Startups often face a flurry of decisions about product launches, hiring, market research, and more. Since many of these activities are driven by the amount of money you have, funding becomes a critical component of early momentum.
Venture capital is an attractive funding option for many startups, since they can raise large amounts of money without any obligation to repay. (Though you give up equity in doing so — it’s not exactly “free.”) But with the fundraising environment for many businesses much cooler than it has been in the (relatively recent) past, it’s harder — particularly for early-stage companies — to raise.
Fortunately, there are alternative financing options for startups. Some may even have advantages over venture capital, depending on your business. It’s important to understand what’s available and the impacts on your business’s future finances — so let’s take a look.
Bank loans
Perhaps the most familiar and traditional form of financing is a bank loan. Banks can structure loans in various ways, from a term loan with a fixed repayment structure to a line of credit.
Some banks are eager to work with small businesses and may participate in loan programs from the Small Business Administration (SBA). The SBA doesn’t make loans directly, but partners with banks to fund loans. Starting a new business from ground zero is riskier to a bank, since it doesn’t have the proven track record of a more established business. A partnership with the SBA reduces the bank’s risk, making it easier for the bank to approve the loan.
While some banks are eager to work with early-stage businesses — especially if they partner with the SBA — loans to SaaS companies in particular are more challenging. Banks typically secure loans with collateral, such as equipment or inventory, which SaaS companies don’t have. Other newly formed companies, such as local restaurants or e-commerce businesses, can secure their loans with equipment or inventory, reducing the bank’s risk.
Additionally, banks often want a personal guarantee from you, the founder. A guarantee makes you liable for the balance of the loan if the business is unable to repay. That may not be something you’re comfortable with (or even financially able to do).
Shareholder loans
A shareholder can lend money to your company, often with more favorable or flexible terms than what a bank would offer. Shareholder loans can be a good alternative to a bank loan for some businesses, as the shareholder earns interest. Plus, shareholders typically share your company goals of profitability and growth — so it can benefit them to provide financing that helps the company.
On the other hand, a shareholder loan can create a conflict of interest between the shareholder and other stakeholders within the company. The shareholder may prioritize the company’s ability to repay the loan above other financial considerations that the company may have, causing tension when key decisions are made. Shareholder loans also have legal and tax implications, making them more complicated than other alternative funding sources.
Venture debt
Venture debt is a type of debt often raised in conjunction with venture capital, since that’s when a company’s creditworthiness and leverage to negotiate favorable terms are at their best. It’s structured like a loan that may come from a specialty finance company or a venture capital firm.
Venture debt has some important distinctions from venture capital investments and bank loans. Unlike venture capital, venture debt does not dilute the company's equity ownership. And unlike bank loans, venture debt doesn't necessarily require any collateral.
Typically, venture debt has a one- to three-year term, with most payments being interest-only. If raised alongside a round of equity funding, it’s usually equivalent to 20–35% of the most recent round.
Venture debt often has higher interest rates than traditional bank loans, due to its higher risk to the lender. Many venture debt deals include warrants on shares: the option for the lender to purchase stock at a later date at a predetermined price, which can be lucrative for the lender but dilutes the interest of existing shareholders. While it makes sense (from the lender’s perspective) to share in the success in exchange for assuming risk, you should consider the impact of exercised warrants.
Venture debt is also typically for companies that are Series A and later, so if your company is pre-seed or seed stage, it may not be an option. (Of note: Pitchbook found a significant drop (39%) in venture debt deals between 2022 and 2023.)
Revenue-based financing
Another type of alternative funding is revenue-based financing, also known as royalty-based financing. Generally, this involves receiving a cash infusion in the form of an investment — in exchange for a percentage of your company’s future revenues. The investor receives an agreed-upon percentage of your revenue until they receive a predetermined return. (In practice, this often looks like a loan-like structure that allows companies with recurring revenue to “pull forward” a portion of that revenue to access it up front).
Revenue-based financing is explicitly tied to your company’s performance — the more revenue you have, the more capital you may be able to access. If your company has a very predictable cash flow but needs cash in the short term to help manage growth, revenue-based financing can be an interesting option.
Revenue-based financing, by definition, will reduce your overall revenue until the investment is repaid. If the amount of financing you receive this way is significant, and you haven’t planned accordingly, it could hurt your company's growth. And if your revenues are unpredictable, it can be hard to know when the overall agreement will be satisfied. As an alternative business funding option, revenue-based financing is also typically more expensive than traditional financing — like a loan — but comes with the flexibility that you pay when you receive revenue, rather than have a fixed repayment schedule.
For any subscription-based businesses, recurring revenue financing is another option. Let’s say you’re earning $4/month per customer. A lender might offer you $44 upfront, but in exchange, you pay the lender $48 for one year of the customer’s contract. You get access to the cash immediately, which you can use to grow your team or market to new customers. In exchange, you relinquish the revenue from that customer for a year.
Working capital loans
If you need short-term financing to cover day-to-day operations, you might want to explore a working capital loan. These loans can be a term loan with fixed payments or a business line of credit that allows you to draw funds from the loan (up to the credit limit) and make payments as needed. If you have a seasonal business or cash flow issues, you can use a working capital loan to make payroll or cover other operational expenses.
Working capital loans are usually easy to obtain from either a bank or private lender. They’re not tied to your company’s equity in any way, and some don’t require collateral. While interest rates are high, they’re lower than a credit card, and the loans typically have a higher credit limit.
Think of working capital loans as access to an “emergency fund” that can supplement other types of financing. However, if you don’t make the required payments on your loan, it will impact your credit score.
Learn more about working capital loans here.
Angel investors
Angel investors are high-net-worth individuals who invest in a company — typically a seed round — in exchange for an equity stake. A company may have many angel investors: well-connected people who are genuinely interested in its success. When the business becomes profitable, angel investors can sell their shares.
Angel investors are usually “accredited investors” as defined by the Securities and Exchange Commission. This specific criteria (such as a net worth greater than $1 million) outlines who can participate in offerings of unregistered and illiquid securities.
If you or others in your company have a network of people who would qualify as angel investors, it might be an alternative financing option. For example, SparkToro, an audience intelligence tool, raised $1.3 million from 35 accredited angel investors rather than pursuing venture capital funding. Angel investments often have more favorable terms for your company than other types of financing.
Crowdfunding
Unlike angel investing, which might raise large sums from a few individuals, crowdfunding raises small dollar amounts from many individuals. Companies can use platforms like Kickstarter or IndieGoGo to raise money, and rely on social media to raise awareness.
Rather than offering equity in the company, crowdfunded campaigns typically promise something to people who contribute, such as a percentage off when the product is released or a free item. Companies that try to raise money this way have to be ready for some upfront lift — since they may need to generate a lot of buzz to reach their fundraising goals — but have very little (if any) ongoing commitment to investors. Results AI notetaking tool Fathom crowdfunded $2 million from Fathom users as part of a $17 million Series A.
It’s important to remember that platforms like Kickstarter charge a fee based on the amount raised. And for some platforms, you may have to reach your complete goal in order to access funds at all.
Understand your alternative funding options
At some point, you’ll undoubtedly ask yourself: how can I raise money for my startup? While bootstrapping your company can be appealing (and is a feat that should be applauded!), at some point, you may want additional capital to fuel your growth — and you should know your options.
There isn’t a single “right way” to fundraise or capitalize your business since it’s heavily dependent on the type of business, your revenue to date, your creditworthiness, and even the people in your network. For some, a bank loan might be the best option, while others may pursue venture capital or alternative business funding.
The best option for your startup is the funding you’re able to secure at the most favorable terms for your current and future needs.
Looking for expert mentorship, fundraising support, and related resources? Check out the Mercury Raise community.
Anna Burgess Yang is a former product manager turned content marketer and journalist. As a niche writer, she focuses on fintech and product-led content. She is also obsessed with tools and automation.