Thanks to incredible growth in the technology marketplace over the past ten years, it is hard to remember a time when you could not order a ride or groceries with the touch of your finger. In recent years, this growth has led to an increase in the number of tech-based startups seeking funding.
It is important to understand that funding for startups is never a one-size-fits-all endeavor. Several types of funding are available, such as:
In determining the suitability of each option, it's essential to know your needs and financing appetite and that your choice of funding can evolve based on your stage of development. By effectively planning for growth, you can find the best funding solutions suited to your stage of business development.
The type of startup funding needed depends largely on the maturity of your company. Below are four typical startup funding stages and the types of financing that are generally most suitable for each.
Most companies rely on equity investment or NRE (or non-recurring engineering income), where a larger business pays the startup's product development costs in exchange for potential future usage and licensing rights) for early-stage startup funding.
The good thing about equity funding is that you have access to professional investors who can guide you towards success. You get to expand your company's network to capital markets and business partnerships while also validating your company's value and technology.
On the other hand, equity funding can be expensive, and your shares might dilute, causing a loss of management control. Plus, venture capitalists are known to be picky when it comes to terms, and they may not continue investing in your business if you miss milestones or if market conditions change.
In this stage, startups can obtain funding in more ways, but it's still considered risky to potential funders and investors. Equity investments, NRE, customer prepaid (or crowdfunding), and venture debt are the most common sources of funding. The NRE option allows you to shore up your product before expansion, which can help with proof of concept when you start approaching banks that fund startups in the next stage.
While an NRE might be just what you need to finalize your product's R&D, it still bears the same risks as any debt: You will have to pay it back eventually through the agreed terms, which could be in the form of cash, usage rights, or licensing rights, no matter how well or poorly your company is doing.
Startups can also start exploring bank services for funding at this stage. While traditional commercial loans evaluate based on a company's past performance, the bank will assess a startup differently. Business and product plans, including product launch schedules, forecasts, and business partnerships lined up, may be considered.
Equity investments, customer prepay, and bank loans are generally most suitable at this stage. More bank loans become available at this stage, which helps avoid further equity dilution. A bank loan will also help to preserve sufficient working capital for expansion and maintain healthy financials and cash flow. Banks that fund startups typically will begin funding at this stage because you can prove that your company has a viable product, sales pipeline, and cash flow. You should closely review the terms of your loan to make sure it is in line with your timeline and liquidity needs.
Public (capital market/IPO), M&A, and bank loans are most common at this development stage. The good thing about a bank loan is that it has little or no dilution to your company's equity, yet it strengthens vendors' and customers' confidence. Plus, it provides reasonable leverage to improve balance sheet quality or ROI for shareholders. However, a bank loan carries interest and is a liability for the business, so work closely with your bank representatives to ensure the relationship is a fit for both parties.
Every technology business startup faces different challenges and financing needs. By understanding your business's specific challenges, industry, and development stage, you can secure the right funding type for you. Talk to our High-Tech Lending Department to see how we can help you with financing that makes sense for growth.
This article does not constitute legal, accounting or other professional advice. Although the information contained herein is intended to be accurate, Cathay Bank does not assume liability for loss or damage due to reliance on such information.
