Most startups are hard to build without some initial cash on hand. Consumer goods businesses, or those that have physical products and associated COGS (cost of good sold) that scale with the growth of the business, are especially hard to build without some initial capital. Simply put, you need to pay for the production of your goods before you can sell them. Where should that money come from? In this post we cover the sources of funding for food startups.
We’ve put together this basic guide to sources of funding for food startups here. While this guide applies to food startups, it’s also applicable to beverage startups and other consumer goods businesses as well. Reach out with questions or let us know if we’ve missed anything!
The List: Sources of Funding for Food Startups
Many founders start businesses using their own personal cash. Financing the initial (small) production run for your business is generally a good idea. Why? It should encourage you to be scrappy and wise about the inventory you initially produce. The sole purpose of your initial inventory run should be to get customer feedback and confirm that you’re creating something that people want — and are willing to pay for. Once you’ve confirmed you’re making something people want, you can produce in larger quantities.
Funding your business out of your own pocket is also a good idea because it demonstrates to future investors — of any kind — that you’ve got skin in the game. Putting your money where your mouth is also shows you believe in your enterprise. (Many SBA programs also won’t lend if the owner doesn’t have any equity in the business.)
Owner financing is also the lowest risk and most easily accessible capital of all of the sources of funding for food startups on this list. Ease of access means you’ll be able to continue to focus on what matters. That’s building the business. But don’t go in blind: The risk is real. What that means is that if your business fails, you probably won’t get your cash back.
Keep Good Records
Make sure you record any cash contributions you make to your business on your books. (You’ll likely want to pay yourself back once your business starts to generate profit!) A good accountant can help you record your owner’s contributions to equity. They can also help you figure out a plan for later withdrawing the money you contributed to start the business. (And check out this guest post for more on startup financial strategy.)
Airbnb famously started their business with a “Visa round.” The founders formerly collected baseball cards. On their episode of How I Built This with Guy Raz, they shared that instead of baseball cards, they had an album of credit cards. It’s kind of a crazy story! But indeed, Airbnb launched their business by using lots, and lots, and lots of credit cards.
Weigh Your Offers and Shoot for 0% Interest Introductory Offers
Many credit cards will offer 12-18 months of 0% interest financing. This effectively offers founders a buffer of time to scale up the business with free cash. Be sure to have a plan in place for how to pay off your balance before the 14-26% interest hits. At that rate, credit cards are expensive capital.
If you decide to pursue a credit card or two to finance your business, watch not only for annual fees. Also consider perks like cash back or other rewards. Also make sure to ask whether your personal credit will be checked with a soft or hard inquiry prior to application.
Over time, your business will build its own credit history. At the beginning, however, it’s likely that your business’s credit will be tied very closely to your own personal credit.
Watch out for Personal Guarantees
Speaking of which, watch out for personal guarantees! It’s important to note that most credit cards, even business ones, require a personal guarantee. A personal guarantee means that if your business fails, you will be personally liable for the debt. There are a handful of credit cards out there that don’t require a personal guarantee (Brex, for instance, does not).
Do your research and make sure you understand the risks of each credit card and its offer before you finance your company in this manner.
Friends & Family
Friends and family can be another source of funding for your business. They’ll often offer more generous terms than angel or institutional investors (see below) — and certainly better terms than credit cards.
Nearly 40% of startups receive funding from friends and family each year. While sometimes referred to as the “Friends & Family Round,” others refer to it as friends, family, and fools. Friends and family are likely to believe in investing in you; fools often don’t recognize the risk in early stage ventures. At the end of the day, and whether family or fools, people who invest at the beginning are backing little more than an idea.
Taking money from friends and family is risky. Most young businesses fail. As an entrepreneur, your job is to believe relentlessly in the future of your business and to back your relentless optimism up with data, sales, and traction. But optimism can be blinding. Odds are that your friends and family may never see their money returned to them.
Be clear with any investor about the risk inherent in early stage ventures. Also take the time to document the investment with a promissory note (if a loan), or using a term sheet (equity investment).
You’ll want to think carefully about the terms for paying back any loans you might get from friends and family — or how their contribution might be reflected as an ownership stake in your business.
Pitch competitions typically provide one or more qualifying and participating businesses with a small cash grant to get started. We’ve saved you a little time searching for relevant pitch competitions, and have put together a list of food startup pitch competitions here.
It often takes a substantial amount of time, energy, and work to apply, qualify, and attend pitch events (whether virtual or not). You’ll want to be strategic in how you use your time. Understand that there may not be a prize payoff — or that the payoff may be small.
While a crowdfunding campaign can theoretically be conducted at any point in a business’s lifecycle, it’s often used as part of a new business’s launch strategy. Crowdfunding campaigns are also a great way to pre-sell inventory, generate awareness for your new venture, and connect with early customers. Note that there are different types of crowdfunding. Backers can give you cash in exchange for rewards, donations, or equity.
Crowdfunding campaigns, not unlike pitch events, take a lot of time, energy, planning, and even money to execute well. No crowdfunding campaign succeeds without a great video. Many startups that beat their fundraising goals paid good money (i.e., thousands or even tens of thousands of dollars!) for the videos that helped get them there.
Be sure to do your research to understand which platform will be best for you and what type of campaign to run (i.e., rewards-based or equity-based). You’ll also want to go into the process with a plan for how you will utilize your network in order to ensure that you’ll be able to start your campaign already having roughly 25% of your total capital raise already committed.
Want to know more about crowdfunding? This quick list of crowdfunding sites will get you started.
Most accelerator programs offer some form of cash, often in exchange for equity in your business. We provide a list of food startup accelerators here — and provide a basic Q&A for thinking about whether to apply for and attend a program in a separate post.
A good accelerator program will not only provide some much-needed cash for young businesses, but will also provide mentorship and direct connections to suppliers, retailers, and other partners who will help drive growth. Of the sources of funding for food startups, this one is particularly good for first-time founders or those that want to grow their networks.
Angel investors are individual investors who invest their own money or as part of an angel group. Their deal sizes tend to be smaller than institutional capital and their terms may also be more flexible. Given the early stage at which angels tend to invest, they often do convertible debt deals, but can also participate in priced rounds.
Angel groups share deal flow, tend to meet regularly, and as a group, can invest more capital collectively than you might expect from an individual angel. In this way, they are also capable of, and may be interested in, leading your fundraising round.
VC money is often harder to get than the other types of funding on this list. That said, it can be a strategic way to finance and grow your business. We cover venture capital as a form of equity financing here — and include a long list of VCs that have historically invested in food and other consumer businesses.
If you want to learn more about VC and the ins and outs of term sheets (especially crucial before you ever present or sign one), read Venture Deals by Brad Feld.
Commercial or Bank Loans
Bank loans typically require that a business has its books in order and has been in business for at least a year. While the cost of capital tends to be lower than credit cards and may be lower than inventory or accounts receivable financing, the process for applying and receiving funds can be more lengthy.
Inventory financing is essentially a revolving line of credit or short term loan that a company can get to fund business operations. Your inventory, or the products that your company produces, serves as collateral for the loan. Terms are generally fairly reasonable and cash is usually available quickly, so this can be a good option for companies that are already producing goods.
Accounts Receivable Financing
Similar to inventory financing, accounts receivable financing is good for businesses that are already producing products and/or cash flow. These businesses can then borrow against their future cash flow.
(Accounts receivable, for those who don’t know, are the assets a business has on their books equivalent to the outstanding balance of invoices sent to customers that have not yet been paid or received.)
SBA loan commentary here.
Wrap Up — Sources of Funding for Food Startups
Anything we missed? Do you have a business that provides financing for food or consumer businesses? Get in touch.