The Entrepreneur’s Guide to Startup Business Loans in 2018: From SBA and Crowdfunding to VC and Beyond
Entrepreneurship continues to rise as more and more individuals set out to pursue a dream.
Many of these entrepreneurs, however, are taking a leap without an established track record, meaning the road to funding can be challenging.
Here's what you'll learn about in this piece. Feel free to jump to any section, or read through the whole thing to get a big-picture view of startup funding in 2018:
- The State of Startups in 2018
- What Predicts Startup Success?
- Top Barriers to Funding
- Types of Funding for Startups
- SBA and Microloans
- Private Bank Loans
- Seed Financing
- Venture Capital
- Online Lending
- Credit Cards
Luckily for these startups, the alternative investment industry has grown from a relatively small part of the financial system in the past to an influential part of the global economy in the present.
What does this mean for you, the entrepreneur? There are plenty of both traditional funding paths (like SBA loans and venture capital) and less conventional options (crowdfunding or microlending) available today. And with the prevalence of these lenders online, it’s easier than ever to connect with the lenders most likely to help you out.
Before we get into the different funding options for startups, let’s look at the state of startups in the U.S. as of 2018.
Startups in the U.S. are rising again steadily since they took a massive dip in 2010. However, creating a successful startup can be tricky; less than one percent go public each year and only half a percent of businesses get venture capital funding. Of those, over 50% lose money.
The success of your future startup may hinge, somewhat, on your industry. According to BLS data, construction, education services, and the information sector have the highest birth rates. “Birth rates in particular sectors generally reflect the economic conditions in the sector in question,” states a BLS report on U.S. startups, meaning that the demand for services in these three sectors has exploded. However, in terms of longevity (survival rates), the top industries are health care and social assistance. Interestingly, construction ranks among the lowest -- meaning this industry may be in high demand, but these startups are less likely to withstand the test of time.
Startups are often viewed skeptically by traditional lenders and investors, so you might feel tempted to sell your assets, shift your mortgage terms, or even hold down a 9-5 job to generate the funds you need to get started.
Luckily, we live in an age where available technology hugely reduces once-typical operation costs while also providing a chance at free or inexpensive advertising and lead generation. Today’s technology has also impacted the speed of innovation -- meaning there are a plethora of ways you can differentiate yourself in the market and adapt with changing times. Forbes writer David Pridham states that 2018 may one of the best years for entrepreneurship yet, due to recent surges in venture capital investment, a growing economy and stock market, and adjustments to business tax code.
It’s clear that generating capital to fund a startup business is key for many entrepreneurs, and it’s helpful to understand the different options and the pros and cons of each. But first, we’ll evaluate some of the qualities which seem to predict startup success to help you get on the right track with your business. Then, we’ll talk about perceived barriers and how to overcome them.
Here are the top qualities of successful entrepreneurs, so you can start embodying them right away and improve your chances of getting funding. Oddly enough, mindset alone can determine whether or not a startup receives funding -- so take a look at the three qualities below and identify your own strengths and opportunities to grow.
Knowing Your Niche
Successful entrepreneurs believe they can change the current playing field. The most successful startups look for ways from the beginning to improve their position among their competitors.
That’s right: before you even have a business, it’s a huge boon if you’re determined to be the best in your niche.
In order to do this, know the rules of your specific industry. While an understanding of business in general is helpful, a deep understanding of your niche is crucial. Recognizing and understanding these specialized rules early on gives entrepreneurs across the board a competitive edge -- whether you’ve created a new software-as-a-service offering, a disruptive new style of baby diaper, or an innovative nutrition bar.
Another important aspect surrounding mindset is big-picture thinking. Big-picture thinkers who see how everything fits together tend to have greater success developing strategies that work. Those with a big-picture mindset at the beginning tend to have a solid likelihood of both startup success and growth, meaning they’ll be more appealing to investors.
Use the expertise of your personal networks to inform investment decisions. The most successful social investment firms focus on the big picture of their competitors’ strategies, using their competitors as sources of ideas instead of seeing them as businesses to “beat.”
Community and Connection
Nothing beats real connection. Meeting up in person is the way real communities develop. And personal connections especially matter with respect to local venture capitalists. While community can’t happen as effectively without face-to-face connections, becoming a respected member of any community won’t happen overnight. Be proactive and find support in your community by engaging with others face-to-face before you start seeking funding. Go to Chamber of Commerce meetings, find a One Million Cups group in your area, or search for other local entrepreneurship incubators or meetups online.
Now, we’ll take a look at some of the top barriers that keep entrepreneurs like you from getting the startup funding they need.
Taxes and Regulations as Barriers
Some of the greatest barriers for new entrepreneurs are federal and state government regulations. The sheer amount of bureaucracy alone can make it difficult for startups to get traction. While U.S. Congress writes vague laws, federal and state agencies often over-regulate, and navigating the legal speak can be treacherous.
Luckily, many are actively advocating changes to benefit startup and small business growth -- so these may only be temporary limitations.
Age as a Barrier
One of the biggest challenges to entrepreneurship today is the average age of startup owners. The most attractive entrepreneurs to fund seem to be under 30 years of age. Their main advantage, in the eyes of lenders, is that they’re fearless when it comes to new initiatives. Their main disadvantage is having little to no past work experience.
If you’re a startup entrepreneur over 30, emphasize your own experience and proven skills to overcome age bias and gain leverage with lenders. If you’re under 30, do your research: the stronger your business plan and your vision, the greater the chance investors will be able to look past your lack of experience.
Credit Score as a Barrier
If your credit score is less than stellar or you’ve got a history of paying late, focus on improving your image. Pay off as much of your personal credit balance as you can. Getting your balance below 30% of your available credit limit is key. Keep anything you’ve paid off on your credit report to show your improvement. Begin paying your bills on time and avoid taking on new or detrimental debts like auto loans, cash advances, or title loans.
Once you’ve addressed your mindset, developed an in-person network, integrated with the local community, described your relevant experience, and improved your credit score, you’re in good shape to seek funding. There are numerous funding options for startups, and each has its own pros and cons. Here’s an outline of the eight main types of funding for startups.
The U.S. Small Business Administration offers up to $50,000 (the average is about $13,000) of funding for small businesses through microloans. Yet because it’s “micro,” the amount of funding granted may not be enough to fuel a startup’s required initial momentum. Other microloan lenders also tend to have solid terms that allow you to grow your financial stability and establish better credit, so a microloan could be the first step to qualifying for more funding as you grow.
SBA 7(a) loans also offer funding that could be helpful for startups, but most SBA loans are reserved for already established businesses with significant collateral. The application and approval processes can also hurt the agility on which startups tend to capitalize.
SBA loans are government-backed, meaning that qualification (in some regards) may be less strict than with traditional bank loans.
Specialized programs are available for Veterans, Export-based businesses, commercial real estate, and more.
Borrow up to $5 million.
Some businesses don’t qualify for the SBA loan.
May have higher interest rates than bank loans.
Loan approval process may be longer.
Bank loans are the most common small business options for medium to long-term financing, but most banks won’t lend to early stage startups without personal guarantees or collateral from the founders. Asset-based loans require clean balance sheet and sufficient assets that the bank will accept as collateral. The bank sets the loan term, the interest rate, and repayment schedule.
Low interest rates interest rates compared to convertible notes.
Startup founders don’t need to give up any business ownership nor control over major business decisions.
The bank can’t claim a percentage of the startup’s profits or shares.
Fixed interest rates mean you can plan your repayments throughout the span of the loan.
The bank can restrict some startup operations.
Collateral is generally required.
Credit agreements will favor the bank.
Assets can be seized by the bank if the startup founder defaults.
Seed investments are received before an entrepreneur seeks further capital. They can be sourced from friends, family, angel investors, and nonprofit grants, and they usually occur as informal loans, convertible notes, convertible preferred stock, and simple agreements for future startup equity.
Startups will often complete several rounds of seed financing before they have enough funding to begin operations. The seed stage is the earliest and most critical funding round, when the monies received will cover early-stage expenses like market research or product development. Here’s more detail about the two main types of seed financing you can seek for your startup.
For early stage startups, friends and family become important sources of seed financing. Investments from friends and family often take the form of informal loans or equity investments.
Benefitting from the trust and personal interest of close friends and family relationships.
Vested interest in your startup’s success.
Less aggressive terms and negotiations.
Support based on less sophistication and business knowledge than that from other business investors.
Less understanding of true startup risks and potential struggles.
More complicated decisions due to the personal element of friend and family involvement: simple business decisions are at risk of becoming intense personal matters.
Startups can often benefit from angel investors, who are most often high net-worth individuals or informal venture capital types of groups who invest in both convertible notes and convertible equity. The capital they provide can be one-time seed money or it can be extended as ongoing support. Startup angel investors usually have a particular interest in the startup’s specific industry – or even in startups in general.
Angel investors generally have – and are willing to offer – more capital than friends and family.
Angel investors don’t typically require a proven track record; they look for startups they believe can be successful, regardless.
The structure of the funding can often be negotiated to a greater extent than can other, formal sources of capital.
Angel investors can be helpful bridges between the amount of funding a startup has received through friends and family and the ability to look for venture capital.
The experience, expertise, and connections of certain angel investors can provide valuable insight to the funded startup. Mentorship is invaluable.
Angel investing is considered a risk.
Angel investors often expect high returns on their investments.
Angel investors usually require clearly defined exit plans, such as initial public offerings or acquisitions.
Angel investors usually expect to have significant representation on your board of advisors; they plan to play an active role in your business.
Venture capital funding is available for startups considered to have the potential for significant long-term growth. Venture capital funding usually involves more risk for investors, but also has the capacity to provide much greater returns. After seed monies have been secured, startup companies may also choose to secure funding from venture capital firms, private equity firms, and large corporations with venture capital branches. Funding is raised through multiple steps.
A great source of funding if your startup company has proven its model and demonstrates a real potential for growth.
Venture capitalists can give you access to significantly greater amounts of funding than any other alternatives for startups.
Long-term funding, since venture capitalists usually look for long-term investment situations.
There’s no obligation to repay venture capital funds before liquidation.
Venture capitalists can also become valuable connectors, as they often have significant business experience and industry connections.
You could be introduced to additional specific business leaders who are able and willing to help your startup grow.
Venture capital firms will usually require equity in exchange for their sizeable investment.
Due to the extent of their contributions, venture capitalists will expect to be significantly involved in the operation and future growth of your startup.
Venture capitalists will also want to secure significant representation on your advisory board.
There will usually be an expectation higher rates of return on the venture capital investment.
Venture capital firms will also frequently require further rights that can affect your startup’s structure and operational mobility.
Startup founders can apply for and obtain small business loans through online lending providers. While traditional bank loan applications can be lengthy and complicated, the online lending application process tends to be much simpler. Because of the simplicity, any funds are usually delivered to the startup founder much more quickly. Kiva is one well-known organization that participates in online lending. Kiva allows individuals to lend money to entrepreneurs.
Lenders can make funding decisions quickly – within hours of receiving the funding application.
In addition to quick decision-making, online lenders also tend to make any approved funds available quickly.
Loans from these types of lenders can be more susceptible to fraud.
There tends to be little assistance for startup founders in filling out the loan application.
Any incorrect application submissions incorrectly can potentially lead to being charged higher rates.
Crowdfunding platforms and social media sites provide startup founders with access to investors and funding alternatives beyond the typical friends and family pool.
Crowdfunding allows entrepreneurs to source backers for startup funding by inviting numerous individuals to each invest a relatively small amount of money. The startup founders can then choose to give investors rewards, products, or services. They can even choose to give small equity shares in exchange for financial support. A few examples of popular crowdfunding campaign websites which allow entrepreneurs to set up campaigns to fund their business idea are:
Indiegogo (the largest global fundraising site)
Kickstarter (good for fundraising prior to raising venture capital)
EquityEats (specifically geared towards restaurants)
Tilt (cheaper fees and a supposed success rate of 91 percent)
Fundable (exclusively for businesses)
Patreon (geared towards artists and creators)
Plum Alley (geared toward women)
GoFundMe (another well-known funding site)
RocketHub (steep fees if you don’t meet your goal)
One of the biggest differences between crowdfunding sites is whether they allow you to keep all the funds you raise, or whether they restrict you to all-or-nothing funding. All-or-nothing means that you must meet or surpass the initial funding goal you choose in order to access any of the funds. In contrast, sites which allow you to keep any funds you raise give you access any amount of money that you raise–you don’t have to meet your goal. The latter gives you more flexibility but can also leave you shorthanded if you need a specific amount of capital.
Before new rules were implemented, the SEC only allowed accredited investors to contribute funding to startups. Now, though, even those with an annual income or net worth under $100,000 are allowed to provide startup funding, with the maximum being five percent of one’s yearly income or net worth. This means startups can raise money more easily by drawing on a larger investor pool, even if they haven’t yet been able to attract the attention of higher net worth individuals.
Allows ideas to be tested in the public realm.
Generates awareness and interest in startup business ideas.
Offers a potentially fast way to raise funding.
Low upfront fees to start a funding campaign.
Easy progress tracking for investors, which may generate enthusiasm and investors to help you promote your startup through their own networks.
An alternative option for startups not eligible for conventional funding.
The ability to reach many investors via one platform.
Online signup is relatively simple.
Potential theft of intellectual property if you haven’t protected your startup idea with a patent or copyright.
If it’s an all-or-nothing model, any funding that’s been pledged gets returned to investors if you don’t meet your goal.
Processing fees and charges for a percentage of total money raised.
Marketing and compliance costs.
More difficult to implement for a more complex startup ides.
Often best for funding needs under $100,000.
With bootstrapping, startup founders self-finance the company at the initial idea stage. They can contribute any assets of their own which the startup can use. They can also liquidate any non-cash assets and contribute them to the startup along with cash.
Keep all of the benefits of any earnings that accrue from your startup.
Keep control over the startup’s ownership and operations.
Without large pools of capital to contribute to the startup, its ability to grow can be severely limited.
Any founders’ capital could receive higher risk-adjusted returns by being invested elsewhere.
Using credit cards seems obvious and simple, but it can mean that startup founders get easy access to funds on very short notice. Both personal credit cards and credit cards tailored specifically to small businesses are options for that kind of funding.
Easy approval for many small business credit cards.
High credit lines.
The potential for large amounts of capital.
Small business credit cards often come with perks like mileage accrual and supply purchase discounts.
Dramatically high Interest rates compared to traditional bank loan interest rates.
Directly affects your credit score if you make late payments or miss a few.
Any blips in payments will hurt the founder’s future chances of getting funding from traditional banks.
|Funding Type||Best Benefits|
|SBA Loans and Microloans||Great for small businesses who don't need excessive funding. Also a good option for those with less-than-perfect credit.|
|Bank Loans||Low interest rates, keep control of your business, payment planning.|
|Family and Friends Seed Funding||Trust, vested interest, less aggressive terms.|
|Angel Investor Seed Funding||No proven track record required. Experience, expertise, and business connections.|
|Venture Capital||More, and longer-term, funding.|
|Online Lending||Quick approval decisions, quick access to funds.|
|Crowdfunding||Simplicity, speed, flexibility, reach.|
|Bootstrapping||Keep full control of your business, no debt required.|
|Credit Cards||Potential for high credit lines and large amounts of capital, accrue additional perks|