As founders know well, the venture funding landscape is vast and varied.
Depending on revenue, market size, and other factors, early-stage companies can access financing from small business loans, angel investors, private equity, venture capital firms, and more.
Let’s take a look at what venture funding options exist for early-stage companies to see what may work best for your company.
While definitions vary, an angel investor is typically an individual that invests anywhere from $25,000 to $2 million in an early-stage company.
Angel investors can be part of a syndicate organization — referred to as an angel group — that includes other similar investors that, as a group, invest in early-stage companies. Angel investors can also refer to wealthy individuals that invest in startups, as well as friends and family that provide capital to an early-stage company.
Angel investing is a form of equity financing. In exchange for capital, an angel investor will take a percentage of ownership in the company, and with it, partial operating control.
Advantages and Disadvantages of Angel Investment
Among its advantages, angel investments are usually less risky than debt financing. If a company were to fail, the capital doesn’t have to be paid back to an angel investor. With a business loan, an entrepreneur is still on the hook to pay back the capital and interest.
However, taking on angel investors means that an entrepreneur will cede total control of their business, as the investor is now a part-owner. Angel investors will also reap part of the company’s profits if the business is sold.
Venture capital is a form of private equity financing in which wealthy individuals will contribute to a venture capital fund that will in turn invest anywhere from $100,000 to $100+ million in early-stage companies. A fund will often make several investments in companies expecting that many will fail, but a few will make a large sale or reach an initial public offering (IPO).
Venture capital is arguably the most well-known form of funding for early-stage companies, but it is hardly the most used financing option.
In exchange for its funding, venture capital firms will take an ownership stake in a portfolio company as well as assume partial operating control. Venture capitalists look for early-stage companies that are growing extremely fast and present at least a 10x return potential. Venture capital firms take big risks with their investments in the hopes of high return through a portfolio company’s acquisition or IPO.
Advantages and Disadvantages of Venture Capital
Among the advantages of venture capital is that a company is not obligated to pay back the funding provided. Venture capital firms not only overlook common revenue and profit requirements that bank loans present, but also typically write bigger checks that can quickly accelerate an early-stage company’s growth.
Conversely, venture capital is rarely a viable option for early-stage companies that aren’t growing 10x per year. In addition to a time-consuming process that’s fraught with rejection, venture capital also can be an expensive proposition for a company, since it further dilutes ownership.
Venture Capital vs. Angel Investment
Both venture capital and angel investment will inject meaningful funding into early-stage companies. When comparing the two as venture funding options, it’s helpful to conduct an honest assessment of your business, including its current stage, trajectory, and goals.
Venture capitalists and angel investors invest in companies at different stages. Often, angel investors will seek businesses that are just starting up but have a likelihood of reaching profitability. Alternatively, venture capitalists seek companies that are surging in growth and have the potential of a massive return via sale or IPO.
Venture capital will provide early-stage businesses a larger investment — anywhere from $100,000 to $100 million — but its 10x return expectations will likely eliminate most companies. Angel investors will offer smaller investments, but its return expectations are also comparably lower.
Regardless, both angel investors and venture capitalists will be taking equity and will want some type of control over how an entrepreneur runs their business. Angel investors are typically more apt to serve as mentors; however, venture capital firms often have broad, valuable networks that can help a company grow.
While every company’s funding needs are different, it’s important that entrepreneurs give careful consideration to why they are fundraising and to what ends that capital will serve. When evaluating your company’s capital options, evaluate your company’s stage, its trajectory, and most importantly, its goals.
The Most Common Forms of Growth Capital
Growth capital financing is typically provided to mature companies that need to significantly grow, restructure their operations, or expand into new markets.
Growth Capital: Venture Debt
Venture debt is a non-convertible, senior term loan that is sometimes used like equity with warrants for company stock.
While its use and terms vary, venture debt is typically repaid in monthly payments over the life of a loan. Venture lending generally results in minimal to no dilution, depending on the use of warrants.
Growth Capital: Revenue-Based Financing
Revenue-based financing is a straightforward investment tool, in which investors provide capital to a business in exchange for a percentage of ongoing revenues.
Instead of buying equity and waiting for an exit, revenue-based financing investors make an investment and earn returns via a monthly royalty payment based on the company’s cash collected from sales. Once a company hits a predetermined investment return cap, the company stops paying the royalty.
Growth Capital: Monthly Recurring Revenue (MRR) Line of Credit
Monthly Recurring Revenue (MRR) Line of Credit is a form of venture debt that’s commonly used by software-as-a-service (SaaS) companies. The amount of capital provided in an MRR line of credit is tied to a borrowing company’s monthly recurring revenue.
SaaS companies’ subscription-based services make them ideal candidates for MRR lines of credit, as lenders view their recurring revenue as a collateral base for a loan. MRR lines of credit can be relatively low-cost financing tools for companies that need funding quickly to invest in their expansion.
Revenue-Based Financing vs. Venture Capital vs. Angel Investment
Each venture funding option available to early-stage companies comes with pros and cons. Understanding the stage of your company and your goals for it are some of the best first steps an entrepreneur can make when evaluating what venture funding tool will work best.
Both venture capital and angel investment are beneficial for companies that want to avoid taking on debt. With both funding tools, entrepreneurs must be willing to offer up equity in their business, as well as some control of their company as both angel and venture capital investors will want some form of oversight.
When considering venture capital in a Series A round, companies should carefully evaluate whether they are prepared for high-growth funding, as premature scaling can be risky. If high growth is still far off, entrepreneurs might consider a seed round via angel investors a more viable and less risky option.
For companies looking for non-dilutive capital, revenue-based financing is an alternative option. Revenue-based financing also allows for a quicker turnaround if a company needs access to capital on a shorter timeline. Revenue-based financing, however, requires a commitment to future revenue, which may not always be possible.
Venture Financing Alternatives
While many early-stage companies seek venture capital or angel investment, there are several venture funding alternatives that entrepreneurs may also want to consider. These popular alternative financing methods include bootstrapping, small business loans, and raising capital from family and friends.
Venture Financing Alternatives: Bootstrapping
Bootstrapping refers to a startup that’s growing its business without venture capital or outside investment. With this approach, founders will often use their personal savings and company revenue to operate and grow their company.
While many startups use this lean growth approach, it places the financial risk solely on its founders. In addition to using their personal savings, founders at times use credit cards, tap their retirement funds, and/or maintain a full-time job to bankroll their startup.
Venture Financing Alternatives: Family and Friends
Friends and family are a common source of funding for entrepreneurs looking to grow their business via alternative financing options.
In this less formal method of fundraising, entrepreneurs will pitch their family and friends on their venture and their vision for it. Family and friends’ funding could come in the form of a loan, equity, or a gift.
There are, of course, risks with this approach. If your venture fails, entrepreneurs risk straining close personal relationships and jeopardizing the financial well-being of those they’re closest to.
Venture Financing Alternatives: Traditional Bank Loans
Banks are common sources of funding for small to medium-sized businesses looking to grow. While the cost of capital can be relatively low when compared to other financing options, traditional institutions like banks are usually looking for companies with assets, profitability, and/or a longer operating history.
It’s also worth noting that banks operate on slow timelines and present certain hurdles to an early-stage company that lacks assets. Often, they’ll require assets — such as buildings or expensive equipment — to collateralize a loan. Loans also have strict repayment terms and require personal guarantees.