The Different Types of Business Funding

Last Updated: 07/31/2020

Not only is it difficult for online businesses to get the funding they need to grow, but their options seem to be shrinking as well. As banks become bigger through expansion and consolidation, small and medium-sized banks are disappearing. This creates a gap in banking solutions for newer companies. In addition, newer, more digitally focussed, business models are emerging that traditional forms of funding simply aren’t designed for.

Luckily, at the same time, there are newer forms of funding emerging for the growing segment of e-commerce founders. It’s important to understand all your funding options and know when the best time is to leverage each type.

The businesses that successfully scale are the ones that understand the various ways to acquire business funding, which are best for them, and know when to leverage them for the best business outcomes.

Lucky for you, we are making it simple!

The Short Of It

There are many ways to fund a new business but the 6 most popular are:
- Bootstrapping
- Crowdfunding
- Grants
- Debt financing
- Revenue-share financing

Not every funding model is right for every business. And certain forms of funding make the most sense at different stages of a business.

So let’s dive into the six funding models mentioned above and the pros and cons of each.

Bootstrapping

Bootstrapping is a clever term for when founders use their own funds as well as the company’s cash flow to fuel business growth. As if they were to pick themselves up by their own bootstraps… get it?

It’s often how many startups begin and typically founders will bootstrap until they are able to launch their brand and prove its market value in order to get other forms of funding.

Some businesses are able to get by on bootstrapping alone; however, those are few and far between—but it can be done. For example, Sarah Blakely scaled women’s undergarment company, Spanx, using her own personal savings and still owns 100% of her business as a result. And software development platform GitHub survived on bootstrapping for its first 4 years of business.


Pros And Cons Of Bootstrapping

Bootstrapping is often romanticized in the entrepreneurial community because it allows you to retain 100% ownership-and therefore control-over your company.

When done right and backed by a solid business plan, it can definitely be an effective way to scale your business, as long as you have the funds to do it. There is also a certain sense of pride that comes with knowing you ‘did it on your own’, which adds to the allure of bootstrapping.

On the other hand, with this type of funding you run the risk of running out of cash if your revenues aren’t what you project them to be. As mentioned, lack of working capital is a major reason startups fail. With limited capital, you also might not be able to scale as fast as you would with outside help and guidance you can get from VCs, for example.

Crowdfunding

Crowdfunding dates back to 2006, with IndieGogo launching a year later and Kickstarter not far behind. Crowdfunding involves raising capital from larger groups of people online in exchange for exclusive perks like free product or swag. Sometimes, equity can be offered as well but this is less common.

The average crowdfunding campaign is for approximately $7000 and lasts about 9 weeks. So it can be a great way to raise money fast (as long as it’s successful, of course).

Learn how ScrunchIt successfully leveraged Kickstarter and Clearbanc to launch and grow a niche business.


Pros And Cons Of Crowdfunding

The biggest benefit of launching a business using crowdfunding is that you get to really test the market. If no one seems interested in supporting your campaign, you probably need to rethink your idea. And it’s better to learn that before you launch rather than after! Plus, you mitigate inventory risk in that you generate pre-orders so you can confidently stock up knowing you’ll sell that amount.

One thing to consider, though, is that if you know to anticipate a certain number of orders you will also need the cash flow to pay for that inventory up front. You can always try to negotiate with your supplier, but this is something to keep in mind to ensure you give your first customers the best experience possible. Bad word of mouth can squash any momentum your crowdfunding campaign helped build.

So long as you meet customer expectations, crowdfunding is an excellent way to attract early adopters and advocates of your brand. Plus, you can collect feedback from them in order to improve your offering and create new or version 2.0 of your existing services or product lines down the road.

The main pitfalls of this type of funding are that you expose yourself to possible competition since you’re showing your hand so to speak and sharing your ideas when they are still young and you aren’t yet established in the marketplace. There are also fees associated with this type of fundraising and the risk of failure is very real. The average success rate of a crowdfunding campaign is 50%.

Grants

Grants are essentially “free money”. Well, not really (is anything ever truly free?) If you want to score a grant, you’ll have to really work for it.

You will have access to different grants depending on the location in which your business is founded. There are often grants offered at national and more local levels. Grants are also offered through corporations who want to give back and support emerging business. Many grants are also offered based on other factors like whether or not you’re a part of a minority group. Typically, they are available for groups such as female founders, environmental businesses, and veterans.

While it’s true grants represent capital you don’t have to pay back, there are some things to consider when researching and applying for one:
- Thoroughly research the types of grants you are eligible to make sure you’re applying for ones you have the best chance at getting.
- Some grants require you to pay a portion of the cost of the project, commonly referred to as “matching funds”
- There are very strict application deadlines when it comes to grants. Careful not to snooze and lose!
- Grant applications require a LOT of documentation so be prepared to share information like financials and a business plan. And keep all documentation on-hand so you can easily access it if need be.
- For grants that involve a “pitch contest” be prepared to do some public speaking and hone your presentation skills


Pros And Cons Of Grants

As mentioned, grants are a form of capital you don’t have to pay back so you can skirt costly fees and interest associated with other forms of funding. They are a great way to acquire a large amount of money; however keep in mind that not all grants are created equal. They can be a little as $500 or as much as $500,000. So depending on how much money you need to fuel business growth, a grant might only represent part of the solution.

You’ll have to apply for the grant you want and this usually takes a lot of time and effort and applications are only accepted during certain times of the year (often only once per year). Grants are often awarded to the more “headline worthy” business as well so can feel less accessible overall.

Also be prepared to meet any reporting requirements like grant-specific audited financials for follow-up.

Debt Financing

Debt financing is when you take on debt as a way to generate revenue for your business. In most cases, you’ll probably need to pay interest on the loan over time. There are many types of of debt financing, including:
- Business Credit Cards
- Term Loans
- Revolving Lines of Credit


Business Credit Cards

Credit cards work in a similar way to loans where you have a pool of money you can pull from anytime, with varying interest rates. Depending on your location and banking options, you’ll want to shop around for the type of card and terms that work best for you and your business.

With business credit cards, however, you can have access to all kinds of fun stuff like perks and rewards, like fancy airport lounge access or cash back incentive (who doesn’t love cash?!)


Term Loans

There are many types of business loans available to help launch and grow your business. Some examples include:
- Revolving line of credit - Asset backed loans (ABL) - backed by inventory or receivables

Pretty much all major banks will have a variety of loans on offer, all with varying repayment terms including interest and fees. You definitely want to shop around for the repayment terms that work best for you. Regardless of the loan, the requirements are usually pretty standard.

Lenders will want to know your credit history so they will run a business credit history, or sometimes a personal credit score, especially if your business hasn’t been around that long. They might also look at things like business history, credit reports and other financials. In some cases, lenders will also want to see your hard assets, like equipment. This is typically the case to qualify for loans with lower rates and fees.

When you decide on a business loan keep in mind there are different methods. For example, repayment based on cash flow means you pay back the loan based on cash payments.


Pros And Cons Of Debt Financing

An advantage of debt financing is that expenses like principal and interest payments are often classified as tax-deductible business expenses. Plus, you don’t have to give up any ownership in order to acquire debt financing.

The biggest drawback is that these loans must be paid back, even if the business fails. Additionally, there’s usually a high rate of interest, and some loans may require collateral in exchange for the funding. The risk is that if your business doesn’t generate revenue fast enough to start making payments, it might result in defaulting on the loan and impacting your credit rating which can have a long term knock-off effect.

Revenue-Share Financing

There’s a new funding model on the block and it’s becoming an increasingly popular option among DTC and e-commerce businesses that struggle to acquire other forms of funding.

Revenue-share models, like Clearbanc, typically use predictive models and machine learning methods to analyze a business and generate a series of investment offers based on their performance. Since the offers are based purely on the data, it tends to be a drastically less biased form of funding and much more accessible since it’s all done online or over the phone, no travel required.


Pros And Cons Of Revenue-Share Financing

Revenue-share democratizes capital by looking at business data, not on whether they would use or like the products, or whether the founders know the right people, or have the right academic credentials.

With revenue-share, you often won’t be asked to sign any risky personal guarantees and you won’t have to give up equity in your business. So you maintain full ownership and decision-making power for your business.

Because revenue-share is based on cold hard data, there is a chance that the emphasis on business priorities will tend to revolve around methods that generate immediate revenue. This can potentially hinder the achievement of longer term goals of the business if not managed carefully and strategically. So remember to always keep your long term strategy hat on!