What Is Startup Capital?
Startup capital is money raised by a new company to meet its initial costs. Entrepreneurs seeking startup capital must create a solid business plan or build a prototype to sell the idea and attract investors. Sources of startup capital include venture capitalists, angel investors, banks, and other financial entities.
Typically, startup capital is a substantial amount that pays for crucial initial expenses like inventory, licenses, office space, and product development. Startup costs vary widely depending on the business type, but they generally range from a few thousand dollars for small, home-based businesses to millions for larger ventures.
Key Takeaways
- Startup capital is the funding an entrepreneur secures to cover the initial costs of a business until it becomes profitable.
- Sources of this capital include venture capitalists, angel investors, and traditional banks.
- Investors favor venture capital because it provides substantial growth funding and expertise, guidance, and access to a wide network, which are critical for a startup’s scalability.
How Startup Capital Works
Young companies that are just in the development phase are called startups. These companies are founded by one or more people who generally want to develop a product or service and bring it to market. Raising money is one of the first things that a startup needs to do. This financing is what most people refer to as startup capital.
Startup capital is what entrepreneurs use to pay for any or all of the required expenses involved in creating a new business. This includes paying for the initial hires, obtaining office space, permits, licenses, inventory, research and market testing, product manufacturing, marketing, or any other operational expense. In many cases, more than one round of startup capital investment, such as a Series B and C funding round, is needed to get a new business off the ground.
The majority of startup capital is provided to young companies by professional investors such as venture capitalists and angel investors. Other sources of startup capital include banks and other financial institutions. Since investing in young companies comes with a great degree of risk, these investors often require a solid business plan in exchange for their money. In return for their investment, they often receive an equity stake in the company.
Startup capital is often sought repeatedly in different funding rounds as the business develops. Each round of funding aims to support specific growth stages, from initial product development to scaling operations and expanding into new markets.
The final funding round may be an initial public offering (IPO) in which the company sells shares of its stock on a public exchange. By doing so, it raises enough cash to reward its investors and invest in further growth of the company.
Types of Startup Capital
Banks provide startup capital in the form of business loans, the traditional way to fund a new business. SBA 7(a) loans are a popular choice for initial startup capital because they offer competitive interest rates and long repayment terms, which can be particularly advantageous for new businesses looking to minimize initial overhead. Additionally, these loans are backed by the Small Business Administration, which reduces the risk for lenders and can make it easier for startups to qualify for the financing they need to launch and grow. The biggest drawback to business loans is that the entrepreneur is required to begin payments of debt plus interest at a time when the venture may not yet be profitable.
Venture capital, provided by either a single investor or multiple investors, is one financing option where the entrepreneur typically exchanges a portion of company equity for funding.The successful applicant generally hands over a share of the company in return for funding. The terms of the agreement between the venture capitalist and the entrepreneur detail various exit strategies, such as an initial public offering (IPO) or acquisition by a larger company.
Angel investors are a type of venture capitalist who actively advises new businesses. Often, they're successful entrepreneurs who invest a portion of their own profits into emerging companies. Besides providing capital, they also frequently mentor the management teams of these startups, offering guidance and expertise to help them grow. Angel investors often collaborate and form syndicates to invest collectively in multiple companies, typically pooling together between $200,000 and $400,000 for each investment.
Startup Capital vs. Seed Capital
The term startup capital is often used interchangeably with seed capital. Although they may seem the same, there are some subtle differences between the two. As mentioned above, startup capital usually comes from professional investors. Seed capital, on the other hand, is often provided by close, personal contacts of a startup's founder(s) such as friends, family members, and other acquaintances. As such, seed capital—or seed money, as it's sometimes called—is typically a more modest sum of money. This financing is usually enough to allow the founder(s) to create a business plan or a prototype that will generate interest with investors of startup capital.
Advantages and Disadvantages of Startup Capital
Venture capitalists have underwritten the success of many of today's biggest internet companies. Google, Meta (formerly Facebook), and Dropbox all started with venture capital and are now established names. Other venture capital-backed ventures were acquired by bigger names—Microsoft purchased GitHub, Cisco bought AppDynamics, and Meta acquired Instagram and WhatsApp.
However, providing young companies with startup capital can be risky. About 75% of venture-backed startups fail, for example. However, these startups usually steer clear of formal bankruptcy because of their capital structure and the swift devaluation of assets when financial troubles become known. Instead, they prefer faster, informal solutions such as M&A sales, acqui-hire transactions, or assignments for the benefit of creditors.
The few companies that endure and grow to scale may go public or sell their operations to a larger company. These are both exit scenarios for venture capitalists that are expected to provide a healthy return on investment (ROI).
That isn't always the case. For example, a company may receive a buyout offer below the cost of the venture capital invested, or the stock may flop at its IPO and never recover its expected value. In these cases, the investors get a poor return for their money.
To find venture capital's most notorious losers you have to go back to the dotcom bust around the turn of the 21st century. The names live on only as memories: TheGlobe.com, Pets.com, and eToys.com, to name a few. Notably, many of the firms that underwrote those ventures also went under.
How Can Businesses Get Startup Capital?
Businesses looking for startup capital can consider self-funding, securing investments from venture capitalists or angel investors, or applying for small-business loans. Traditional bank loans and SBA 7(a) loans are common choices, with SBA loans providing competitive interest rates and long repayment terms. These loans are backed by the SBA, which reduces risks for lenders and helps startups secure funds. Alternatively, venture capitalists and angel investors offer funding in exchange for equity, often also providing strategic advice and mentoring.
Why is Startup Capital Important?
Startup capital is essential for covering the initial costs of a new business until it begins generating profit. This capital can come from various sources such as banks, venture capitalists, and angel investors, each offering different advantages depending on the business's needs. Whether for buying inventory, hiring staff, or funding product development, startup capital supports the business in its critical early stages, allowing it to grow and succeed.
What is The Most Common Type of Startup Capital?
The most common sources of startup funds for small businesses include personal savings, bank loans, and investments from venture capitalists and angel investors. Additionally, innovative methods like crowdfunding and peer-to-peer lending are also becoming popular. Some entrepreneurs even turn to using personal credit cards or home equity loans to fund their business. Each source offers different benefits, and businesses may choose based on their specific needs and stages of growth.
The Bottom Line
Startup capital is crucial for new businesses to cover initial costs and reach profitability. It helps entrepreneurs fund important early expenses like inventory, office space, and product development. This capital is typically sourced from personal savings but may also be acquired via bank loans, venture capitalists, and angel investors. Each source of startup capital offers unique advantages tailored to a business's specific requirements and developmental stage.
