The past decade introduced new technologies that have made starting a business easier than ever. Nowadays, people with innovative ideas can sell their products with a credit card and the clicks of a few buttons.
Yet, despite the new found accessibility to consumer distribution, financial processes have nonetheless remained exclusive, as traditional financial institutions (such as banks) are reluctant to fund companies without many assets. Thus, the biggest pain point for many founders is how they can raise capital to turn their dreams into reality. In fact, 38% of startup failures can be attributed to running out of funding, while only 8% of startups are attributed to poor product, according to CBInsights. This suggests that funding is more of a hurdle to business than innovation; people have great ideas, but they don’t have the means to turn it into a successful business.
This article will give an in-depth overview of the different ways you can fund your business, so you can find the right fit for you.
The Banking Solution
Large businesses, and well-established small-to-medium enterprises (SME), will prefer to raise capital through business loans from traditional financial institutions, such as banks. Loans are favourable to many businesses because they can raise capital without selling ownership, and interest rates are relatively low. In fact, according to SBA, business loans, credit cards, and lines of credit account for 75% of financing for new firms.
However, the truth is that bank loans are exclusive, to the extent that banks will only give offers to businesses that have high asset valuation. This stems from the traditional approach of assessing risk through collateral. Offers are determined by the total value of assets in a business so in the case that the borrower defaults, the bank can cover their losses by selling the borrowers’ assets.
Unfortunately, this approach is highly unfavourable for smaller SMEs and startups. Businesses are becoming increasingly tech-driven and asset-lite. Digital native startups, such as E-Commerce or subscription-as-a-service (SaaS) businesses usually don’t have many assets and banks don’t know how to value their digital property. Consequently, E-Commerce and SaaS businesses are labelled as high risk and are seldom given bank loans.
Additionally, bank fees usually have interest bearing or associated fees, which will add to the repayment costs. Founders that borrow from banks should be familiar with the financial consequences that may result from late payment or prolonged/shortened terms. Usually, banks will not offer much flexibility in terms of repayment, which can cause difficulties for retail or online retail companies, as sales for these businesses usually fluctuate between seasons.
In short, bank loans can offer your business large sums of capital at a low interest rate, without the need to sell equity. On the flip side, repayment is not flexible and can come with hidden fees, and they ultimately are not accessible to everyone.
The Venture Capital Solution
Venture Capital (VC) is one of the longest standing methods of startup fundraising and it has no signs of slowing down. According to KPMG, VC funding reached a decade-high of US$150 billion in 2017. Clearly, VC is an effective method of fundraising, proven by its long track record of success. VC methods of fundraising have also gained mainstream popularity, with shows such as Shark Tank and Dragons Den bringing the whole process into national television.
Usually, a VC deal involves a trade in equity for growth capital. In other words, founders sell a portion of their ownership of the company for funding. A VC offer does not require direct cash repayment. VC companies earn their money back by selling their stake in the business after the business grows.
A VC deal is advantageous in many ways. Firstly, a VC offer does not require any direct cash repayment. This will make it easier for founders to manage their cash flow. This is especially important for startups because they don’t make a lot of revenue until the business matures. In fact, it took VC unicorns Airbnb and Uber over a billion dollars in debt to grow their business, according to PitchBook. The hard truth is that it takes money to make money. Founders that accept VC offers don’t have to take additional financial burdens to raise capital.
Moreover, VC companies often have a lot of experience in growing startups and businesses. Founders who choose to accept VC offers will also be bringing expert advice and consulting into the table. Startups will receive a lot of external assistance in making big business decisions, making VC a good choice for founders who want to focus more on innovation and less on business growth.
Despite this, VC offers come with it’s fair share of shortcomings. To begin, it is very hard to get an offer. VC companies often have to wait years to get returns on their investments. Thus, they will only invest into businesses and products they truly believe in. This is not to say that your product isn’t good enough, but that they may not believe in it.
VC deals will also dilute ownership of your business. Founders usually have to give 10 to 15% of their ownership away to VC companies. In addition to this, the investors usually require the business to give up board seats and a degree of executive autonomy over the business. Founders will lose a degree of control over their business, making it more difficult to execute their vision. Sometimes, VC advice can also lead a startup in the wrong direction. It is the founders who have the true vision for their product; this is something not all VC companies may understand.
While trading equity for capital may fix cash flow burdens in the short term, it can be more expensive in the long term when the business becomes successful. While 10-15%, a typical percentage to trade off in one VC deal, is still manageable, startups can go through several funding rounds in the span of five years. In fact, companies raise nearly three funding rounds before they get to a Series A funding, according to TechCrunch. Several VC funding rounds could result in founders losing majority ownership.
The effects of this can be financially, and operationally detrimental in the long term.
- It is very expensive to buy back shares or stakes. By the time the company has grown to the point where ownership is worth preserving, the valuation of shares will have multiplied.
- To lose majority ownership means to lose control over the business. The founder will no longer be able to implement their vision without the consideration of other shareholders.
- Net profits will be split amongst shareholders. In the long term, this can mean bigger financial losses as compared to debt.
Furthermore, an unfortunate reality that must be considered is social inequality. VC offers are not entirely based on financials. In other words, it requires founders to pitch and present their products as the next big innovation. To involve qualitative methods of valuation could potentially introduce room for bias. According to PitchBook, male founders raised a total of US$109.36 billion while female founders only brought in US$2.86 billion, acc. While this statistic can only represent correlation, it may still be another hurdle for female, or social minority entrepreneurs, who want to raise VC funds. Instead, debt financing, which is based mostly on financial reports, can be a much more unbiased way of raising funds, since charisma and presentation will not do much to affect numbers.
The Venture Debt Solution
Venture debt is not as exposed as VC since it’s business model is very much similar to that of a bank. What sets venture debt apart from bank loans is that venture debt companies usually invest into companies that are already VC backed, and will offer debt financing to startups and small companies regardless of asset valuation.
Venture debt is a form of non-dilutive financing. Founders can raise growth capital without having to trade it for equity. However, like any other business loan, founders will have to repay their debt, usually on a monthly basis.
Venture debt is usually for companies that are passed the research and development stage, and are looking to drive revenue growth. Startups that have already market tested and have begun distribution of their products are favoured by venture debt companies, as opposed to VC companies, who can make decisions at the planning stage so as to make a more favourable equity deal.
As with any other types of debt financing, venture debt loans require the borrower to have good financials. However, what sets the venture debt valuation process apart from a typical bank is that venture debt is usually based on financial statements, rather than asset valuation. In other words, a venture debt firm is more interested in analyzing your revenue and ad-spending compared to how many assets you have.
Ultimately, venture debt should be the first choice for founders who have a developed, market tested product that has already begun distribution. This is because their ideas have been tested, and they work! It is unfavourable for founders to trade equity for growth capital to spend on revenue-linked spending.
For example, a company may have a great product with a loyal fan base, however they do not have large exposure. To fund an ad-campaign, they need to raise US$200,000. To trade 15% of stake in a company just to buy ads is, quite frankly, unfair! This initial investment of US$200,000 can triple or even quadruple the revenue of the company, without needing expert input from a VC company, so trading equity for ad-spending is not a good tradeoff.
Additionally, venture debt companies typically do not ask for board seats. Founders can continue executing their vision without external interference. Therefore, if your business needs funding to increase exposure through ad-spending or marketing, it is recommended that you fund your business through debt financing.
However, debt financing comes with drawbacks, many of which overlap with bank loans. Founders will have to repay their debt through monthly instalments. If deadlines are not met, this could induce additional costs, or add interest to the repayment process. Venture debt companies are usually unforgiving and may not provide flexibility on the repayment process.
The Revenue Based Financing Solution (RBF)
Revenue based financing (RBF) is a method of alternative financing that provides founders with non-dilutive growth capital through a cash advance that is repaid through a unique revenue share model. Founders that receive cash advances through an RBF company will repay this advance by giving a small percentage of their revenue every month until the advance has been fully covered. It is important to note that RBF companies do not give out loans; instead, they are investing in your future revenue.
RBF offers a flexible solution to founders, allowing them to repay their cash advance at their own pace. Since companies pay a small percentage of their revenue every month until the cash advance has been repaid, companies can pay less when their revenues are down. This is especially fitting to digitally-native retail companies, such as E-Commerce and direct-to-consumer (D2C) businesses, as revenue goes up and down based on sales.
RBF is also one of the best ways for mobile app developers to raise money. Mobile app sales fluctuate based on the release of new apps. There will always be a slump in sales in between release dates. Therefore, venture debt and bank loans are not suitable for app developers, since regardless of the monthly revenue, they must pay the same amount. RBF fixes this problem by allowing app developers to pay less when sales are down.
Additionally, the entire RBF process is entirely revenue driven. To determine the cash available to founders, RBF will form valuations that are based on the company’s sales and revenue, eliminating any forms of asset or social bias. This makes RBF a good alternative to bank loans, which will require high asset valuations for any type of loan offer, and VC, an industry that takes equity and is reliant on a ‘good pitch’.
Find out more about RBF here.
The Choco Up Solution
If your business has market tested products and is already making revenue, then Choco Up may be the best fit to your financial needs.
At Choco Up, we bring flexibility to the next level. We understand the pains of fundraising, and the risks that founders take when they want to raise capital. That is why Choco Up’s RBF solutions are tailored to fit your financial needs, by offering non-dilutive, collateral free funding that is repaid through a percentage of your revenue.
One of the biggest problems startups face is cash flow. To build a business, you need the right people. Yet, without cash to begin, it is hard to keep them. This juxtaposition of needing money to buy money makes a very crucial pain point for many founders. In 2018, 82% of businesses that went under did so because of cash flow problems, according to Fundera. Additionally, the digital-native startup ecosystem is adding more complexity to the cash flow problem.
Choco Up’s RBF solutions can fix many of these cash flow problems.
- Many companies, especially those in E-Commerce and app development, will face accounts receivable (AR) delay problems. For example, read more about how Amazon can take up to 34 days to pay vendors the money they are owed, and how Apple’s Appstore can take up to 55 days to pay their developers. Choco Up can fix this by paying up to 50% of what Appstore or Amazon owes their clients on a consistent basis, so E-Commerce and app development businesses can reinvest their capital quicker.
- You want to start an ad-campaign to drive revenue, but can’t balance their funds between marketing and inventory. Choco Up can fix this by offering a cash advance for either purpose, so that your startup can grow at full speed. Find out more about how Choco Up can fix cash flow problems for E-Commerce businesses specifically!
- You need a bridge round between your main funding rounds, due to burnout. Burnout is a natural part of any startup and could be the result of rapid growth. It does not necessarily mean your business is not profitable! Choco Up can help you get to the next funding series by offering you a bridge round.
Additionally, Choco Up can offer your business expertise on Asian finance and tech markets, giving you insights on how to dominate Hong Kong, Singapore, and other significant regions in the Asia Pacific. We do not require clients to trade equity or board seats for growth capital, like VC companies, so you can enjoy our advice and full autonomy over your business.
Click here to apply for funding!
Interested in learning more about raising capital for your company? Check out the following guides we prepared for you: