Alternative funding for tech startups
Tech startups can sometimes find it difficult to use a bank or startup loan as the sole method of funding their business at the early stages. It can take a long time for an app or platform to become profitable – just look at Twitter, one of the biggest and most important social networks in the world, which still makes a considerable net loss every year. Monetising a tech startup can take years, and involve the building of large audiences, impressive growth, and winning investors. If you’re a small tech startup with no track record and no proven record or idea for monetising your product, you'll need to look at a range of options.
Here are some alternative funding ideas for tech startups – and here’s how VSU-funded business Frugl are monetising their app, if you’re in need of a bit of inspiration to get you going.
‘Bootstrapping’ is a form of funding which involves using your own resources to build a minimum viable product and get it out in the market as soon as possible, then using audience feedback to refine and improve it. Rather than investing a lot of time and money into creating a product that you think is the ideal version, only to find that it needs many revisions, you instead create a product that your potential buyers actually want. Any profits created by the MVP can then be put back into developing the product. It’s cheaper and more efficient, and is a method popular with many startups – look online and you’ll find many businesses extolling the ‘Lean Startup’ life.
Pros: You can work more efficiently towards a final product, gain customers and followers from the get-go, and potentially start turning over a profit at an earlier stage. The customers and sign-ups can then be leveraged as proof of demand for your product, making it easier for you to gain other forms of funding in the long run.
Cons: You’ll almost definitely need to tighten your belt and make sacrifices at the beginning to find the money and time to create a MVP and get it out there, and it can take longer when you’re limited by funding and time constraints than if you won investment and could quit your day job to work on it full time. If your product is one that requires a lot of expense to create even at the MVP level, it also might not be the solution for you.
There are lots of grants out there, and many of them are ideal for tech startups looking for a funding boost, especially if your business is very innovative or specific.
Innovate UK, the technology strategy board, runs several funding competitions. These include:
- Catalysts. You can be funded for up to 60% of your project costs within the Agri-Tech, Biomedical, Energy and Industrial Biotechnology industries. You’ll also need to be working with another business, or a research partner. These are ongoing grants and can be applied for through the Innovate UK website.
- Feasibility studies. You can get up to £400,000 to test a business idea and see if it will work through Innovate UK. You can get up to 70% of your costs covered if you’re a business.
- Research and development funding. You could get from £25,000 to more than £5 million to fund a research and development programme, in order to test and develop a new product, service or process. To be eligible you must work in the science, technology or engineering industries, and you must be working with another business or a research partner.
- Horizon 2020. This is EU funding for UK SMEs working in high-tech industries and that want to work with other businesses in Europe. Opportunities will be advertising as they arrive – at present there are no competitions ongoing, but it’s worth keeping an eye on.
- Knowledge Transfer Partnerships. You can get up to £80,000 if you work with a newly-qualified graduate and a research organisation – the funding covers the cost of the graduate on a specific innovation project.
- Launchpads. Launchpads provide funding of up to £100,000 to turn an innovative idea into a commercial product. To qualify you must be an SME in a high-tech industry based in a specific part of the UK, have ambitions to grow, and match the money you receive with your own funding.
- Small Business Research Initiative (SBRI). This is a chance to win a contract to research and develop a new product or service for the private sector, helping to improve public services with your invention. You can win from £50,000 to £100,000 to test the idea, and contracts of up to £1 million to develop it.
- Nesta. Nesta is an innovation charity that provides support and funding to businesses in the tech industry that are making a difference.
Pros: Free money – you don’t have to pay a grant back – and the prestige. Especially good for businesses in niche industries, where there’s often less competition for the money.
Cons: Grant proposals can take a long time to put together, there can be quite a lot of competition, and the money has to be used for a specific purpose. It’s rare that a grant can fund the business alone – you’ll usually be expected to match at least part of the funding with your own finance.
Crowdfunding can be broadly split into two main types – equity crowdfunding and reward-based crowdfunding. As the names suggest, equity crowdfunding is where people pledge money to your business and receive equity in it; reward-based is where people pledge money to your business and receive a reward.
For tech businesses without a tangible product, reward-based crowdfunding might seem difficult – what can you offer those who pledge money to your business? However, it’s possible if you think outside the box. You could offer early access to the app or platform, or VIP features; you could offer your own skills, a ticket to the launch party, or a year’s (or lifetime’s!) subscription.
Crowdfunding platforms specifically designed for startups include Crowdfunder, Crowdcube, and Seedrs, whereas other common crowdfunding platforms include Kickstarter, evolving into more niche platforms such as Unbound (for publishing) and Bzzbnk (for social enterprise).
Pros: With reward-based crowdfunding, your startup retains full control, and with equity-based you can give away exactly as much as you’re comfortable with – you’re in the driving seat. It also helps validate your idea by showing there’s an established market for it, as you’ve proved there are people willing to put their money where their mouth is.
Cons: Crowdfunding is extremely time-consuming – it requires a big commitment in order for your campaign to succeed. You’ll need to market your campaign tirelessly. And if your project doesn’t meet its goal, it can reflect badly on your business.
On the other end of the scale, over-funding your project, while it might seem like the dream, can come with its own problems. Over-funding can place a lot of extra demand that you might not have bargained for on your business, and if you’re not prepared for it this can be disastrous.
Making tax work for investors
The Seed Enterprise Investment Scheme and Enterprise Investment Scheme are schemes that have been set up to encourage investment in startups through incentives and tax breaks, making startups more attractive prospects for investors.
For the SEIS, investors get relief of 50% of the investment (with a maximum annual investment of £100,000 a year) against tax, no capital gains tax to be paid on any profits made from the investment, loss relief, and potential inheritance tax benefits. For EIS many of the same benefits are in place, but for lower amounts, eg. tax relief is 30% rather than 50%. These are significant incentives designed to get investors over the fear of investing in high-risk startups.
Pros: These schemes can make the bargaining position of tech startups looking to win investment much stronger, and help them negotiate a better deal. Investment means you’re not financing your startup through debt.
Cons: Without a track record, investors may still be doubtful about investing unless they are really passionate about the idea and willing to take the risk. Investment means you will give up equity in your business and also relinquish some control, which can limit your freedom to develop and pivot if you’re at a really early stage. Also, winning investment at this stage can put a lot of pressure on you to meet investors’ expectation and monetise your business as soon as possible.
It’s easy to get peer-to-peer lending confused with crowdfunding – both methods use people power to fund your business, but peer-to-peer lending is basically like a crowdfunded loan. Rather than give people equity or rewards in return for pledging, you pay interest on the money that is lent to you. Peer-to-peer loans are generally made up of many different investors, including councils and government-backed programmes. You can apply for loans of up to £1 million pounds with leading platform Funding Circle, for example.
Pros: Can borrow large sums of money, easier and more flexible than a bank loan, and validates your idea by proving people back it.
Cons: Accruing interest can get expensive, and while it might be easier to get funded than through a bank loan, unproven businesses might still find it difficult.
Angel investors and syndicates
Angel investors are typically the investors that fund startups, rather than venture capital, as they provide smaller sums of money and are more hands-off (for more information on the differences between them, read our guide.) While angels investors are often individuals, more platforms are diversifying – such as Syndicate Room, an investment platform that requires an investment from a lead angel, but which then allows other to invest in the project (Virgin Startup Ambassador Frugl is currently fundraising through this method.)
More and more we’re seeing the emergence of ‘super-angels’ – investors who combine sums more often seen in Venture Capital with the early-stage investment of angel investors.
Pros: By winning a lump sum of funding, businesses can concentrate time and energy on developing their app or product. They can also potentially benefit from the expertise of the angel investor, without having to compromise as much as they would with a venture capital investor.
Cons: Lots of startups are competing for angel investment, you still give away equity, and if you don’t have a proven track record it will still be difficult for you to win over investors unless your idea is one they that completely bowls them over.
Find out what angel investors are looking for here with this advice from Angel’s Den.
As well as funding, there are resources out there that can help make running a tech startup easier and move you ever-forwards towards monetising, whether it’s helping you with equipment costs or giving you tax breaks.
- Innovation vouchers. These can give you up to £5,000 to pay for an expert to advise you on aspects of your business and help grow your business.
- Leasing and asset finance. If you require specialised equipment or can’t afford the high-tech tools you require, leasing and asset financing is an affordable way to access them.
- Research and development tax credits. This initiative can reduce your business’s tax bill, or you can choose to receive a lump sum tax credit instead if applicable.
Innovation directory – a resource from Innovate that tells you the organisations and initiatives available to help your business
IC Tomorrow network – a community for networking and education on digital innovation
Enterprise Europe – advice on support and opportunities available in the EU
Business finance support finder – government resource to help locate appropriate loans and support
Business enterprise news and opportunities – resource to stay up to date with what the government is doing for enterprise funding.
Image credit: Flickr Creative Commons