Alternative Funding Options For Startups
Starting a business is no easy feat, especially when it comes to securing funding. For many startups, venture capital funding is the go-to option. But with increasingly adverse market conditions, raising money through this traditional route is getting tougher by the day.
VC funding fell by 35% from 2021 to 2022, whilst European tech startups nearly doubled the amount of debt funding in 2022. The statistics make it clear that there is an increasing need for growing companies to consider alternative sources of funding. Below we’ve explored some alternative sources of funding you can consider for your startup.
Revenue or Asset-based Financing
Revenue-based financing is not a new invention, having been used in more traditional industries such as pharmaceuticals or oil & gas for decades. However, it’s now an option becoming increasingly accessible to startups with new providers focussed specifically on lending to SMEs coming to market.
Revenue-based financing, also known as revenue-based loans, involves a lender providing a loan to a startup in exchange for a percentage of the company's future revenue. This type of financing is beneficial for companies that may not have significant assets or a strong credit history but can show steady revenue streams. It is less risky when it comes to cash flow as repayments are linked to a percentage of revenue and another benefit is that startups are not required to give up equity or provide personal guarantees. Providers also have much less stringent lending requirements than traditional banks, making it an attractive option.
Asset-based financing, on the other hand, involves a lender providing a loan to a startup using its assets, such as inventory or equipment, as collateral. This type of financing is beneficial for startups that have significant assets but may not have a strong credit history. With asset-based financing, the lender can seize the assets if the company is unable to repay the loan, making it a riskier option for startups compared to unsecured methods of financing.
Bridge Funding
Bridge funding is a type of short-term funding that can be used to bridge the gap between a startup's last funding round and its upcoming round. This type of funding is particularly useful when you are experiencing delays in a secured funding round due to extended financial due diligence procedures or administrative delays. Bridge funding can be provided by investors or other lenders and is typically secured against the company’s future round, interest payments also tend to be lower as the funding is granted on a fixed term.
Bridge funding can be an excellent way for startups to continue operating while waiting for their next funding round. It can provide the necessary funds to pay for ongoing expenses, such as salaries and rent, and can help avoid a cash flow crisis.
Crowdfunding
Crowdfunding has become increasingly popular in recent years, and for good reason. It’s a relatively easy and low-cost way for startups to raise funds. Crowdfunding involves pitching a business idea or product to a large number of people via an online platform. These "backers" can then pledge a certain amount of money to support the idea. In return, backers may receive rewards such as the product itself or other benefits like exclusive access or discounts.
Although launching a crowdfunding campaign can be a big administrative burden with campaigns typically targeted at a large number of investors each investing smaller amounts, one of the main benefits of crowdfunding is that it allows startup companies to test the market for their product or idea before investing too much money.
By pitching to potential customers, startups can gauge interest and adjust their product or business model accordingly. Additionally, crowdfunding campaigns can also help with marketing and brand awareness. By promoting their campaign on social media and other platforms, startups can reach a wider audience and build a community of supporters.
Table 1: Overview - Pros and Cons of Alternative Financing Options
The Importance of Metrics in the Alternative Financing Process
Accurate metrics are crucial when taking out any kind of financing because they provide lenders with a clear understanding of a startup's financial health and its ability to repay the debt.
Lenders will typically evaluate a variety of financial metrics when considering a loan application, such as revenue growth, profit margins, and cash flow. Growing companies that can demonstrate a strong financial track record and a clear plan for repaying the debt are more likely to be approved for financing and may receive more favorable terms.
Accurate metrics also play an important role in managing debt once it has been acquired. Startups that closely monitor key metrics such as debt-to-equity ratios, interest coverage ratios, and cash flow forecasts can make informed decisions about how to allocate resources and manage their debt obligations.
All in all, accurate metrics provide a solid foundation for making sound financial decisions and can help you navigate the challenges of debt financing while maximising growth potential.
Summary
The alternative financing options listed above, as well as others that we haven’t covered in this particular blogpost, are a great method of financing for companies that are finding venture capital fundraising challenging in the current climate or simply don’t fit the venture capital profile.
The advantages of these types of financing can include greater control over the business for the founders, lower cost of capital compared to equity financing, and interest payments that are tax-deductible. However, debt financing can also come with the risk of default and bankruptcy, as well as restrictions on the startup's financial flexibility.
Ultimately, the choice of financing will depend on the goals and circumstances of your startup, and you should carefully evaluate the pros and cons of each option before making a decision.
FAQs
All the answers you need for all the questions you’ve got.
(But also TL;DR)
How should a startup business prepare its budget?
To prepare a budget for your startup, begin by listing all potential expenses you anticipate in starting and operating your business. Next, organise these expenses into categories. After that, estimate your monthly revenue and calculate the total costs required to start and run your business.
What are the key steps to creating an effective budget?
Step 1: Determine and track your income sources.
Step 2: Make a list of your cost. Include both fixed and variable costs.
Step 3: Set achievable financial goals.
Step 4: Develop a plan to meet those goals.
Step 5: Put everything together to build your budget.
Step 6: Regularly review and revise your forecast to ensure it remains effective.
What does capital budgeting entail for a startup?
Capital budgeting for a startup involves allocating a set amount of funds for specific purposes, such as purchasing new equipment or expanding business operations. This process is crucial as it supports making strategic investments that are expected to yield long-term benefits for the startup.
FAQs
All the answers you need for all the questions you’ve got.
(But also TL;DR)
How can a startup forecast its cash flow?
To forecast cash flow for a startup, follow these steps:
Step 1: Create a sales forecast by estimating the revenue your products or services will generate over the forecast period.
Step 2: Develop a profit and loss forecast to understand your expected expenses and income.
Step 3: Prepare your cash flow forecast, which involves calculating expected cash inflows and outflows. This can often be done for longer-term by using assumptions around payment terms to forecast a Balance Sheet, and using the movements in Balance Sheet and Net Profit/Loss to calculate the cashflow.
Step 4: Consider ways of improving cash flow by improving your invoicing methods, considering short-term borrowing, and negotiate better payment terms to manage cash flow effectively.
What is the most accurate method to forecast cash flow?
The most accurate method for forecasting cash flow in the short-term is the direct method, which utilises actual cash flow data. In contrast, the indirect method is better suited for longer term forecasting using projected balance sheet movements and income statements to estimate future cash flows.
How is cash flow calculated?
Cash flow is calculated by deducting cash outflows from cash inflows over a specific period. This calculation alongside forecasts of future cash flow helps determine if there is sufficient money available to sustain business.
How do you project cash flow over three years?
To project cash flow over a three-year period, undertake the following steps:
Step 1: Collect historical financial data.
Step 2: Identify all expected cash inflows, which could include revenue, investment, grant income, etc.
Step 3: Estimate all anticipated cash outflows including expenses, suppliers that need to be paid, investments into assets, debt repayments, etc.
Step 4: Calculate the net cash flow by subtracting outflows from inflows.
Step 5: Consider your cash reserves and explore financing options if needed.
Step 6: Regularly review and adjust your projections to ensure accuracy and relevance.
FAQs
All the answers you need for all the questions you’ve got.
(But also TL;DR)
When should a startup consider hiring a CFO?
A startup should think about hiring a Chief Financial Officer (CFO) when it begins to experience rapid growth, finds it challenging to manage finances, or needs to navigate complex investment scenarios. A seasoned financial professional can provide the necessary expertise to handle these challenges effectively.
What are the indicators that my business might need CFO support?
You might need to hire a CFO or consider outsourcing this role if you notice any of the following signs: a decrease in gross profit margins despite increasing revenue, uncontrolled business growth, lack of cash reserves despite having a financially successful year, or a halt in business growth.
Does my startup really need a full-time CFO?
Recruiting a full-time CFO is an expensive hire. Given budget constraints and the need to prove the viability of your business idea, founders will often need to prioritise investing into building and commercialising their product. That's where CFO services for startups are a cost-effective solution for founders looking to take their financial management to the next level.
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