5 Types of Funding for Your Business (With Definitions)
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The planning phase can be an exciting phase of starting a business, as there's a lot of enthusiasm for the vision of the company and its potential products. Businesses typically raise capital to take ideas from the planning phase and turn them into practical solutions. Learning about different types of funding can help you make informed decisions on how to proceed during different building stages. In this article, we explore what funding means for companies and explain the different funding options available to businesses.
What does funding mean?
Funding is the financial investment that investors make in a startup company. During the first business operations phase, startups require capital and investment to buy supplies, hire staff, and market products to potential customers. Investors create opportunities for new businesses by providing the financial means to successfully start this process. Investors play a pivotal role in helping startups gain the finances they need, have an interest in helping entrepreneurs succeed, and receive a financial rewarded for their investment.
New companies are at a critical stage and usually require outside funding to succeed. Most startups engage in multiple stages of funding and try to reach different types of investors to diversify the startup capital. Investors may also help new businesses by sharing advice on their experience in the marketplace or providing their network of suppliers and manufacturers. Finding the right investor to fund your company may provide you with both the pre-seed funding phase and tips for bringing your first product to market.
Types of funding
Each startup has a different funding path and timeline and typically requires different types of funding throughout its unique business journey. Some startups may take months to prepare all the funding, while others may take years with multiple rounds. Here are the most common funding options for startup companies:
1. Pre-seed funding
The initial phase of funding, also called pre-seed funding, may involve reaching out to many types of investors. You can contact anyone in your network of friends, family members, and colleagues during the pre-seed funding phase. For example, you may have developed a product that makes people's lives easier, and you may have friends who like your idea and want to help.
It may take a short period for you to gather a group of investors who are enthusiastic about your product and vision, or it may take longer to inspire a group of investors. During this initial phase, investors may not see a return on their investment. During this phase, company founders typically have the flexibility to focus on their vision for the company with little input from outside investors.
2. Seed funding
Seed funding is the first official round of investment, and businesses typically contact several types of investors. During the seed funding phase, a business can work on receiving enough financial support to start manufacturing products, conducting market research, and taking other practical steps to bring products to market.
Businesses may conduct market research during this phase to discover the ideal customer, the person who is most likely to become an early adopter of the products. Businesses can also hire product designers, sales managers, and other roles. Some businesses that primarily operate online may require less initial investment, as they don't have a physical inventory of products.
3. Series funding
After the initial phases of investment are over, and businesses can show key performance indicators like sales figures, startups may seek to expand the investor base. This phase of funding also uses long-term profit models and practical solutions to grow the business. Many businesses in this phase have a proven record of success, which makes finding capital easier during a successive series of funding. These are the series subcategories:
Series A: This involves funding from traditional capital firms, such as banks, investment agencies, and government grants. During this phase, investors usually take a less active role in the decision-making process.
Series B: This is a larger, more intensive funding series in which startups reach out to traditional capital firms and anchor investors who help attract other investors. As companies grow, they require investment from different investors and from those that can offer advice on products and services.
Series C: This phase involves raising significant sums of money for funding, while also offering investors a significant return on their investment. Companies during this phase have a proven track record of sales and can show investors they can receive a substantial return while also minimizing risk.
Series D and E: Larger businesses that want to expand into the global market may consider these funding phases. During these phases, businesses work with millions of dollars of investment capital, and this is also the last phase of funding before an initial public offering.
As you learn about the different series, you may see a progression in capital funding. Series A is the initial investment phase, while series B involves gathering support and resources as you provide tangible evidence that your company can deliver its goals. Different companies have different risk profiles that may cause concern for potential investors. In between series, you may hire an outside consulting team to assess major risk factors in your business, as this may allow you to address any issues investors have.
4. Debt financing
Debt financing involves startups raising funding by allowing investors to become creditors. Startups borrow money from investors, which includes repayment terms regardless of whether the company makes a profit. You may consider this to be a risky form of funding, but it can be one of the most efficient ways to raise an initial amount. There are several debt financing options available, including the following:
Venture debt: Similar to selling equity in your company, venture debt is a short-term loan that specialized banking institutions and private investors offer. One to three years is the common repayment period for this type of loan, with interest accrued over the payment period.
Canada Small Business Financing Program: According to the Government of Canada, there are many options for financing available to small businesses. With up to $1 million dollars of financing available, you can easily gain the capital you need a successful business.
Asset loan: For businesses that have substantial assets, such as facilities, materials, and equipment, they may use these as collateral for receiving a loan. This allows banks to take on the risk of giving a loan to a company.
Accounts receivable (AR) line of credit: A banking institution issues an AR line of credit by assessing the accounts receivable of a startup. This involves taking unpaid invoices as collateral so that the business can take out a loan.
5. Equity funding
Equity funding provides value to investors by offering company stock after an initial investment. Investors can sell and trade these stocks on a stock exchange. The following are typical examples of equity funding:
Crowdfunding: Crowdfunding involves using an online platform to request funding from several individuals. Usually done during the initial seeding phase, crowdfunding can be a great tool for companies that are well known within a region.
Angel investors: Angel investors have a high net income in their industries and want to help entrepreneurs by investing in startup companies. Unlike large banking establishments, angel investors usually work on their own, allowing them to make quick decisions on how to provide funding for startups.
Venture capital firms: Venture capital firms are private companies that invest in startup companies. Venture capital firms are usually involved in scaling up and many are willing to take on risk to gain a large return on their investment.
How to find the right type of funding
Although it may seem difficult to find funding options for a small business, there are many ways to find the right type of funding. Whether it is attending the trade show circuit or reaching out through government agencies, there are several things that you can do to find results and raise funding. If you're interested in learning more about funding for small businesses, examine the list below:
Trade shows: one of the best places to find investors is to attend trade shows and other networking events. When you attend a trade show, you not only can find investors, but you can also find new clients and network with suppliers.
Government funding initiatives: The Canadian Government's Business Benefits Finder website is a great starting place for any research into government grants and funding for small businesses. Small business owners can check to see if they are eligible for programs that include support and advice.
Websites: In today's tech driven culture, small businesses can find investors through online angel investing website platforms. These provide possibilities for small business owners to pitch to investors around the world.
Please note that none of the companies, institutions, or organizations mentioned in this article are affiliated with Indeed.
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