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Guides

The Alternative Funding Guide

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Guides

The Alternative Funding Guide

Words Founders Factory

In collaboration with Esme Verity

March 22nd 2023 / 10 min read

Over the past few decades, venture capital has asserted itself as the dominant source of finance for tech startups looking to fund and grow their businesses. In just 15 years, VC investment has grown tenfold—from around $30 billion invested in 2006, to over $330 billion invested in 2021.

It’s a model which particularly suits how software and technology works: successful startups can produce outsized returns in a relatively short period of time—a result of scalable business models driven by network effects. It’s also key to understand that many early stage VC backed startups are pre-revenue and capital intensive, and therefore often unable to secure traditional business loans.

But you would be wrong to think that VC is the only option on the table. In fact, less than 1% of businesses receive venture funding. From crowdfunding to grants to angel investing, founders have a number of options when they are looking to go out and raise capital. No two businesses are the same, and it can be useful to consider these alternatives on the path to building a successful company.

“It should be no less aspirational to bootstrap your business, take on debt, or use innovative financing, than to raise millions in VC money,” insists Esme Verity, founder of Considered Capital.

Here, we outline the main alternative funding options for startups, including:

Crowdfunding (equity, rewards-based)
Crowdlending
Grants & non-dilutive funding
Revenue-based financing
Incubators
Accelerators
Family & friend financing
Angel investors
Tax incentives

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Alternative funding sources

Crowdfunding

Imagine asking your biggest fans to fund your business—this is the compelling premise behind crowdfunding. With platforms like Kickstarter and Crowdcube, crowdfunding is a popular way to raise money while also engaging a community around your product. In essence, you are asking for funding from a much wider group of individuals, usually in exchange for equity or something contextual to the product, like rewards or exclusive access. For amateur investors, it’s hugely accessible: you can often invest as little as £10.

The key thing for founders to note with crowdfunding is this: you need to be doing it for a reason besides accessing capital. The most successful crowdfunding rounds are from companies who buy into the idea of being funded by their community, and growing the company’s community of advocates in the process. This has proven to be a successful customer acquisition strategy for challenger banks and D2C brands alike.

There are several types of crowdfunding, including:

➡️ Equity crowdfunding

This is similar to a more conventional VC approach, where you offer equity in return for investment: however, your typical crowd won’t be expecting VC-like returns. Essentially you are making your community co-owners in the business. Note, this is usually rolled up alongside angel funding: it’s often advised to have lead investors participating in your crowdfund, often constituting over 50% of your target.

Certain brands have big enough user bases to fill a crowd campaign alone (see Allbirds or Brewdog). It’s principally well-suited for B2C and D2C businesses—retail investors like something that they themselves can use or consume. Product-based businesses can make the most of this by launching a pre-order for their product.

Read our advice on how to pull off an equity crowdfunding campaign

How much can you raise: There’s no fixed amount, but Crowdcube puts funding into three brackets—seed (£150k-£250k), early funding (£250k-£750k), and growth funding (£750k+).

✅ PROS:

You can convert existing customers into investors. By offering equity, you strengthen their relationship with the brand. Don’t underestimate the power of word of mouth.
You can tap into broader trends to attract new investors. Someone with a personal interest in your sector will recognise the market opportunity and will therefore be drawn to invest.

❌ CONS:

You need to raise 50-75% before you launch. Other investors tend to lead a crowd raise in order for it to work. Some startups raise anywhere up to 90% of their total before they launch online.
It requires significant day-to-day management. It’s not as easy as launching and seeing the money roll in. You need resources as well as a well-coordinated, well-publicised effort from all parties to pull off a successful campaign.

➡️ Rewards-based crowdfunding

Instead of equity, you offer your investors non-financial rewards. This is a win-win for fundraisers and donors: the former gets funding for their business, the latter gets goods or services (often exclusively) for their money. Similar to equity crowdfunding, founders should view this as a tool to engage early customers. It’s a way to gauge interest in your product, especially something that’s not yet widely released.

The rewards you offer can vary greatly. A few rules of thumb to follow:

Offer something your customers wouldn’t ordinarily be able to buy/access
Offer a range of rewards to incentivise different tiers of investment (note that £25 is roughly the most popular donation, so consider something significant at this price bracket)
Price products fairly
Consider offering limited/itemised rewards (e.g. for your first 100 backers)

Read UpEffect’s full guide on offering rewards

✅ PROS:

Get early feedback on your product. Use this to gauge interest in something you are about to launch, particularly valuable from those discerning enough to invest money in it.
Advantageous to businesses with no traction. These businesses might struggle to raise equity funding and so will need to offer alternative incentives
Chance to reward and engage loyal customers. This will convert them into brand ambassadors
You don’t dilute your equity. This is particularly important for businesses who can’t sell their equity

❌ CONS:

Investors may be less interested if there’s no financial return. You’re likely to attract a different type of investor—one more vested in supporting your product as opposed to its financial success

Crowdlending / peer-to-peer lending

This is worth distinguishing from other types of crowdfunding, as it's a pretty different proposition. Peer-to-peer (P2P) lending matches borrowers (aka fundraisers) with lenders via online platforms. Startups enter information about their business, how much money they need, and how they’ll spend the money: they are then matched to suitable lenders. Some loans are unsecured (tied to revenue), while others are secured (tied to certain assets), depending on the size of the loan.

P2P lending platforms include Funding Circle, Kiva, and Lending Club.

✅ PROS:

You can apply for loans of varying sizes
You don’t dilute your equity
It’s a fairly simple process. Decisions are often made quickly, meaning you can borrow with little delay

❌ CONS:

Often come with higher interest rates than traditional loans
May have to repay the loan regardless of your company’s success. Being late with repayment could harm your credit rating

Read the British Business Bank’s guide to P2P lending

Grants & non-dilutive funding

Grants are offered by a range of organisations looking to support businesses across different sectors and industries. Grant organisations are many and varied, often geared towards scientific or medical breakthroughs, but also widely applicable to businesses meeting some or all of the following criteria:

Truly innovative (what they are doing hasn’t been done before)
Commercially viable (business model to back up technology)
Based in a sector ripe for research and development
Socially driven

✅ PROS:

The application process can help you articulate your vision. The process will force you to clearly think out where your business fits in the wider landscape, and what differentiates it.
You won’t dilute your equity. Most organisations won’t ask for anything in return for their funding
It can help move the needle on other fundraising. Investors will view grant funding as a seal of approval by an expert body, making them more likely to invest.

❌ CONS:

The application is incredibly time consuming. Applications will take upwards of 50 hours of your time, meaning unsuccessful applications are particularly wasteful. Grants are highly competitive meaning the majority of applications are unsuccessful
Grant applications are incredibly rigorous. Fall below any of the stringent criteria and your application will likely be rejected
You may need external help. Many startups hire a grant writer to support on the application. They’re certainly worth it, but come at a cost.

You can read the Founders Factory guide to grant funding

Revenue-based financing

This is a type of loan whereby your monthly repayments to the lender are a percentage of your revenue, as opposed to being a fixed amount. This type of financing is particularly geared towards growth: for instance, hiring new employees, or launching a marketing campaign, which are likely to directly result in revenue growth.

✅ PROS:

You won’t dilute your equity
Can give you a quick cash injection
Gives you flexibility rather than standard monthly repayments. Unlike traditional debt, repayments are tied to revenue, meaning if your business slows down, your payments also slow down. Good for certain businesses where revenue may be unevenly distributed month-to-month
No personal collateral against the loan

❌ CONS:

You need strong margins to make this work
You may need stable monthly revenue
Unless your planned use of funds is growth-related, this may be difficult to obtain

Sifted shared this useful guide of the biggest providers of revenue-based financing

Incubators & Venture Studios

While often grouped in together, there are key differences between incubators and accelerators.

Incubators start working with founders from ground zero, usually when a business is just an idea—often without a fixed programme timeline. In Founders Factory’s venture studio, ideas are developed internally before partnering with an entrepreneur to lead the business.

We also build "founder-led" concepts: a scenario where a founder joins us with a preconceived idea that maps to one of our investment themes, which we then develop into a company together. Investment will vary greatly between firms: early stage startups in our venture studio receive £50k initial investment (from which founders can take a salary), and a further £150k once they launch their MVP and spin out as a business, in exchange for 25% equity.

✅ PROS:

You gain a valuable partner. You have access to an expert team that would be difficult and expensive to attract as an idea-stage founder. The incubator/venture studio essentially becomes your co-founder, supporting in various functions with the benefit of their experience and resources.
Your venture is de-risked. The selection and development of a concept involves extensive testing and validation, sometimes even before founders join the business. This minimises early risk factors and hastens the route to product/market fit.
You’ll be connected to other investors and partners. Many incubators/venture studios maintain curated investor and partner networks, offering founders direct access to angels, funds and other sources of capital and commercial opportunities.

❌ CONS:

You start with less equity. Deals vary, but incubators/venture studios will take a meaningful stake for their contribution (some even take a majority share). It’s important to decide if this model aligns with your intended structure and strategic direction for the business.

Find out more about our Venture Studio

Accelerators

Accelerators invest in early stage founders and founding teams, often at pre-seed and seed, but also at Series A+. Startups entering an accelerator might join seeking support validating their MVP and acquiring first customers. Alternatively, they may have achieved product/market fit and require resources and expertise to scale their business.

Programmes operate in a fixed time frame (at Founders Factory, six months), and sometimes in a cohort - or otherwise on a rolling basis. At Founders Factory, companies joining our Accelerator receive £30-250k in addition to six months support from a dedicated team, in exchange for up to 7% equity.

✅ PROS:

You receive more than just capital. Joining an accelerator is more about the operational support you get, as well as the network you gain access to. Operational support can be valued in the hundreds of thousands (equivalent to hiring an expert, full-time startup team for several months, not forgetting the network connections).
Accelerators signal confidence to other investors. Acceptance to a prestigious accelerator is a vouch of confidence in your business. Accelerators will also likely introduce you to investors for raising further capital (similar to incubators, often involving a pitch day).

❌ CONS:

The capital you receive may be limited. Accelerators will generally not lead a round or invest larger amounts of cash compared to traditional VCs.

Find out more about our Accelerator programmes

Family & friends financing

For many startups, this is usually the first source of funding. This is where you’ll receive early investment from your nearest and dearest who have a vested interest in supporting your endeavour as opposed to looking for strong financial returns.

This funding route is much more informal, meaning that terms will likely be much more flexible. Don’t, however, take your friends’ and family’s generosity for granted: you should still treat this as investment, showing a solid business plan and underlining the risk in their investment at such an early stage. Also, despite the name, this need not be restricted to direct friends and family: use this as an opportunity to reach out to friends of friends who may be strategically valuable to the business.

✅ PROS:

You can raise from a very early stage. You may still be in the idea/pre-product stage when most other funding routes are closed off to you
You can get a quick cash injection. You can normally avoid the usual due diligence process at this stage
You can avoid giving up too much equity. Investment will be flexible and (usually) less oriented around financial returns
You can start to build your network. Early investors (especially those who can offer strategic support) may prove to be useful mentors to the business

❌ CONS:

You’re playing with the money of people close to you. Any losses come with an additional tinge of responsibility
This funding is fairly exclusive. Founders from higher socio-economic backgrounds may easily access those; for others, it may be much harder to access

Angel investors

On paper, Angel investors are similar to venture capitalists—they’re both looking to invest money in exchange for equity in your company. But in reality, angels operate quite differently. Fundamentally, angels look to return on an investment-by-investment basis, whereas VCs look to return the whole fund; they are also investing their own money, as opposed to someone else’s.

On average, angels see a return of about 27% (2.5 to 3x) their investment within 5 to 7 years. So if they invest $10k, they expect to see a return of $25k-to-$30k. For an individual, this is a significant return from one investment; for a VC, this would barely register.

As such, angels tend to make their investments quite differently. Deals are fostered through and built on personal relationships rather than on hard metrics. Many would consider the angel role even more as an advisor, albeit one who is paying to be your advisor. In short, the benefits of working with angels typically goes far beyond capital.

Angel investors take on a variety of profiles. You’ll often see many founders/former founders, particularly those who have exited, becoming angels; you’ll also likely see successful VCs starting to operate on the side as angels. Don’t confuse these with ‘family offices’, which deploy capital from a single wealthy family. As an incentive to invest, angel investors in the UK get fantastic tax breaks from investing in UK companies (see SEIS or EIS schemes).

While some angels invest alone, many are drawn towards investing as a collective. Angels often get together with their peers and organise into a syndicate or network. This allows each angel to invest a smaller check, yet invest large sums into a company as a single entity. Collectively, they’ll share deals, perform due diligence, and listen to pitches.

✅ PROS:

Can offer you more than capital aka ‘smart capital’. Angels (particularly founders/former founders) can offer you mentoring and support in the running of your business. They may also occupy advisory positions (including board seats). This is a huge advantage of receiving angel investment, so make the most of it.
Having certain angels on board can give positive signals to VCs. This may help you raise rounds faster in the future
More inclined to write smaller checks. This can be helpful for early product development, or for topping up a larger VC-led round.
More likely to invest in you at an early stage. Angels are inclined to fund businesses they want to see in the world. This is particularly useful for companies who may not have proven traction yet, but show early promise.
They can make decisions more quickly. Since it’s their own money, angels need less consultation or approval for investment decisions, meaning they can supply a quick cash injection.
They can be more flexible. Angels tend not to be driven by certain theses like VCs, so can be flexible around where they put their money.

❌ CONS:

They are more driven by their own expertise. While they can be more flexible, Angels are often driven by sector (particularly if they have experience in that space), which may limit who you can speak to and ask for money from.
Very relationship driven. It may be that you have to commit lots of time to cultivating relationships with angel investors, well in advance of you seeking funding from them. This can be advantageous, but also time consuming.
Often very informal. Remember, this isn’t their full time job, so they may give much less time and thought to the process

Read our guide to Angel Investing

Tax incentives

Governments (the UK and US included) offer research and development (R&D) tax credits to incentivise entrepreneurship. These usually amount to a reduction in your corporation tax, or as a cash lump sum if your business operates at a loss. You can check your eligibility here.

Key criteria for a business to qualify is:

You’re doing something new and innovative
You require high skilled talent for what you’re doing

✅ PROS:

The application is non-persuasive. Unlike grants, which require a degree of convincing, you’re either eligible or you’re not. This makes applications much simpler.
They can help you claim for significant costs. Staff wages, software costs, utility costs, and material costs can all be claimed for tax relief. Businesses that get R&D tax credits can start to really structure their business around the support they receive

❌ CONS:

You may have to pay for support. It can be complex and time consuming applying for R&D tax relief, so many businesses opt to pay for advisors. You need to be selective with who you choose, and make sure you aren’t paying over the odds.
Some businesses simply won’t be eligible. The flipside of non-persuasive applications is that, if you don’t qualify, then that’s that.
It can take you a long time to get your money back. Don’t view it as a quick cash injection

Your funding roadmap

By Esme Verity, founder of Considered Capital, who run the Alternative Funding School

As you can see you’ve got a lot of options when it comes to raising startup funding. But how do you decide which funding route is right for you?

1. Understand the type of business you are building

Consider—what is your end goal? Decide early on if you want a high-growth startup that will raise VC funding and require large sums of money to grow and scale or are you happy retaining a larger equity stake in a more traditional, linear-trajectory business. The answer to these questions will impact what funding options are open to you.

2. Identity the type of funding that’ll work for your business

One of the hardest things about fundraising is figuring out the type of funding that is right for your business. Consider what stage your business is at, your growth potential, and your business model. Keep this in mind when weighing up the pros and cons of each type of funding. Considered Capital hosts a six-week Alternative Funding School, giving founders practical hands-on support for raising mission-aligned funding.

3. Create a list of funding providers

Create a simple spreadsheet and add all the funding providers that would be a good match for your business (it can help to look at organisations that have funded similar businesses). Include the type of funding, the stage they invest in, how much they’ll invest and any deadlines. Research funding well ahead of time (at least 6-9 months) so you don’t miss any important deadlines.

4. Put together your materials

Well put together funding materials (pitch decks, funding proposals, business plans, financial forecasts) make all the difference when speaking with potential funders. While you don’t need to recreate your deck or business plan for every funder, it may be wise to tailor your messaging in order to speak to the unique goals of that particular capital provider.

Just as with building a startup, there is no right or wrong answer when it comes to funding your startup. This will really depend on what suits you and your business.

On the one hand, venture capital isn’t for everyone. Evaluate your profile as a business, and if you don’t think your business model or mission fits the VC route, then don’t waste your time pursuing it.

But at the same time, venture capital and alternative funding sources are not mutually exclusive. There may be many reasons why you can’t attract VC investment (wrong timing, wrong positioning, etc), but that doesn’t rule it out for ever. Alternative funding sources can pull different levers for your business that will bring you closer to raising VC further down the line.