Angel investors are wealthy (accredited) individuals, often-retired entrepreneurs or executives that take an interest in startup investing. They often have a particular interest, such as technology or food ventures. Angels fill a critical gap between friends and family seed funding and venture capital, and typically take an equity stake, or debt that converts to equity. Unlike venture capitalists, which pool money from institutions and wealthy investors into investment funds, angels invest their own money. As the field has grown, individual angels have organized into groups to share deal flow and due diligence (vetting of companies). Today there are angel networks across the country.

Angel investors will tell you that they invest in people more than ideas. So keep in mind, it’s about you, your passion and expertise. Do your homework before you approach an angel or angel group to make sure it’s a potential fit.

Pros:

• Angels are willing to take more risk and invest at an earlier stage than other investors, such as VCs and banks
• Hands-on approach, offering advice, mentoring and introductions that can help a young company.
• Angels are often willing to take a chance on an entrepreneur who has passion and ability, but has not fully figured out her business plan
• Flexible use of funds without burden of paying down debt

Cons:

• Forfeit sole ownership, anywhere from 10% to 50% or more
• Typically smaller amounts than venture capitalists, usually less than $1 million
• Angels want to see an exit so they can recoup their investment, by either an IPO or acquisition.
• Time consuming: may be difficult to find

Banks are the largest lenders to small businesses, and are probably the first place you think about when getting a loan. While banks offer some of the lowest cost loans, qualifying for one can be difficult – usually requiring a borrower to have strong personal and/or business credit scores, a personal guarantee, collateral, and healthy financials. The process to secure a bank loan can take between one and three months. Developing a successful relationship with a bank can make it easier to secure future loans and lines of credit.

Bank loans must be used for very specific business purposes. Check with your lender to ensure that you are following the guidelines.

Think a bank loan is right for you? Keep reading.

Crowdfunding

Crowdfunding is a new and evolving fundraising alternative that marries social media and finance. With crowdfunding, entrepreneurs reach out to the “crowd”—typically their friends, customers, supporters and social network—for funding. The idea is that lots of smaller sums of money can take the place of one or two large investors or patrons.

Entrepreneurs create a crowdfunding campaign (usually consisting of written and video content) and publish it on a crowdfunding website or platform. The campaign provides basic information explaining their venture or idea, the amount of money they are seeking, what it will be used for, and what contributors (or investors) will get in return. The best campaigns inspire people to want to donate or invest. The crowdfunding platform typically takes a fee, from 3% to 10% of the money raised. CrowdsUnite is a review site to help you compare crowdfunding platforms.

There are two main types of crowdfunding—reward and equity.

1. Reward Crowdfunding

Reward crowdfunding is the most common form, popularized by websites like Indiegogo and Kickstarter. Entrepreneurs solicit financial contributions in exchange for rewards—those rewards could include a thank you note, t-shirt or a discounted product.  Sometimes contributors are paying up front for a product that they would like to see developed—a form of pre-selling. Because there is no financial return promised, securities law do not apply. However, tax laws apply.

On Kickstarter along, more than $1 billion has been raised since 2009 for projects spanning film, music, food, gaming and technology. There are also rewards-based sites that specialize in niche markets, for example, Plum Alley for female entrepreneurs and ioby for community-based projects.

2. Investment Crowdfunding

Investment crowdfunding works the same way, except in exchange for a financial return—either a stake in the company through equity shares, interest payments on a loan, or a share of revenues. Crowdfunder, CircleUp and MicroVentures are all examples of crowdfunding platforms that use the equity model.

Because there is a promised financial return, securities laws come into play. The U.S. Securities and Exchange Commission (SEC) recently finalized rules under Title III of the Jumpstart Our Business Startups (JOBS) Act to open up opportunities for everyday Americans to participate in investment crowdfunding and invest in small businesses. Previously, investment crowdfunding was only open to accredited investors, defined as individuals with annual incomes of more than $200,000 or a net worth of more than $1 million.

Now, those earning more than $100,000 can invest up to $10,000 and those earning less than $100,000 can invest up to 5 percent of their annual income in a promising small business.

Real estate crowdfunding has become a hot crowdfunding market, as well. If your business has a real estate component – for example, a building you need to buy – sites like FundRise, RealtyMogul and Loquidity offer another option.

3. Debt Crowdfunding

Debt crowdfunding is another type of crowdfunding in which many investors give small amounts toward a larger loan that you can pay back over time. One example is Kiva, which offers interest-free loans through its platform. Like Kickstarter, Kiva requires that a loan receive full funding to disburse funds. Debt crowdfunding is similar to peer-to-peer lending platforms like Funding Circle. Another, Street Shares, connects veterans to interested investors through a peer-to-peer model. 

Are you a good candidate for crowdfunding?

Ask yourself these questions:

• Do you have a loyal following or inspiring story?
• Do you have a good email list and social media presence?
• Are you looking to engage an audience of potential customers?
• Are your sales and (target) customers confined to one state? Then intrastate crowdfunding might be a good fit.

Pros and Cons of Crowdfunding

Pros

• Opens up new pools of capital that were previously unavailable to entrepreneurs
• Eliminates the gatekeepers: Many companies that have been turned down by banks, VCs and other gatekeepers have successfully raised money through crowdfunding.
• Flexibility: there’s a crowdfunding platform for every market niche and financial situation
• Promotion: Crowdfunding is as much about marketing as it is finance. It’s an opportunity to raise awareness, promote a brand and engage new and existing customers.
• Vet your idea: The crowd can validate your idea and provide valuable input and feedback for products or services that are under development, avoiding costly mistakes down the road.

Cons

• Resources: Crowdfunding campaigns require a lot of time and social media savvy
• Tax implications: crowdfunding platforms report funds raised to the IRS. While this remains something of a gray area, money raised on a rewards-based site may be considered taxable income (although that may be offset by expenses).
• Investor relations: Many business owners may not be prepared for having 100 or 1,000 new ‘owners.’ Although their rights may be limited, these investors may nonetheless demand time and attention
• Legal liability: Investors are allowed under the JOBS Act law to sue companies for misleading information or material omissions. It just takes just one disgruntled investor…
• IP protection: a crowdfunding campaign can expose your great idea and intellectual property for all to see—and copy

One viable funding option is to get your friends and family to invest in your business. Before requesting assistance, decide if you are requesting a loan from friends and family, or offering a share of your business. A loan requires repayment over time, while a direct investor takes an active role in your business decisions.

If the investment is structured like a business loan, you can use existing services to formalize the agreement, streamline the payments, and make the tax returns simple. These formal agreements protect your friends’ and family’s investments in your business. It is important to develop a repayment plan that includes how you will use the funds, your business plan, how progress will be measured, and how the repayment will be made.

Funds received from friends and family can be used for any purpose. If you draw up a contract, be sure to follow any guidelines included in the document.

Community Development Financial Institutions (CDFI)

A Community Development Financial Institution (CDFI) is a class of financial institution that caters to and provides assistance to underserved and low-income communities. CDFIs, which are certified by the U.S. Treasury Department, can be community banks, credit unions, nonprofit organizations, venture capital funds or loan funds. They typically raise the money they lend through grants, low-interest loans, foundations, the government or banks looking to satisfy Community Reinvestment Act requirements. CDFIs are very focused on community, targeting their funding to small businesses, microenterprises, nonprofit organizations, commercial real estate and affordable housing.

Many CDFIs have revolving loan funds that target a specific state or geographic region, making low interest loans to small business owners and micro-entrepreneurs that might not qualify for a bank loan. Like old-fashioned bankers, this is a high-touch model, and funding often comes with mentoring and other support (that’s one reason why CDFI loan portfolios held up relatively well throughout the financial crisis compared to bank portfolios).

Many CDFIs also participate in 7(a) loans through SBA’s Community Advantage Program for loans up to $250,000 and other SBA loan programs.

Some CDFIs also maintain venture capital funds that provide equity or royalty (revenue-sharing funding).

To locate a CDFI near you, visit Opportunity Finance Network’s CDFI locator tool.

• Competitive rates
• Good option for entrepreneurs unable to secure traditional bank loans
• High-touch model: funding is paired with mentoring support and training
• No predatory practices
• Wide coverage across the U.S.

• Small value loans may not be sufficient
• Personal guarantee and/or collateral often required

Think a CDFI loan is right for you? Keep reading.

Marketplace lenders, one of the newest types of lenders, use online platforms to connect consumers or businesses seeking to borrow money with investors willing to buy or invest in the loan. Generally, these platforms handle all underwriting and customer service interactions with the borrower. Once a loan is originated, a marketplace lender will typically service the loan while arranging to transfer ownership to investors. Marketplace lending platforms often market both new loans and loans to refinance or consolidate existing debt.

Marketplace lenders can provide loans even if you don’t have perfect credit. But these loans may have very high interest rates and expensive fees (learn more about loan types). While marketplace lenders are required to follow federal and state consumer financial protection laws, it is important to keep in mind that they generally are not regulated by the government in the way banks are.

Most marketplace lenders allow you to use your loan funds for any business purpose. Check your loan terms for more information on how you can use your funds.

Think a market place loan is right for you? Keep reading.

The U.S. Small Business Administration (SBA) is a federal agency that helps entrepreneurs manage their businesses and gain access to capital. SBA loans have some of the lowest interest rates available, and some loans are available exclusively to small business owners. The agency doesn’t lend the money directly to entrepreneurs to start or grow a business, but sets guidelines for loans made by its partners (lenders, community development organizations and micro-lending institutions). The SBA guarantees the repayments on these loans to minimize the risk for its lending partners. SBA Linc can connect you with SBA approved lenders in your state.

The SBA pre-screens loan applicants with FICO’s SBSS score, a small business credit score. While most businesses, even younger ones, can qualify for an SBA loan – having a limited business history makes it more difficult. SBA offers a variety of loan programs for very specific purposes. If you apply for an SBA loan, check with your local approved lender about how you can use these funds.

Think an SBA loan is right for you? Keep reading. 

Like angel investing, venture capital is a type of equity financing that involves giving up a portion of the ownership of business in exchange for money from investors. Venture capital (VC) firms are usually organized as partnerships. They raise money from institutional investors, such as pension funds and endowments, which the VC partners then invest in promising startups. This is a step up from angel investing. VCs can now be found in many areas of the country and a growing number of corporations have created venture investment arms as well, including Google, Dell, General Mills and Walgreens. Some of the biggest names in tech were backed by venture capital, including Google, Facebook and Uber. But overall, a tiny fraction—less than 1%—of all startups receive venture funding.

Although VCs are also focused on early stage companies, they typically are interested in a rarified breed of company—ones with billion-dollar market prospects and the potential to return 10 times or more the initial investment. Here’s a tip: don’t waste your time on venture capital unless you’re going for the big leagues.

Pros:

• A venture capital investor can lend prestige and credibility to a young venture
• Hands-on approach, offering advice, contacts, mentoring and introductions that can help a young company.
• VCs invest large amounts of money—$1 million or more —which is good for capital-intensive companies
• Flexible use of funds without burden of paying down debt

Cons:

• Forfeit sole ownership
• VCs look for an “exit” so they can recoup their investment, by an IPO or acquisition within 5 to 10 years
• Time consuming: may be difficult to find
• VCs are focused on high growth opportunities and you may be pushed to grow faster than you like
• The personal stakes are high. If founders do not execute according to plan, they may find themselves out of a job.

Big banks approve just 2 out of 10 small business loan requests. Small businesses have better luck with small banks (under $10 billion in assets) including credit unions.  Credit unions have traditionally been key allies for small business, making a disproportionate share of small business loans. In general, working with small businesses is a main focus of community banks. They have a deep understanding of the local community and take that into account when considering loan applications from local businesses.

Credit unions are nonprofit financial cooperatives owned by their members/depositors. They offer similar services as banks, including small business loans, but often have a “community” focus or mission. Their earnings are returned to their members in the form of lower loan rates, higher interest on deposits and lower fees. Credit unions are currently restricted to lending up to 12.5% of their assets.

Pros

• Low interest rates, typically between 6% and 10%
• Long loan terms (multi-year)
• Commitment to local community
• Great customer service, personal touch

Cons

• Long application times
• High hurdles, i.e. in business for 2+ years, good credit, collateral requirements
• Tightly regulated – limited flexibility
• Less range of products and technology than big banks
• Consolidation of community banks and credit unions

Resources:

• The National Credit Union Administration offers a credit union locator and other helpful resources.