“If you’re starting a business and you take out a loan, you’re a moron,” Shark Tank investor and long-term entrepreneur Mark Cuban says. While his words may come across as harsh or even crass, he goes on to make a fair point: “There are so many uncertainties involved with starting a business, yet the one certainly that you’ll have to have, is paying back your loan.” This is an area that trips up many startup founders and even causes people to pull money out of their own pockets to fund their business. But, there are ways to fund your new business without using personal funds and without taking out a loan. Two primary options are venture capital (VC) and factoring for startups. Below, we’ll walk you through how they work and why factoring is often the more suitable alternative.
Why Startup Financing and Alternative Funding is Vital
Virtually all businesses require external capital at some point. However, because startups aren’t running at full speed just yet and their revenue has not stabilized, their capital needs are often much greater than established businesses.
Cover Initial Operating Costs
Two in five startups that fail simply ran out of cash, CNBC reports. While it’s easy to say this comes down to poor financial management, costs such as product development, marketing and advertising, and administrative expenses can add up. Many startups tap into funding solutions to cover everyday expenses until revenue picks up.
Scale Operations
Once the business takes off, the next step is scaling. While this naturally involves increasing expenses related to raw materials or equipment that require capital, startups often find themselves in need of larger facilities and technology to help manage rapid growth. In these cases, business growth funding allows the startup to scale without cutting corners.
Bridge Cash Flow Gaps and Build a Cushion
Cash flow solutions are often vital for startups and established businesses alike, especially those that serve other businesses. This happens when the business invoices customers after work or goods are delivered, then waits weeks or months for an invoice to be paid.
Attract and Retain Top Talent
Startups have to work especially hard to attract and retain talent. While some do this by offering shares of the company, others seal the deal with competitive salaries, hiring bonuses, and perks. This, paired with the costs of finding and onboarding talent, can add to the financial load.
Venture Capital Explained
VC is a type of funding that fuels startups with high growth potential. Around $171 billion is awarded in VC each year, Statista reports. However, funding is down in recent years, with the U.S. showing nearly a 30 percent decline, according to InvestmentNews. Industries like tech, healthcare, and renewable energy, where rapid scaling and large returns are expected, tend to get the most attention from venture capitalists.
Unlike loans or other financing options, VC does not require repayment. Instead, investors provide capital in exchange for equity. In other words, they own a portion of your business. However, this also means they’re usually bringing expertise, mentorship, and connections to your startup in addition to cash.
How Venture Capital Works
VC is very different from other alternative funding solutions, and the full process can take anywhere from around three to six months.
1. Pitch
Startups usually pitch their business to VC firms or angel investors. You’ll need to present a clear value proposition, a detailed business plan, and evidence of market demand and growth potential.
2. Due Diligence
If the VC firm is interested, they’ll dig into your business. This includes analyzing your financials, performing market research, evaluating your team, and doing competitor analysis.
3. Investment
Once they’re satisfied, the firm will provide funding in exchange for equity. There’s usually some negotiation during this stage.
The funding is often released in stages, referred to as rounds, that are tied to milestones. Common rounds include:
- Seed Funding: Generally speaking, seed funding should last your business 12 to 24 months and helps you get your business off the ground. An average deal will be in the neighborhood of $3.5 million and the investor will receive anywhere between 15 and 35 percent of your company’s equity in exchange.
- Series A, B, and C: Subsequent rounds, including Series A, B, and C, each provide a business with anywhere from 12 to 18 months of cash. These phases are designed to help the business scale operations, enter new markets, or develop new products. Deals can provide the business with anywhere from around $20 million to $60 million or more, with each round taking anywhere from roughly ten to 30 percent of the company’s equity.
4. Active Involvement
VC firms often take an active role in your company. They may be involved in decisions, help you scale, build partnerships, and even help you navigate exits like IPOs and acquisitions.
How to Qualify for Venture Capital
Roughly 98 to 99 percent of businesses that request venture capital are denied, Forbes reports. This is because VCs have rigid requirements like those outlined below.
- A Disruptive Idea: Your product or service must solve a significant problem or address an unmet market need.
- Scalability: Your business must be poised for rapid growth. VCs also want startups that can scale exponentially, not just incrementally.
- A Strong Team: Your leadership team’s experience, resilience, and vision are critical. VCs invest as much in people as they do in ideas.
- Traction: While early-stage startups can secure funding, VCs often want proof of traction, such as customer growth, revenue, or partnerships.
Benefits of Venture Capital for Startups
There are a few benefits that set VC apart from other types of funding.
- Large Sums of Money: VCs can provide millions of dollars, enabling businesses to grow rapidly and enter markets.
- Strategic Expertise: VCs often have industry expertise and provide mentorship, which can help shorten the learning curve and help you avoid issues.
- Networking Opportunities: VCs can connect you with other investors, customers, and business partners, which can facilitate growth.
- No Immediate Debt: Since VC funding isn’t a loan, there are no monthly payments or interest to worry about.
Drawbacks of Venture Capital for Startups
Despite the benefits, VC comes at a cost.
- Loss of Control: Giving up equity means investors have a say in major decisions. Some VCs even require a seat on your board of directors.
- High Expectations: VCs prioritize rapid growth and high returns. This can make startup founders feel pressured to scale faster than they’re ready and force them to make decisions that prioritize investor return on investment (ROI) over long-term sustainability or values.
- Rigorous Qualifications: The application process is lengthy and competitive. Many startups spend months pitching without success.
- Equity Dilution: The more funding rounds you go through, the smaller your ownership stake becomes. If your company eventually sells, your payout may be significantly reduced.
Invoice Factoring Explained
Invoice factoring is a type of funding that’s popular with businesses that serve other businesses, especially those that invoice and offer lengthy payment terms. The total U.S. market size is valued at roughly $172 billion annually, according to Grand View Research.
Like venture capital, factoring does not require the business to take on debt. However, instead of giving up equity in exchange for capital, you sell your unpaid invoices to a factoring company for immediate cash.
How Invoice Factoring Works
The factoring process is simple and straightforward. Depending on your level of preparedness and the factoring company you choose, your business can be approved and receive cash in just a day or two.
1. Submit Your Invoice
You provide your factoring company with an unpaid client invoice. The factor then assesses its value and the creditworthiness of your client.
2. Receive Your Advance
Once approved, the factor sends you money immediately. This advance is usually between 70 and 90 percent of the invoice’s value, though it can be more or less depending on factors like your industry and the creditworthiness of the client. The remaining balance is held as a reserve.
3. Receive Your Reserve
Your client pays the factoring company when the invoice is due based on the terms you’ve set with your client. Once the invoice is paid, you receive the reserve, minus a small fee for the service.
How to Qualify for Factoring
One of the best things about factoring is that it’s relatively easy to qualify for compared to traditional loans or venture capital. Let’s review what factoring companies typically look for.
- Creditworthy Clients: Since repayment depends on your clients, factoring companies focus on their ability to pay invoices on time rather than your credit score.
- Invoice Validity: The invoices you factor must be legitimate and free of disputes.
- Industry Fit: Factoring is especially common in industries like trucking, manufacturing, and staffing, where payment delays are common.
- Consistent Revenue: Startups can qualify, though you’ll usually need to have been in business for a few months and have steady invoicing.
Benefits of Factoring for Startups
The unique way that factoring works means it comes with a wealth of benefits for startups.
- Easy Approval: Factoring doesn’t require stellar credit or years of financial history.
- Fast Cash Flow: Factoring typically pays out in one or two business days. However, when you partner with a factoring company like Charter Capital, you can qualify for same-day funding. This makes it ideal for businesses with urgent cash flow needs.
- No Debt: Because factoring is not a loan, it doesn’t add to your liabilities or hurt your credit score.
- Flexible Terms: Use factoring as a one-time solution or on an ongoing basis. You can factor invoices as needed.
Drawbacks of Factoring for Startups
While factoring has many benefits, there are some things businesses should be aware of before signing up.
- Cost: A typical factoring fee can be anywhere from one to five percent of an invoice’s value. While this is a small amount, it’s important to approach it responsibly and ensure you’re receiving ROI.
- Client Interaction: Your factoring company will likely have contact with your clients when verifying invoices and collecting. Be sure to partner with a factor that has a good reputation and a strong sense of professionalism.
- Limited to Invoiced Businesses: Factoring is only an option for companies that invoice clients for services or products after delivery.
- Client Risk: If your clients have poor payment habits, the factoring company may offer terms that reflect the increased risk or decline to factor their invoices.
Key Differences in Venture Capital vs. Factoring
When it comes to funding your startup, both VC and factoring offer unique advantages. Let’s take a look at how they stack up.
Ownership and Control
VC requires you to give up a portion of your equity, which means sharing decisions with investors. Factoring does not. If maintaining control of your business is important to you, factoring is the better solution.
Speed of Funding
From pitch to funding, it takes months to see cash from VC. Conversely, factoring can provide funds right away. If your startup needs funding now or within the next 90 days, factoring comes out on top.
Eligibility and Requirements
VC firms are very selective and look for rapid growth potential. Factoring companies focus on your clients’ ability to repay their invoices. If you’re in a consumer industry or poised for exponential growth, VC might work for you. If you operate a B2B business, factoring will be more accessible.
Cost
While VC doesn’t require repayment, it still comes at a cost—equity in your business. Conversely, factoring comes with a small fee. It’s a transparent and manageable cost that doesn’t impact your long-term profitability. If keeping profits within your business matters more than raising large sums, factoring offers better value.
Purpose of Funding
VC is ideal for large-scale, high-risk initiatives like R&D, market expansion, or launching a disruptive new product. Factoring is designed to address cash flow issues. It’s well-suited for things like payroll, purchasing inventory, or managing day-to-day expenses while you wait for clients to pay.
Long-Term Impact on Your Business
While VC can bring mentorship and networking opportunities, the pressure to grow quickly and deliver high returns can lead to risky decisions that may harm your business in the long run. Factoring, on the other hand, provides funding without influencing your strategy. You can grow at your own pace without external pressure.
Explore Invoice Factoring for Your Startup
If your startup requires funding and traditional financing, and VC don’t align with your needs, factoring may be the accessible solution you’re looking for. With decades of experience supporting growing businesses and competitive rates, Charter Capital can help you bridge cash flow gaps and build a stronger company without taking on debt. To explore the fit more, request a complimentary rate quote.
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