What is Startup Capital?
Setting up a business can be cost-intensive. Consequently, an entrepreneur requires sufficient startup capital to meet the financial needs of their new venture. More specifically, the costs of developing a product, marketing, advertising, hiring employees, and setting up an office space. Having said that, businesses in the first stage of the business lifecycle can fund their affairs through personal savings, crowdfunding, business loans, venture capital, angel investment, and more. Startup capital is sometimes confused with seed capital although the two terms have a slight difference. Entrepreneurs use the former to fund an already active business while they need the latter to fund initial research before operations begin.
Table of contents:
- What is Startup Capital?
- Examples of Startup Capital
- Startup Capital vs. Seed Capital
- What’s Next?
What is Startup Capital?
Startup capital consists of the initial funds required to set up a business and sustain it in its infancy. This capital typically funds the establishment costs of a business. Besides initiating business operations, startup capital goes towards paying bills and utilities, salaries and wages, office supplies and equipment, hiring professionals, marketing, advertising, and much more. In other words, covering all the types of costs that a business incurs on a regular basis.
Limited finances can stifle the growth and success of a business. Building a unique brand, attracting clients, and attracting investors without sufficient startup capital can be a steep challenge. Research indicates that the availability of capital significantly impacts the success of a business. However, most businesses prosper once they overcome the startup phase. Simply put, businesses require sufficient startup capital to take off.
How to Raise Capital for a Startup
The amount required to set up and sustain a new business is directly proportional to its expected costs. In other words, startup capital depends on the projected short-term expenses of a business which vary on a case-by-case basis. Here are the initial capital options accessible to startups.
Family and Friends
A startup business can raise initial capital from friends and family to actualize their idea. Unfortunately, this option comes with the risk of strained relations if the business fails and refunding becomes a challenge. Surprisingly, studies show that slightly over 20% of new startups acquire funding through relatives and acquaintances.
It’s important to inform the loaner that you’re just starting out and they may need to be patient with the results they expect. For their part, they should specify whether they expect repayment of the advanced money and how they would like that to happen. Additionally, you should clearly communicate the risks involved to avoid future misunderstandings if unexpected challenges arise. To reward the efforts of the lender, the business can allocate a share to them or consider another way to reimburse them.
Many entrepreneurs use personal funds to avoid the risks of borrowing from family and friends. If product development is not part of the initial plan, the costs of running a business can be relatively low and manageable through personal funding. However, the business might need to consider other options if significant finances are required. The advantage of personal funding is that the entrepreneur retains full ownership of the business because it eliminates the need for shareholders’ capital.
Angel investors are high-net-worth individuals who invest in startups for a stake in the business. They can fund a startup to the tune of $100,000 or more. However, getting an angel investor can be challenging without a lucrative business concept.
In addition to a lucrative idea, a solid business plan is needed to pique the interest of high-net-worth investors. Such stakeholders typically come to “dictate” most affairs of the funded business. Consequently, the entrepreneur can lose control of their startup.
This involves several high-net-worth investors pooling their resources and sharing a deal flow. Deal flow refers to the rate of receiving business proposals from prospective investors. Also, the term is common with venture capitalists and banks. Big investment banks handle all types of deal flows while venture capitalists specialize in specific deals. The different types of deal flow include:
- Venture funding
- Initial public offers–IPOs
- Syndications and private placements; and
- Mergers & Acquisitions
Crowdfunding refers to raising capital from many small-scale investors to finance the affairs of a startup. This method of funding leverages the power of social media and online crowdfunding platforms, such as Kickstarter and GoFundMe. The process entails bringing together prospective investors and owners of startups, promoting variety, and increasing the chances of attracting an investor.
Crowdfunding, particularly equity-focused crowdfunding, allows the owners of startups to raise funds without losing control of their businesses. This funding option allows investors to get equity in the funded venture. On the downside, crowdfunding can damage the reputation of a new business because of the notion that crowdfunded businesses are not self-starters.
Additionally, a startup might be required to return the advanced funds to investors if the funding goal is not achieved. Unfortunately, businesses must pay a fee of between 5% and 12% to participate in crowdfunding platforms besides other punitive charges on some platforms.
Startup Capital vs. Seed Capital
Although both startup and seed funding raise the initial capital of a new business, they have notable application differences. Startup capital goes toward covering the expenses of operating a startup. In other words, this funding is used to meet the financial needs of a business that is in operation.
In contrast, seed capital is used to fund the expenses of a prospective startup. This capital mainly helps in offsetting the expenses incurred by startups to conduct initial research into the market and their proposed product or service (proof of concept).
Startup capital allows businesses to meet their early financial needs and prepare such businesses for accelerated growth. On the other hand, seed capital helps entrepreneurs discover, research, and explore their prospects.
A lack of sufficient initial funds can impact the success of a business. For example, an entrepreneur may close shop if they can’t meet their business expenses, such as salaries, rent, and other bills. However, this should be the time to explore startup funding for the initial establishment and sustenance of the business.
When the financial challenges of setting up a business are overcome, growth usually follows. Most investors are attracted by growing businesses that survive the infancy stage because such businesses can be nurtured for accelerated expansion.
The growth of your business can be the driving factor behind attracting major investments. With a good investor on your side, the business quickly reaches new heights and might attract an M&A deal. However, most investors prefer working with entrepreneurs who understand the best practices for building a reliable financial strategy. Start your journey of becoming a better entrepreneur with our Corporate Finance Course.
Ready to take the next step towards a career in Finance?
From foundational topics in Accounting and Financial Analysis, through Corporate Finance and M&A, to specialized Fintech and Economics courses, the 365 Financial Analyst curriculum is designed to prepare you for the world of Finance as it is today. Whether you are a total beginner or a working professional, our expert-led courses offer the opportunity to upskill at your own pace. Find the right fit for you and start learning today!