How to raise funds for your Startup and Small businesses? 7 Best Funding Options

Whether you have a start-up or a small business, you need money to grow. However, raising capital for small businesses is always a challenge as they do not have easy access to the various funding options available - be it debt or equity. If you need funding for your business, read on to find out what methods or ways of raising capital for small businesses.

We will not limit the discussion to traditional bank financing, but will also discuss options to raise long-term capital from the capital market to help you choose the best funding method. We will discuss all the fundraising methods such as bank loans, private equity, venture capital, SME IPO, government grants, crowdfunding, etc. along with their advantages and disadvantages for the company.

Here are the 7 most popular funding options available to small businesses to raise the required amount of capital.

1. Bank Loans

Debt financing simply means borrowing capital from lenders. Loans from banks and other financial institutions are the most common method of raising debt capital. Banks offer different types of loans or financing options from which you can choose the one that best suits your financing needs. Here are some types of bank financing:

Working Capital Loans: These are short-term loans that are provided to entrepreneurs to quickly handle day-to-day operations swiftly.
Term loans: Term loans are long-term loans offered by banks and financial institutions. SMEs that require funds for capital expenditure, e.g. setting up a new factory, purchasing a new plant and machinery, etc., should apply for long-term loans.
Cash credit or line of credit: This is also a short-term loan granted to companies up to a certain credit limit. SMEs that have no credit balance also apply for cash loans to cover their short-term financing needs.
Overdraft Facility: If your account has no credit balance, but the bank still allows you to carry out transactions or withdraw money up to the limit approved by the bank, this is called an overdraft. It is therefore a similar procedure to a cash credit, with the difference that the amount of the overdraft depends on the creditworthiness of the account holder.

Advantages of debt financing for SMEs	Disadvantages of raising debt capital
Banks, financial institutions and lenders do not receive any stake in the company. So promoters don't have to dilute their equity. No dilution of ownership and control of the company by the lenders. Despite the financial burden, debt is considered a cheaper source of funding as the interest paid is tax deductible, helping to reduce your company's tax liability.	Getting a bank loan is difficult for small businesses as banks analyze the business plan, valuation, current performance such as revenue, profitability, etc. before sanctioning any loan. SMEs are already struggling with financing problems and availing bank loans and borrowed capital is another financial burden as companies are required to pay interest on time and repay the principal on maturity. SME owners who receive bank loans must adhere to debt covenants and agreements. The amount of interest charged on the loan also depends on the term of the loan and your credit profile, i.e. your ability to service your debt on time. Debt financing has a lien on your business assets so that lenders can realize your assets and recover their capital in the event of a default.

Debt capital comes with fixed interest payment so companies can consider raising equity capital. When a company decides to sell its shares to raise capital, this is referred to as equity financing. In general, there are two ways to raise equity: private placement and public offering.

As the name suggests, a private placement is the sale of shares to a selected group of investors. It is the most suitable form of financing for companies in the start-up or early phase. This is because, companies at their nascent stages are not yet large enough for a public offering, whereas they can be financed by private companies if they have impressive business prospects.

Let’s now look at the possible financing options available to SMEs in a private placement of shares:

2. Startups seek seed capital from Angel Investors

Angel investors are high-net-worth individuals who provide seed capital to start-up companies. New entrepreneurs or early growth-stage companies that have a solid business model can receive funding from angel investors.

Advantages of Angel Funding: Angel investors provide capital to startups that do not even have an operating history.

Disadvantages of Angel Funding: These investors provide less capital. If you need more capital, consider venture capital funding (see below).

3. Early-growth businesses can obtain Venture capital (VC) Funding

If your company is beyond the start-up phase, is already generating revenue, and has strong growth potential, you can opt for VC financing. venture capitalists are private investors who provide enough capital to help you grow your business in return for the equity stake in your company.

Know more on How to get VC Funding?

Advantages of VC Funding

They provide small entrepreneurs with sufficient capital for operational scalability.
You do not have to make monthly payments such as interest, dividends, etc.
You get more than just funding as VCs provide their expertise and supervision and help you build valuable industry contacts.

Disadvantages of VC Funding

Venture capitalists do extensive due diligence before investing, so the process can take some time.
Be prepared to transfer ownership and control to the venture capitalists as they will receive a stake in the company.
VCs want a clear exit strategy in the event of an IPO or acquisition.
Promoters need to be flexible to give up control of their company.

4. SMEs can Raise Funds through Capital Market via SME IPO

SMEs that are well positioned, have a solid operating performance, a good customer base, and have convincing growth plans can consider selling shares via an IPO. This is the first time that promoters are taking their company public through an SME IPO to raise funds through the capital market.

The IPO is the best way to raise long-term capital for SMEs looking to expand. Also, it is a historic moment for any company when it becomes a listed SME company. In India, the BSE SME and the NSE Emerge are the two platforms for listing SME shares.

Also, if you need capital after the IPO, you can make an additional offering of shares called FPO (Further Public Offering) to get the required capital. Know more on IPO Vs FPO

Advantages of SME IPO	Disadvantages of fundraising via SME IPO
Best option for raising substantial capital from institutional and retail investors. If a company is not well received by investors despite a strong growth prospectus, e.g. due to negative sentiments in the industry, volatile economic outlook, etc., your IPO may not be successful.	SME IPO Fundraising involves stringent regulatory and compliance norms, not only during the IPO process but also afterwards. The process of going public takes time due to regulatory scrutiny, due diligence, engagement of intermediaries, in-principle approval by the stock exchange, and much more. Before you go public, your company must be financially stable and have a solid financial track record and growth prospects. Going public is therefore only a viable financing option for later stage companies to expand further. All shareholders become owners, so you as the promoter must be willing to dilute control over the company.

10 Things to be considered by SMEs before going public

There are also several other financing options for growing small and medium-sized enterprises, which are explained below;

5. Crowdfunding

Crowdfunding is a fundraising platform for emerging start-ups and fast-growing small businesses. Business founders or promoters can raise small amounts of money from a large number of investors on online crowdfunding platforms. The best financing option for SMEs with unique sales proposition.

6. Government Grants and Subsidies for Startups and Small Businesses

The government runs various programs or schemes to support the growth of SMEs, particularly in the technology, renewable energy, and healthcare sectors. If you meet the criteria, government grants are the best funding solution for you. Some of the initiatives taken by the government to promote the growth of MSMEs are the Credit Linked Capital Subsidy Scheme, Emergency Credit Line Guarantee Scheme, etc.

The best thing about the grants is that they are a free or no cost source of funding as you do not have to pay anything back to the government.

7. Revenue-based Funding

Revenue-based financing (RBF) is an unsecured debt offered to start-ups or SMEs. As mentioned, investors receive a share of the company’s revenue, for example, 10% of revenue. This is often used by digital SMEs such as e-commerce companies, software-as-a-service companies, SMEs that follow a subscription-based revenue model, etc.

Best Way to Raise Funds for Small Businesses

Obtaining Debt capital is a viable option for SMEs who can pay their interest liabilities timely while having a good debt service coverage ratio.
For Companies where promoters do not want any fixed financial liabilities and are willing to dilute ownership stake in the company, raising equity capital is the best fundraising option.
Small and medium-sized companies with strong fundamentals and unique positioning and also have promising growth prospectus, can even choose to go public and raise money from the primary market.
Companies can even use a mix of debt and equity capital to create an optimal capital structure.

Ways to Raise Funds for Small Businesses