tl;dr – If you choose or cannot go down the VC path in financing your startup there are other options. Bootstrapping, finding patient money, crowdfunding, financing via personal loans & credit cards, and reinvesting any profit are paths you can take to grow your startup. My favorite is for a founder to fund their startup through a side business that generates positive cash flow but is low touch.
Previously we discussed whether taking VC money makes sense for you and your company. If you decided that VC is not the right path for funding your company don’t worry as there are alternatives.
Below are some of the more common alternative financing paths for founders and general thoughts around each.
I am a huge proponent of bootstrapping your company for as long as possible whether you seek VC financing or not. The reason is that it forces your company to run lean and focus on the key levers it needs to succeed. Perhaps more importantly you do not have to go to outside capital at a stage where your company is too early to raise. If you try to raise outside capital too early you are more likely to get killed on terms (e.g. more dilution) or you could just fail to raise altogether.
Many founders initially bootstrap and fund their companies and life needs through their savings including retirement savings. If you believe you can build a great company then why would you put that money elsewhere? Digging into your savings results in a centralization of risk (i.e. more eggs in your company) and a founder and their family should be OK with such risk.
Staying in the bootstrap realm is my favorite way for a founder to fund their startup – a side hustle. A proper side hustle is something you work on part time that brings in enough cash to keep your life afloat and pay some of your company’s bills. One of my clients set up a small ecommerce business with the intention of working on it a couple years before launching their startup. Eventually they build their ecommerce business to a point where it brought in six figures in profit annually and they only spent about 10 hours of work each a month on the company. Because of this that client has felt less pressure to raise capital and still has the time to work full time on their startup without affecting their savings!
There are two issues with this approach. The first being that it will take time to build this side hustle if you don’t have one already. The second is that it may not provide enough capital to fund the company so you may still need other sources.
Financing a startup via personal credit cards or loans is my least favorite option but one that must be mentioned. Although they are non-dilutive methods of financing the losses can be personal and liability is not limited. A personal loan is owed to the founder individually as are credit cards. Credit card rates (and to a lesser extent personal loan rates) are extremely high and a founder should consider how will they service this debt and eventually pay it off.
If not careful a founder can push themselves to personal financial ruin and may have to sell their equity in their startup prematurely. Sometimes founders can take personal loans from their company to pay off prior debt with such loans secured by their equity stake. However, that means you must be comfortable with having open and honest conversations with your investors about your financial situation.
As an FYI I am not mentioning traditional lending in this case because unfortunately it is extremely tough to find lenders who are willing to invest in an early stage startup. The lack of historical company financials, the fact that most startups are running at a loss, and the lack of hard assets to secure against (e.g. machinery) make underwriting difficult for most traditional lenders.
This bucket really is mainly friends and family but can include some family offices and angels who are fine with doubles (i.e. not needed to 100x their return in 5 years) and long term holds with dividend returns in their portfolio.
These investors are invested for the long term and are interested in a founder building a stable and profitable company rather than a boom or bust company. Their risk profile is less venture and more S&P 500 but their faith in you and/or the opportunity allows them to make the investment in your company.
There are two things to keep in mind when considering this approach – (1) can you find enough patient capital and (2) how will Thanksgiving be if your company goes belly up after taking family investment?
If you are unfamiliar with what does the term “securities” means just think of it as anything but a pure debt (i.e. loan) investment. There are crowdfunding platforms (e.g. WeFunder, MicroVentures, etc.) that connect companies with accredited and non-accredited investors who are interested in purchasing securities.
While the ability to connect with new investors is solid for companies (especially B2C companies) there are concerns a founder must keep in mind. First, if you sell securities to an unaccredited investor then you must adhere to the Reg CF rules which add a layer of costs with filings including items such as third party reviewed financials that need to happen. Second, the platforms charge a fee for their services and for connecting companies with investors. Finally, a company may end up with a bunch of $100 checks on their cap table so the platform provider must be able to handle items such as communications and obtain proxy power or otherwise you can have a mess on your hands.
There are two flavors here – debt and project based (Kickstarter). A Kickstarter campaign may make sense for a super early company that is looking to put together a product and wants to generate hype and doesn’t need a large amount of capital. However, it doesn’t really work if you want to raise larger amounts.
A debt crowdfund makes sense for companies that can’t or don’t want to secure traditional loans and can become cash flow positive enough to service their debt. I’ve seen businesses such as restaurants use Next Seed to finance themselves in this manner, but it is atypical for a tech or tech enable startup as servicing debt would be an issue.
Reinvest the Company’s Cash
If you can make your business cash flow positive and don’t have the desire to grow at all costs and run a deficit you can simply reinvest your company’s cash back into the company. Many founders choose to grow organically because they want to retain control of the company and don’t feel the rush to capture markets and market share. One of the risks with this approach is a larger company may be able to beat you in pricing due to cash reserves and push you out of a market.
Out of all the possible avenues mentioned above my favorite is funding your current startup through a previous low -touch positive cash flow generating company. This way you don’t empty your savings, run the risk of hurting family relationships, take on fees and random investors from platforms or rely on luck/network of knowing patient people who will invest.