Every business/startup requires funds from sources other than the founder, if not at the beginning, then somewhere during the life cycle of the business. It could be funds needed for the purchase of inventory and equipment, Operating capital, scaling, expansion, and so on.
The major drawback of loans and why many founders do not explore this option is first the requirement of substantial collateral and a good credit record. Taking a loan can also mount undue pressure on the business since one is expected to make periodic repayments whether or not the business is making a profit. There is also the issue of the interest rates and other terms and conditions to be fulfilled.
Due to this, most startups will bootstrap, source funding from friends and family, get some early investors, and seek grants where possible. There is always a wide option, even though some first-time founders dread the topic of fundraising. Some of the most popular are angel investors and venture capitalists.
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Here is a quick explanation. Angel Investors are high net worth individuals who pull out funds from their deep pockets to finance the startup. It requires conviction in your product or service because the angel investor needs to be sure that the funds he is injecting into your business will not go down the drain. It could be a one-time injecting of funds, or a regular (predetermined) injecting of funds to carry the company to profitability. There could also be a predetermined lock-in period of investments, depending on the regulations of the country where the startup is based.
Venture capital comes from companies or groups that raise funds to fund startups that meet their requirements. They could be focused on a sector or group of sectors. Even if the startup is young, they can get venture capital if they have a valid solution to take to the market and a strong team behind the wheels.
Whatever source you are getting the funds from, here are some financing options you could be considering while fundraising.
Equity Financing: Raising funds through equity means you would be bringing the investors in as co-owners of the startup. By contributing to the business capital, they will share in the business risks as well as profits. Your equity partners could be friends, venture capitalists, private equity investors, or angel investors.
As a rule, you should involve legal experts when using the equity option, and ensure to do a proper valuation of your business.
Convertible debts: This is a loan an investor makes to a company using an instrument called a convertible note. The note will state the amount invested, the interest rate, and the maturity date for the principal and interest to be repaid. It is called a convertible note because the intent is that the loan converts to equity if and when the company does equity financing. There are a lot more details to the convertible note/debts, and the founder will be properly advised on this if he chooses to use it.
SAFE (simple agreement for future equity): This is similar to the convertible notes/debts but there is no interest on the sum invested, and there is no maturity date where it is to be repaid. However the safe can be converted. Both parties will usually work out the modalities of what they are willing to settle for.
There is another called Venture Debt. This involves a lender (usually specialized banks) offering a startup some working capital for specific projects. This option is open to startups that do not have positive cash flows or significant assets to use as collateral but already have some venture backing.
Some other not-so-popular financing options are Crowdfunding or going through incubators. Founders will generally have to do some research and find the options that are best suited for the growth stage the startup has attained.