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Alternatives to VC Funding - The Definitive New Zealand Guide

Our guides looks at the pros and cons of eight different options - Loans from Friends and Family, Crowdfunding, Grants, Bootstrapping, Angel Investors, Venture Debt, Annual Recurring Revenue (ARR) Lending and Mezzanine Financing

Updated 16 March 2022

Although venture capital has aided in the rapid growth of startups over the last few decades, entrepreneurs are increasingly looking for alternatives to venture capital to fund their developing enterprises.

Know This First: Why is venture capital losing its appeal?
  • For one thing, entrepreneurs do not want to relinquish power over decision-making or limit their ability to benefit from their ideas, both of which are common results of venture capital deals.
  • Furthermore, venture funders frequently seek the best potential rates of return, causing businesses to pursue an aggressive, unrealistic growth strategy that does not benefit the company in the long run.

Venture capitalists have also shown a strong interest in investing in IT companies or those who can brand themselves IT-related. However, many enterprises, particularly those that manufacture, market, and develop tangible products or are primarily seasonal and have been forced to look elsewhere for capital due to Silicon Valley favouritism.

As a result of these factors, many startups and middle-market enterprises are forced to seek out venture capital alternatives. Thankfully, several popular options give you significantly more control over your company's vision and future while also providing much-needed funding to propel a fantastic idea to profitability and long-term success.

Our guide gives you all the options in one place
In this guide, we'll go over the major venture capital alternatives and explain the benefits and drawbacks of each. While several of the following funding solutions were already popular before the COVID-19 pandemic, they have continued to grow organically through borrower-friendly conditions and greater flexibility than typical venture capital investments. We cover:

Alternatives to VC Funding

Loans from Friends and Family

Startup founders can find family members or friends that align with their ideas and that may have a bit of extra cash on the side to support your startup. When deciding to easily accept a friend or family member's money, make sure that they understand the risks involved with angel investments. They are relatively high risk in nature, and there are no guarantees that they will get their money back. On the other hand, investors and individuals are willing to write smaller checks, between $10,000 - $150,000, of their money because they just like the founder of the startup concept.

Advantages:
  • One of the main advantages of taking money from friends and family is that they are likely to support you and will be less stringent with how you use the money and when you pay it back.
  • Family and friends are keen to support you, whatever that looks like.

Disadvantages:
  • One of the main disadvantages of taking money from friends and family is the reputational risk. If your venture fails, you've effectively negatively impacted the people closest to you.
  • This can potentially harm the relationship you have with them going forward.

Crowdfunding

Companies who use crowdfunding raise money online through platforms like PledgeMe, Snowball Effect, Kickstarter or Indiegogo from the general public, rather than from conventional companies like banks or even venture capitalists. In general, crowdfunding entails pooling together many small contributions from people rather than one big backer. In many cases, startups will offer a couple of benefits to those that support the crowdfunding campaign in return for their funding, including first products or discounts on future services. 

It is essential that an organisation chooses a top-quality, popular crowdfunding platform where the fees are attractive to the founders.

Advantages:
  • The biggest advantage of crowdfunding campaigns is the ability to raise money from current or future customers that you otherwise wouldn't have access to and the ability to leverage the crowdfunding campaign as a marketing campaign.

Disadvantages:
  • The disadvantage of crowdfunding is the issue of aggregating the many small shareholders. As a result, the cap table will become crowded and can make it unattractive for VC investors to follow on. A way to avoid this is to create a nominee structure for all the crowdfunding investors.
  • For more information on crowdfunding, see our guide.

Grants

Some government and non-profit organisations offer interest-free grants (or sometimes completely free money) to companies working in certain industries, creating social impact or other aligned interests.

Advantages:
  • The good thing about grants is that they are typically non-dilutive, meaning you will not need to provide ownership or shares in exchange for this funding.

Disadvantages:
  • The one drawback of this is that it can take some time to write, draft and go through the grant process (upwards of 3 – 6 months+).
  • Some organisations that provide grants include Callaghan Innovation, MBIE and various startup accelerators.

Bootstrapping

Bootstrapping is the challenging experience of building a startup with limited external capital. If a founder uses their personal capital, reinvests the revenue generated, takes on personal debt, and brings a business into being without the assistance of investors, they will have successfully "bootstrapped" their business.

On top of the independence from not giving away ownership, bootstrapping means you don't need to share the profits with anyone except the team who helped you with the startup initially. Many more companies bootstrap than people who raise money from angel investors or venture capitalists, but it is not easy to bootstrap. The lack of cash can force founders to rush their way into financing by any available means. 

Founders can also remove personal loans against assets — e.g. mortgaging their house or cars. However, these options are extremely risky. Putting your house up as collateral and spending your family's savings to finance your business can work, and all is well if it does – the investment has paid off. However, the more likely scenario is the business does not succeed as you had hoped, and your family is impacted as a result of it (or worse – you find yourself in bankruptcy).

Many businesses successfully bootstrap, patiently learning how to deliver value to a market long enough to obtain multiple years of recurring revenue. At this time, companies can begin to show this consistent revenue to banks for loans to finance their future growth. When you bootstrap, you work hard on your business and don't take outside capital; you employ your income to run the business.

Advantages:
  • One advantage of bootstrapping is that you retain control of the company and do not have to provide shares for funding.
  • You can specialise in running your business rather than constantly pitch for fundraising (which is time and resource-intensive), and you'll build up traction for better terms in future fundraising campaigns.

Disadvantages:
  • One of the downsides to bootstrapping is that you will likely not be able to grow as fast as you would like to. There are scale limits since you only have your own money to invest and spend into your startup.
  • For example, if you had opportunities that you could pursue but don't have the cash to make them happen, you are forced to wait until you have more cash to pursue those opportunities. During this time your competitors may have already gotten VC funding and taken that opportunity away from you. This is one of the main drawbacks of pure bootstrapping.

Angel Investors

Angel investors are a frequent alternative to venture capital (especially when a company is earlier on in their lifecycle). Good connections are key in locating angel investors.

Advantages:
  • Angel investors are typically much more hands-off and will require less governance once invested.

Disadvantages:
  • The biggest downside with angel investors is that they may not provide the quality advice necessary for you to scale in the right markets or areas.
  • Angel investors make many small cheque investments in different startups and don't have the time to be as hands-on as VC investors might be.
  • For more information on angel investing, see our guide.

Venture Debt

Venture debt is a great alternative to venture capital for organisations that have already given up some of their equity through capital investments. Many founders are averse to losing even more equity in their firm through another round of venture capital funding, or they may want funding for a specific project that is not suitable for venture capital equity investment.

Private equity firms, business development firms and other companies may all offer venture debt opportunities. Traditional banks expect a track record of profitability, which is generally absent at such an early stage of growth, making it difficult for startups to find funding. Some of the most well-known startups, such as Airbnb and Uber, have used venture debt to fund parts of their expansion rather than seeking fresh traditional funding.

Companies interested in pursuing venture debt must be certain that they will be able to repay the loan. While a startup's finances may not be eligible for a standard bank loan, venture debt is not the best option for a company with a shaky financial base. In addition, venture debt is often senior debt, and if the borrower fails to repay the loan as agreed, they may face bankruptcy or the repossession of their assets.

On the other hand, venture debt has a lot of potential because it can provide much-needed financing for development at a far lower cost than additional rounds of venture capital funding. As a result, venture debt is frequently used in conjunction with equity funding because the founders do not risk losing any more equity in their company.

Annual Recurring Revenue (ARR) Lending

ARR or MRR investment is a venture capital alternative for firms that rely on subscription-based payments, service-based platforms, or other mechanisms that profit from repeating scheduled revenue. It is comparable to venture debt in many aspects. For example, individuals and organisations schedule months or years of payments for continuing access to an updated, cloud-based software programme with a software-as-a-service (SaaS) company as an example.

In many cases, creditors offer ARR or MRR investment as a line of credit to supply ongoing financing for an organisation. This will offer extensively greater capital that an organisation might want. However, this isn't always the best way to raise capital for all organisations. Businesses need to have a consistent sales price structure, normally subscription-based and are comfortably in at least a few hundred thousand dollars in ARR. If ARR / MRR lending is suitable for your startup's sales numbers, your next step could be to research the applicable creditors to speak about ARR lending. Some companies like pipe.com offer revenue-based financing.

Mezzanine Financing

Mezzanine investment may be a mixture of debt and fairness financing, which could integrate components of every for greater balance for organisation founders. This form of financing is meant to bridge the gap or offer a mezzanine alongside debt financing.

Advantages:
  • No dilution of capital which protects existing investors.

Disadvantages:
  • As with different sorts of debt, organisations need to settle on investments that they assume to pay off, as they'll lose their credibility if they fail to pay off the mezzanine mortgage.

Concluding Comments

  • Given the Venture Capital industry's predominant focus on early-stage tech companies, getting funding is typically particularly hard to secure for the overwhelming majority of companies.
  • Those who manage to secure funding from Venture Capitalists also have to deal with a considerable number of downsides. This may include giving up equity ownership, fighting overly aggressive growth plans and losing control over business decisions.
  • For the above reasons, entrepreneurs have strayed away from venture capital and towards alternatives that provide funding for different businesses in various industries, different levels of growth and with investment terms that are much more borrower-friendly.
  • The right alternative for you will depend upon a few of key factors. Firstly, whether or not you would like to give up ownership control or not, whether you've got excess cash available to bootstrap, and whether you'll be ready to meet the lender's terms and whether your ARR enables you to pursue certain options.
  • Overall, there are many different alternatives to VC funding, and each company will have some options that will work better than others.
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