Startup Capital: Definition & Overview

KEY TAKEAWAYS

• Startup capital is the money that gets raised by an entrepreneur to help cover business costs until it can turn a profit. 
• Sources of startup capital can include traditional banks, venture capitalists, and angel investors. 
• Venture capital can be the preferred method of startup capital because the entrepreneur does not have to pay anything back until the company is profitable. 

What Is Startup Capital?

Startup capital is money used by new companies to fund their initial stages of operation. It’s more of a general term than a strictly defined concept. Startup capital can come from many sources and be used for a variety of expenses.

Common sources of startup capital include venture capital, angel investors, and financial institutions. But it also includes new models like crowdfunding and peer-to-peer lending. 

If a company successfully raises enough startup capital, they often use it to fund initial costs such as:

• Buying inventory
• Renting space
• Furnishings
• Bills and utilities
• Hiring staff
• Purchasing licenses
• Funding development
• Marketing

How Startup Capital Works 

When companies are just going through the first few development stages, they’re considered to be startups. Usually, the startup is created to bring a product or service to market and it’s usually founded by one or more people. 

But to bring the product or service to market, the business will need financing to help get it there. This type of financing is what’s called startup capital. It will go to covering any business expenses, which can include marketing, product manufacturing, licenses, permits, operational expenses, and research and market testing. 

There are often multiple rounds of startup capital that’s provided by various investors, like an angel investor, a venture capitalist, or sometimes financial institutions. Investing in a new company can be risky, which is why most investors will receive an equity stake in the startup in return for their investment. 

Different Types of Startup Capital

Small businesses and startups have several different options when it comes to funding. Here’s a breakdown of some of the most common types of startup capital.

Bootstrapping

Bootstrapping is when entrepreneurs use their own funds to start a new business. This startup capital model prioritizes independence over large sums of money. It allows founders to retain 100% ownership of their company and make key decisions without oversight from investors. 

Bootstrapped companies are forced to develop a profitable business model early on. However, it also means that founders must assume all of the financial risk themselves. 

Venture Capital

A venture capital firm (VC)  provides large amounts of money to new businesses in exchange for equity. However, the risk of investing in startups is quite high. So most VC firms ask for a high percentage of ownership in exchange for providing startup capital. 

The goal of a VC is to turn a high profit in a few years by selling the company or conducting an initial public offering (IPO). But there are other benefits to venture capital besides money. 

VC firms employ industry experts who can use their expertise and connections to help startups achieve high growth.

Angel Investors

Angel investors are usually wealthy individuals who invest in companies independently. They may or may not provide expert guidance or get involved in business operations. It all depends on the angel investor and whether or not they want to be hands-on or not.

Either way, angel investors expect a high return on their investment. Many successful companies received early help from angel investors.

Crowdfunding

Crowdfunding has emerged as an innovative funding strategy that relies on many small investors to fund a single project. There are several platforms that help facilitate hundreds of successful fundraising campaigns.

Crowdfunding offers a unique advantage to entrepreneurs. They don’t have to give up any equity in their company to raise funds. Instead, many crowdfunding platforms are rewards-based. Backers receive incentives like discounted products or experiences in exchange for their investment. 

Bank Loans

Bank loans remain one of the most common ways to fund a new business venture. However, they can be difficult to obtain for startups without any hard assets. Many startups are focused on digital rather than physical assets, so banks view them as too risky. As a result, startups may not receive any loan offers or be able to afford the loan terms. 

How Do You Get Startup Capital?

First, start with your business plan. Funding a new business requires a solid, realistic budget. After you’ve figured out what your main startup expenses will be, you can assess your different funding options. 

Think about your priorities. Do you want the freedom to make your own decisions and work things out as you go along? Are you comfortable with risking your own finances? If so, then you might consider bootstrapping the business. Ask your family and friends to contribute. Or, apply for a small business loan if you have good credit.

If you think your idea will excite investors with deep pockets, pitch it to venture capital firms or angel investors. Look for advisors with proven experience in your industry and reach out to any connections. 

For startups that need high amounts of capital to fund fast-paced growth, this is the way to go. Venture capital and angel investors have backed some of the biggest companies in the world. 

However, this strategy will require you to give up a significant portion of the equity in your company. Be sure to carefully consider your ideal exit strategy before partnering with any external investors. 

Advantages and Disadvantages of Startup Capital

Obtaining startup capital from angel investors and venture capitalists has led to the success of many startups. Yet, providing startup capital to a young business can come with its own set of risks and challenges. 

The main goal of investors is to back a proposal that has a high likelihood of turning into a lucrative operation. This is where they’re going to get rewarded for their initial investment. That said, not every startup is going to reach the level of an IPO, which is where most of their return can come from. 

If an investor issues startup capital to a startup and they don’t achieve the level of an IPO, or the IPO doesn’t go well, they won’t receive a high return for their money. But on the flip side, startups that do well will make investors large amounts of money. 

There are advantages and disadvantages to every type of investment. Not everyone is going to work out the way it might have been expected to. But that’s why many investors consider several variables before issuing any startup capital. 

Summary

Startup capital is necessary to fund the growth of a new business. Every company approaches the fundraising process differently. It just depends on their particular market and available opportunities. 

With so many options out there, it’s essential to consider each one carefully in the context of your startup.