As a founder starting or growing a business, you know access to capital is crucial for growth - especially if you can’t fund the business yourself.
You have several options for funding your startup: money from family/friends, bank loans, angel investor or venture capital, crowdfunding, grants from a governmental program or research institution, and now an additional option - a Convertible Income Share Agreement (CISA).
Every entrepreneur’s situation is different, so choosing the right source of funding is just as important as getting money in the door.
The type of funding your startup business can raise depends on many factors: stage of the company, business strategy, track record as an entrepreneur, etc. Each funding method has its own benefits and drawbacks. For example:
You’ll also learn about a new, innovative startup funding option that doesn’t require early-stage founders to sacrifice excess ownership or bet the proverbial farm: convertible income share agreements.
Almost 65% of entrepreneurs start their businesses with personal or family savings, or using income from a primary job or spouse’s job, according to the Kauffman Foundation. While bootstrapping - starting and growing a business with little or no outside cash or other support - is feasible for certain types of businesses with no large upfront costs, some founders progress to the point where they need more capital for growth than they can afford on their own.
Also, funding a business with personal money may detract from quality of life, particularly if the entrepreneur has to cut back in other areas.
Nonetheless, at the earliest stages, this is often the only way to fund a business. Plus, other traditional sources of capital often like to see that the entrepreneur is personally invested before they invest.
Unfortunately, this option assumes a lump sum of cash available to invest in the business - and many don’t. Almost 70% of adult Americans have less than $1,000 in a savings account.
This means two things: 1) Americans need to spend less and save more, and 2) there are likely talented entrepreneurs that are prevented from starting or growing their company due to their personal financial situation..
Pros and Cons of Self-Funding a Startup
Another source of funding for startups is friends and family (sometimes referred to as F&F). Often, this is the first outside capital that comes into a startup. These people trust the entrepreneur personally and might provide capital at very favorable terms. The investment is considered debt if the money is to be repaid, or equity if the investors become part-owners of a piece of the business.
For many entrepreneurs, raising money from friends or family isn’t an option. Relatively few people have the privilege of a wealthy network of friends and family.
Other founders have the desire to insulate their business from their personal lives. If things go south, losing your friends and family’s money could hurt relationships.
Lastly, many businesses grow too large for friends and family money to be able to fund, requiring institutional sources of capital.
Pros and Cons of Friends & Family for Funding a Startup
Another common source of funding for startups is a bank loan or debt investment. These come in many flavors. We’ll go into more detail about the specific options, but for now, know that a traditional bank loan can either be a personal loan to the entrepreneur as an individual, or a business loan to the entrepreneur’s business.
A standard bank loan typically looks like this:
Bank loans typically take the form of an SBA (Small Business Administration) loan, or a loan to finance a specific purchase or transaction. Here’s a quick overview:
Pros and Cons of Bank Loans for Startup Funding
For a small portion of startups, equity financing is an option. Equity financing means the entrepreneur sells a portion of their business to an investor partner. This is the classic Venture Capital and angel investor model for financing early stage startups.
Venture capital (VC) firms write various check sizes, typically starting at $100k and going up from there. However, VC funding accounts for less than 1% of all new business funding. Furthermore, the chances of receiving a venture capital investment drop substantially if you are located outside of the 10 largest U.S. cities or if you are not a white male. studies show that 79% of venture capital funding goes to all male teams and 77% of venture capital investments are in companies located in the top 10 U.S. cities.
VCs look for a very specific growth profile of a company. asking, “How can this business get to $100 million in revenue in 5-10 years?” If your business doesn’t fit that high growth profile, then venture capital is likely not a fit.
Angel investors are another form of equity investment. Angels can write much smaller checks, sometimes as small as $5k. Angels often look for similar types of high growth, but are much more flexible in what they will invest in.
Other types of equity investors include Private Equity, Family Offices, and High Net Worth Individuals.
With venture capital firms, angels and other types of equity investors, startups can only get funding if they’re able to 1) match their investment criteria and 2) get in contact with them to pitch the idea.
Pros and Cons of Equity Funding for Startups
Less discussed are a few other ways for entrepreneurs to access capital for their business. These options are often less dilutive than traditional venture capital investment and may leverage company assets like blue-chip customers, unpaid invoices, equipment, or other intangibles. These options can be a great fit for some entrepreneurs or some business models. Companies with large amounts of inventory or extremely predictable recurring revenue streams are good candidates for certain types of alternative financing.
Indie.vc has put together a list of alternatives to equity financing, including factoring, venture debt, mezzanine debt, inventory financing, among others. We’ll go over Revenue-based financing and Factoring, then introduce a new financing option for entrepreneurs: the Chisos Convertible Income Share Agreement, which takes a hybrid approach to early-stage funding.
Pros and Cons of Revenue-Based Financing
Companies with high recurring revenues and hefty margins can take advantage of revenue-based financing, which typically claims a fixed percentage of revenues up to a certain multiple (or cap). This means the loan is repaid faster when revenues are larger and more slowly when revenues weaken, therefore fluctuating with the state of the business.
Pros and Cons of Factoring
Factoring is similar to revenue-based financing, except that the loan is backed by the company’s accounts receivable. This kind of financing can be a good fit for customers with well-known, large, reliable customers (e.g. blue chip companies) who pay invoices slowly. Factoring is typically structured as a line of credit, so the business only borrows what it needs when it needs it.
Chisos designed the CISA to provide flexibility without hamstringing the business or the entrepreneur. It combines the best elements of equity and institutional investing, while being responsive to the unique challenges of idea- and early-stage businesses. The CISA is an excellent fit for idea-stage and side-hustle founders, or founders looking to avoid the governance and growth obligations that come with other institutional capital.
Often even businesses with strong potential aren’t candidates for either VC or a traditional small business loan. Here are a few common reasons:
Unlike other providers of funding for startups, Chisos will fund businesses with any of these characteristics if the founder is impressive.
The CISA also solves the problem of access to capital.
What happens when an entrepreneur outside of CA or NY has 10 years of experience in her field and wants to start a company to solve a problem she deals with on a daily basis? Where will she get the funding if she has not been able to save enough money and doesn’t have a wealthy friends and family network? What if she needs $25K to build a prototype or MVP? What if the problem she is solving is “only” a $100 million problem? Any one of these hurdles could prevent this company from becoming a reality; collectively, they all but guarantee that this first-time founder will be excluded from entrepreneurship.
At Chisos, this is the core problem we’re looking to solve.
So how does a CISA work?
After a founder has completed our background and diligence process, we sign a Convertible Income Share Agreement, which consists of an equity component from the company (usually a SAFE) and an income share agreement with the founder. The investment is then distributed to the company for use in the business. The investment amounts usually range from $15K-50K.
As the founder works on building the business their repayment on the income share agreement will depend on their personal income. If the founder is not taking a salary from the business, then they owe $0 for that period of time. When the founder begins earning over $40K / year from any income source, they will start making payments on the income share agreement.
We view the CISA as a founder friendly hybrid instrument that sits somewhere between traditional venture capital and traditional debt. While we do require a certain amount of repayment via the income share agreement, the payments are flexible and scale with the founders income. Unlike traditional debt, the payments will never be overly burdensome if the founder should lose their income. Furthermore, there is no compounding interest that could cause the amount due to balloons to unmanageable levels. On the equity side, the CISA allows the founder to claw back up to 2/3rds of their equity, meaning the founder keeps more of their own company.
For more in-depth detail about the CISA’s structure, read Chisos Investment Terms Explained (Part 1).
Pros and Cons of CISA Funding
If you are starting a company or thinking about starting a company, Chisos wants to get you started. You can apply here.
What to keep in mind when considering funding options: