at that time, the banks were not ready to work with a start-up/Fintech. The only way we could get the business off the ground was to start lending ourselves. After we signed our deal with RBS, we decided to pull back from lending so that we could concentrate on R&D. We plan to launch new products such as a consumer lending platform, a mortgage platform with the similar characteristics of our SME lending platform,” he said in a recent interview with Forbes.
But What About VCs?
Venture capital firms are undoubtedly an excellent way for startups to grow. In exchange for equity, founders gain a mentor and advocate at the firm–an industry leader who can often contribute expertise and clout in negotiations. This kind of collaboration could be useful as a company grows, but it is never a guaranteed win.
VC contracts involve complicated legal guidelines. Some even impose performance milestones on the team and other strict measures. VCs wield so much control thanks to the equity they control. It might seem like a free way to get funding at first, but equity may equate to “mandatory advice.” More than just shares and profits, many startups end up ceding creative control as well. Not all VCs behave this way, but they are all profit-seekers at heart.
A New Generation of Startups
Savvy startup owners have the option to go around town knocking on the doors of every VC in the business, or they can take a step back and look at other options to grow a healthy business. Loans can be a sensible option, but might seem intimidating because of the financials and paperwork required.
A loan is still a loan, and will still add liabilities to the balance sheet and affect cash flow. This might be difficult for a company without tangible sales, credit, or revenue. However, the enormous strides made by fintech have made it a much more enticing option. This is doubly true for founders who have read tales about their peers who lost a grip on their baby to VCs.
Thanks to cutting-edge technology, loans are now more inexpensive than before. Many do not require collateral and have easy standards on credit. Additionally, while 1 percent of equity may end up representing millions, a loan will always be a flat dollar rate. These simple agreements, in which the lending party is not interested in control, are perfect for certain people. Individualistic types strongly prefer this arrangement to compromising with VCs, but in the end (or the beginning), the choice always boils down to the founder.
Read more about raising capital at TechCo
FAQs
Accessibility: Venture capital tends to be more accessible at earlier stages than traditional or venture loans. Banks won't lend to unproven companies, but VCs hungry for high returns will take that risk in exchange for an ownership stake in the company.
What is better venture capital or bank loan? ›
Stage of the Business:
Venture capital is most suitable for early-stage startups or high-growth companies with a disruptive business model and significant market potential. Traditional financing options, such as bank loans, are better suited for more established businesses with a track record of revenue generation.
Does your startup need venture capital money? ›
For your startup to succeed, you need to have a great idea and the passion to make it happen. You also need money. While you can start a business with your own savings, it's often more practical to get venture capital funding from investors who believe in your company.
Is debt or equity financing better for startups? ›
New businesses with no credit history may struggle to qualify for loans. For these reasons, equity funding is often the best option for getting the capital you need to grow. “Equity financing may be necessary if you can't qualify for a startup business loan and want to avoid more expensive options like credit cards.
What is the main problem with using a venture capitalist for a startup company? ›
Depending on the size of the VC firm's stake in your company, which could be more than 50%, you could lose management control. Essentially, you could be giving up ownership of your own business.
What are the disadvantages of venture capital? ›
Disadvantages
- Approaching a venture capitalist can be tedious.
- Venture capitalists usually take a long time to make a decision.
- Finding investors can distract a business owner from their business.
- The founder's ownership stake is reduced.
- Extensive due diligence is required.
- The company is expected to grow rapidly.
Venture capital provides funding to new businesses that do not have enough cash flow to take on debts. This arrangement can be mutually beneficial because businesses get the capital they need to bootstrap their operations, and investors gain equity in promising companies.
Why avoid venture capital? ›
You don't want to give up control. Make no mistake, the second you take venture funding, regardless of your percentage ownership in the company, you've effectively ceded control of your company to your investors. And you will not gain control back until your company is cash flow positive.
What percentage of startups get VC funding? ›
Only 0.05% of startups get VC funding
Many promising startups seek venture capital as a way to secure investment, but it's extremely competitive and rare. A mere 0.05% of startups get VC funding.
What are the odds of getting VC funding? ›
Venture capital is absurdly hard to secure.
Stories of startups that raised VC funding seem to dominate financial headlines, but in reality only about five in 10,000 startup businesses receive venture funding — less than 0.05%, according to Fundera.
Difficult to acquire: Perhaps the biggest drawback of debt financing is that it is not easy to get. Most banks will want to see financial viability and a list of assets before qualifying a startup for financing. In many cases, startups don't have the hard assets that bank loans require.
What is a good debt-to-equity ratio for a startup? ›
Generally, a good debt ratio for a business is around 1 to 1.5. However, the debt-to-equity ratio can vary significantly based on the business's growth stage and industry sector. For example, newer and expanding companies often utilise debt to drive growth.
What are the two most likely sources of debt financing for a startup company? ›
Common sources of debt financing include business development companies (BDCs), private equity firms, individual investors, and asset managers.
Why shouldn't you raise venture capital? ›
VCs will not make your business a success, and often over-sell their value to entrepreneurs. I'm also a proponent of raising smaller rounds from angel investors in your space, who can add credibility, insights, introductions and more without selling a huge chunk of your company.
What happens to VC money if startup fails? ›
If the startup fails, they will not only lose their original investment but also any potential returns that they might have earned had the startup been successful. If the venture capitalists are unable to recoup their investment, they will be forced to write off their losses as bad debt.
Should you accept VC funding? ›
If you're in a big market, developing a disruptive product requires significant capital to build the infrastructure and get off the ground. Taking VC money is not only worthwhile if your market is as big as you think it is, but it might also be your only funding option for the amount of capital you need.
What is better than venture capital? ›
Angel investors vs.
Involvement level: Angel investors often take a more hands-on approach, providing mentorship and advice based on their experience. Decision process: As individual investors, angels may have a quicker decision-making process than venture capital firms.
What is the difference between venture debt and bank loan? ›
Unlike traditional loans, venture debt considers the equity raised by the company and focuses on the borrower's ability to raise further capital rather than cash flow. Credit and debt available to commercial borrowers is underwritten based on the amount of cash flow they generate.
What is the interest rate on venture capital loans? ›
Interest rate
However, they may also be lower than other forms of financing like equity investments, as they do not require dilution of ownership. On average, the interest rates for venture loans can range from approximately 9% to 14%.
What is an advantage of using venture capital as a source of finance? ›
It offers several advantages, such as getting the money your startup needs, no monthly repayments, and support and guidance from experienced entrepreneurs. However, you'll have to exchange a substantial percentage of ownership equity to your funders.
