Business

A Comprehensive Comparison Between Traditional and Alternate Startup Funding Options

Since the Startup India scheme launched in 2016, there has been much focus on building a resilient startup ecosystem in India. As the world’s third-largest startup ecosystem, India has been able to transform the startup space. This is also evident because India is home to 108 unicorn startups, as of May 2023. Access to startup funding has been vital to establishing and expanding this ecosystem. 

A startup can secure capital through a startup business loan. Another route that startups can take is via alternate financing options. These include equity funding, crowdfunding, or grants. Understanding the difference between the two options will help you know the ideal route for your startup. 

So, read on to understand this difference and know how startup business loans fare against other financing methods. 

What are Startup Business Loans?

Like other businesses, startups also require sufficient capital to establish themselves and expand their operations. New entrepreneurs get a startup business loan to manage cash flow efficiently and fund advertising, production, payroll, and other expenses.

Startup business loans are lending facilities specifically designed to assist new businesses financially. As the name suggests, these loans are available to individuals who are setting up or have recently started a new business. 

You need a robust business plan to apply for these loans. Apart from considering credit score and business ownership certificates, lenders also assess your business plan to understand the viability of your business. 

You may also have to meet other specific criteria set by the lenders. These depend on the lender, your business type, and vintage. Sometimes, the lenders may come to you with a pre-approved business loan offer, too.

Pre-approved business loans are comparatively easier to apply for since the processing and disbursal of funds are instant. However, these are only available to select customers whom the lenders deem creditworthy.

Alternate Financing Options for Startups

While debt funding is the traditional way to finance your startup, you can also opt for unconventional ways of funding. These include: 

Crowdfunding

Crowdfunding is when startups raise funds through small donations from people. This is very different from a pre-approved business loan, where you acquire funds from one entity.

Most of these crowdfunding campaigns happen over internet platforms and have a set monetary goal, along with the time frame in which it is to be raised. Crowdfunding platforms enable fundraisers to connect with the crowd, and to make this available, they charge a fee. 

Unlike venture and angel investors, financiers in crowdfunding campaigns do not get interest or equity in return. However, the startup may confer them with long-term consumer benefits for their early investment. 

Crowdfunding requires a lot of commitment, and the people who drive these campaigns generally have some personal investment. This may be due to the mission of the project or their connection with the leader. As such, it is not a given that every startup will be able to raise funds through crowdfunding. 

Angel Investors

Angel investors are those financiers who provide initial seed funding to a startup business. In exchange, they get proportional ownership in the business. Angel investors are unique because they provide a hands-on approach once they invest in the startup. 

Given this, an angel investor from the same field can prove to be beneficial, as they can help boost the business. Angel investing is not akin to lending, as these investors put money behind an idea and expect rewards only if it takes off.

Note that getting the backing of angel investors is very competitive because they are typically very discerning about where they invest. 

Venture Capitalists

Venture capitalists, like angel investors, offer capital in exchange for equity. However, unlike angel investors, they have a more structured and less hands-on approach. Funding from venture capitalists comes from hedge funds and investment pools. 

Because of this, they can offer higher capital to startups. However, venture capitalists feature in the later stages of startup funding. They generally infuse funds into a business when the commercialization of its product is already complete but still needs scaling.  

Venture capitalists invest in startups only after carefully assessing their financial health and potential for growth. Hence, they often require startups to provide detailed business records, including cash inflow and outflow, profitability, revenue streams, etc.

Account Receivables Financing

Access to funds is necessary for startups looking to establish their foothold or expand their operations. However, it becomes equally essential in times of unexpected expenses or bridge periods of undesirable cash flow. 

You can get revenue-based financing if your startup is already established. This financing option allows you to borrow funds against the bills you have issued but have not received the payment for. 

This strategy is best suited for small businesses that need to collect recurring payments or defined annual annuities. The process involves transferring outstanding invoices to the financier, who pursues them as the new holder. It can also fetch you lower interest rates as compared to a startup business loan.

Grants

Grants are the capital rewards provided by the donors, including the central and state governments, to support startups that have achieved certain milestones. 

The primary difference between grants and other financing options is that the former does not need to be repaid. However, you will have to report on how you plan to optimize the funds to the donor. 

Most grants are designed for specific purposes or to support certain sectors. For instance, a wide range of grants are available in the research and development field or a field where women entrepreneurs are in the majority.

Comparison Between Different Financing Options for Startups

The following table presents a comparison of a startup business loan, equity financing, and grants on different counts. 

Characteristics Startup Business Loans Equity Financing  Grants
Nature You will have to repay the amount with the interest Investors provide funding in exchange for equity in the startup These do not need to be repaid
Risk The risk factor for the lender is lower if the loan is backed by collateral The risk factor for investors is high as there is no guarantee of repayment of investment No risk factor 
Repayment More pressure on the startup to adhere to a repayment timeline Comparatively less pressure on the startup to adhere to a repayment timeline No pressure to repay
Returns Lenders get interest on the amount borrowed Financiers get returns through capital growth  No returns for donors
Involvement Debt financiers have less involvement  Equity fund investors are actively involved Donors have no involvement
Sources Banks, NBFCs, and government-backed Credit Schemes Angel Investors, Venture Capitalists, and Crowdfunding Central and state governments and private entities

Alternative financing options for startups offer flexibility of repayment through equity, future revenue, or other sources. These options are appropriate for startups looking for fund infusion, accelerated growth, or protection from unforeseen circumstances.  

On the other hand, the traditional debt funding method comes with its own set of benefits. For instance, a startup business loan has relatively lower costs, a simpler scalability model, and a defined regulatory environment. Thus, you should consider available credit, cash-flow forecasts, and short-term demands when choosing your funding option.

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