Access to finance is one of the most significant barriers that entrepreneurs face. Early-stage companies with great concepts routinely fail if they are unable to source an injection of cash that allows them to develop their product to the point of revenue generation. Adequate financing is an absolute necessity for multiple aspects of a startup, whether it is initial setup, hiring, marketing, or expanding the business. Ultimately, capital is the lifeblood that allows entrepreneurs to take the risks that lead to innovation and exponential growth.
It is well established that startups are likely to find it difficult to borrow from traditional lenders as they lack the assets required to secure a loan and do not have a proven record they can demonstrate to banks. In response to this, policymakers and other ecosystem actors have pursued a range of strategies and policies to support early-stage companies. These measures include popular initiatives such as grants, equity investment, loan guarantee schemes, co-investment funds, crowdfunding and tax relief schemes. However, there is a danger of such policies ‘crowding out’ private money so policymakers must also be careful to design policies for instances where there is a clear market gap or the potential for stimulating further private funds.
This Spotlight series examines each of the policy mechanisms available to help increase access to finance amongst startups and entrepreneurs.
1. Grant Funding
Grant funding is a key financial support mechanism for startups, especially those in the early stages of development or those working on innovative projects. Unlike loans or investment capital, grants do not require repayment, making them an attractive source of funding for new businesses. This funding is provided by governments, corporations, foundations, or non-profit organizations and is typically aimed at supporting projects or initiatives that align with the grantor's objectives, such as technological innovation, social impact, or economic development. Consequently, applicants are generally expected to meet specific criteria and often go through a rigorous application process, competing with large numbers of other businesses vying for limited funding.
Grant funding has several benefits for startups including risk reduction. Since grants do not require repayment, they reduce financial risk and pressure on cash flow. On top of this, receiving a grant can serve as a form of validation for the startup’s mission and business model, potentially attracting other forms of investment. However, an overreliance on public money can also be seen as a warning sign to potential investors. Additionally, startups often find the application processes arduous and a significant drain on limited resources with no guarantee of a positive outcome due to the highly competitive nature of the funding. Likewise, some grants can come with restrictions on how the money can be used, requiring careful planning and adherence to the grant terms that could potentially stifle the freedom of the startup.
Case Study: YouWin!
The Youth Enterprise With Innovation in Nigeria (YouWiN!) program is a national business plan competition in Nigeria aimed at fostering youth entrepreneurship and innovation by providing 1,200 grants worth 10 million Naira to young Nigerians looking to launch a startup or expand their existing business. What is unique is that the program did not actually select the winning applicants; they were chosen randomly. It represents a collaborative effort involving Nigeria's Ministry of Finance, the Ministry of Communication Technology, and the Ministry of Youth Development, with support from the Department for International Development (DFID) and the World Bank. Launched in late 2011 during President Goodluck Jonathan's administration, the initiative has supported the creation of over 3,900 startups.
The impact of YouWin! was assessed in a report by the World Bank in 2015 using an academically rigorous model of assessment. Accordingly, this program can demonstrate the proof of its impact and has been given the highest evidence level available on Atlas. The report found that the initiative was highly successful and had resulted in the creation of 7,000 new jobs at a cost of roughly $8,500 per job created which is cheaper than most other job creation policies in developing countries. Additionally, three years after applying, new firm applicant winners were 37 percentage points more likely than the control group to be operating a business and 23 percentage points more likely to have a firm with 10 or more workers, while existing firm winners were 20 percentage points more likely to have survived, and 21 percentage points more likely to have a firm with 10 or more workers.
Read the full case study on YouWin! by clicking here and you can also search GEN Atlas for other Grant Funding programs.
2. Startup Loans
Startup loans are designed to support the initial costs of starting a new business. These loans can provide essential capital for various needs, such as inventory, equipment, rent, employee salaries, and other early-stage operational expenses. Crucially, loans are attractive to founders as they provide liquidity without having to give up equity or reducing their control over the business. As a result of the significant barriers to raising debt, entrepreneurs are often forced to take on significant personal risk by offering personal assets such as their home as a guarantee. This is especially true of innovative firms who cannot even point to the success of other similar ventures. To remedy this challenge, state actors have been incentivized to step in and fill the gap either through direct provision of loans or through incentives to banks and other financial institutions to lend money to startups.
Case Study: Startup Loan Program
The Startup Loan Program is a state-run financial assistance scheme that provides loans directly to entrepreneurs who are ready to launch a new business or are within their first year of operation. The program is run by the Japan Finance Corporation and is part of their broader mission to provide financial capital to small and medium businesses as well as micro-businesses. Crucially, the program does not require collateral from the applicant or a guarantor, although providing this can lower the interest rate that the recipient of the loan will pay. To qualify for the program applicants must demonstrate a viable business plan that will either create new jobs or is perusing technological innovation.
The Japan Finance Corporation estimates that 79,000 jobs are created through the program annually. They calculate this based on the average number of employees at companies launched through the loan program. However, this approach lacks an academically rigorous method of demonstrating the true impact of the program, such as a control group.
Read the full case study on the Startup Loan Program by clicking here and you can also search GEN Atlas for other Startup Loan Programs.
3. Loan Guarantees
The process of selecting viable candidates for startup loans requires a high level of expertise to avoid investing in unsuitable businesses as well as protecting for fraud. With this in mind, many state actors prefer to provide loans to startups indirectly. One such method of this is through Loan Guarantee schemes. The primary goal of these schemes is to offer credit guarantee coverage for debt facilities extended by banks to startups. This coverage is provided by government or authorized entities to ensure banks are more willing to lend to startups, knowing that a portion of their funds are secured against default. These schemes provide startups with a means to secure loans at potentially lower interest rates and with less stringent collateral requirements.
Case Study: BPI France
Bpifrance, formally known as Banque publique d'investissement, is a public sector investment bank whose mission is to promote development and financing of French startups. Bpifrance operates using a diverse array of financial tools, including loans, guarantees, equity investments, and advisory services, to assist businesses at every stage of their development, from the initial startup phase through expansion and on to succession planning. In 2020, approximately 69,000 unique businesses received support from Bpifrance, securing in excess of €27 billion in funding. Loan guarantees are one of the main instruments used by Bpifrance with several schemes including the Growth Loan and Seed Loan programs that share credit risk with commercial banks. Approximately 37,000 startups benefited from these schemes in 2020.
Bpifrance have published an evaluation of their loan guarantee programs which found demonstrates that changes to the application process in 2015 led to the creation of 460 to 920 firms per year which created between 920 and 1,840 new jobs at cost to tax payer of roughly €6,000 per job. The report also found that despite a higher probability of bankruptcy for firms that rely upon guarantees to receive loans (12% to 6%), the growth rates of firms receiving a guaranteed loan are similar to those receiving non-guaranteed.
Read the full case study on the BPI France by clicking here and you can also search GEN Atlas for other Loan Guarantee Programs.
4. Co-investment
A co-investment scheme refers to a scenario where investors make a minority investment in a company in conjunction with a private equity fund manager or venture capital firm. The aim of this to multiply the amount of funds raised by quality startups who already have the ability to raise some capital. Policymakers can utilize this type of scheme by investing public money in funding rounds led by competitively-selected partners with the decision-making process being controlled by the partners. This mechanism also allows policymakers to distribute funding without undertaking complicated and costly selection processes that are typically associated with grant and loan schemes. This approach generally attracts large institutional investors and is usually not accessible to small or retail investors. Co-investments can lead to better performance compared to traditional fund structures and also help to avoid capital exposure limitations and diversification requirements.
Case Study: Enisa Participative Loans
The ENISA participative loan scheme is a financing program designed to support startups and small and medium-sized enterprises (SMEs) with an annual budget of €100 million. It operates like an equity loan, where the interest rate varies based on the company's profits with loans of up to €75,000. The maturities of the participative loans range from 7 to 9 years, and the repayment of the principal is delayed from 5 to up to 7 years. The explicit interest rate applied is floating and collateral is not required.
This scheme utilizes a co-investment model by targeting investments in the first rounds of private capital raised by the companies to stimulate growth. The loan is designed to co-finance the company's strategic plan, with a focus on innovation. The scheme also aims to make it easier for companies to apply for new financing as they grow and evolve. The scheme primarily targets newly formed startups and SMEs, especially those established by young entrepreneurs.
The impact of the ENISA Participative Loan scheme has been evaluated through an academic study of 512 entrepreneurial ventures that participated in the program between 2005 and 2011. Consequently, this program can demonstrate the proof of its impact and has been given the highest evidence level available on Atlas.
The study, published in 2019, found that the loans significantly boosted their recipients and sales. Furthermore, In the two years following receipt of the loan, a 1-million-euro loan generated an increase in average employment of between 12.1 and 14.7 jobs and an increase in sales of between €1.09 million and €1.97 million. The effect was larger for high-tech, young and small entrepreneurial ventures. Participative loans also increased their recipient’s annual growth by 10.6% for employment and by 18% for sales. However, the assessment also revealed the limitations of the scheme as it found there was no evidence of industry or regional spillovers and no impact on business survival rates. Since the scheme was created in 2005, ENISA has granted loans worth over €1 billion to over 6,000 Spanish SMEs.
Read the full case study on ENISA by clicking here and you can also search GEN Atlas for other co-investment schemes.
5. Equity Funding
Equity investment refers to the process of raising capital through the sale of shares in a company. For startups, equity investment is a crucial way to secure necessary funding without taking on debt. This funding is typically used for product development, market expansion, and operational costs, among other needs. The concept of equity investment is rooted in the principle of shared ownership and shared risk. As startups often operate in environments of high uncertainty and require significant amounts of capital to innovate and scale, they might find equity investment particularly attractive. Unlike debt financing, which obliges the startup to pay back the borrowed amount with interest, equity investment does not require repayment in the traditional sense. Instead, investors are betting on the future success of the company, hoping that the value of their equity stake will increase over time as the company grows.
While equity investment offers startups a way to raise capital without incurring debt, it comes with its own set of challenges. Founders must be prepared to give up a portion of their ownership and, potentially, some control over their company. Each round of funding dilutes the founders' share of the company, and significant equity stakes might give investors the leverage to influence company decisions. Despite these challenges, the benefits of accessing capital, expertise, and investor networks can often outweigh the drawbacks for startups looking to scale and succeed.
Case Study: The European Innovation Council (EIC)
The European Innovation Council (EIC) is a key initiative by the European Union aimed at supporting the commercialization of high-risk, high-impact technologies in the region. Established as part of the Horizon Europe framework, which is the EU's flagship research and innovation program running from 2021 to 2027, the EIC seeks to foster innovation and entrepreneurship across Europe. It does so by providing financial support, mentorship, and networking opportunities to innovators, researchers, and entrepreneurs working on ground-breaking projects that have the potential to create new markets and address global challenges.
The EIC operates with a substantial budget, part of which is allocated to the EIC Accelerator, which targets individual startups and small and medium-sized enterprises (SMEs) that are developing and scaling up innovative technologies but might find it challenging to attract financing due to the high risks involved. The EIC Accelerator offers both grant funding and equity investment, making it a unique blend of support for companies in their early stages, helping them bridge the gap between research activities and market entry.
The most recent impact report of the EIC was published in 2022 and found that the 1600 innovative companies and 500+ technology projects that have been funded through the EIC have secured €10 billion in follow on investments and developed a combined portfolio valuation of €40 billion. However, the impact assessment does not use control groups to measure the direct impact the EIC had in helping its participants achieving follow on investment and growth.
Read the full case study on the EIC by clicking here and you can also search GEN Atlas for other co-investment schemes.
6. Venture Capital
Venture capital (VC) is a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. Venture capital generally comes from well-off investors, investment banks, and any other financial institutions. Unlike traditional financing methods, venture capital is distinctive in its approach, focusing not just on providing monetary support but also delivering value through expertise, mentorship, and strategic connections within the industry.
A fundamental characteristic of venture capital is its inherent high-risk, high-reward nature. Investors are essentially placing bets on startups, which, despite their unproven markets and nascent operational models, exhibit the potential for exponential growth and, consequently, substantial returns on investment. This financial injection is typically exchanged for equity in the company, granting venture capitalists a share of ownership and a proportionate claim to future profits. Venture capital is particularly prominent in sectors known for rapid innovation and growth, such as technology, biotechnology, clean technology, and software. These industries attract venture capital due to their potential to disrupt existing markets and create new ones, promising lucrative returns on investment.
Case Study: Cooperative Venturing Program
The Cooperative Venturing Program is a privately funded support system run by VentureCapital.org (VCO), which is designed to help early-stage ventures raise capital during the period before revenue generation. The program utilizes a diverse team of mentors to help entrepreneurs secure capital and expand their networks. When a venture is accepted into the Cooperative Venturing Program, VCO assigns a team of four to eight mentors who help the founders prepare an investment pitch to present at the next VCO Deal Forum. These forums assemble a diverse panel of investors with expertise in each founders’ business sector and are held four times a year. During the program, the founders and mentor team meet virtually for an hour twice a week five or six times to prepare their investment pitch.
Although VCO has not measured the direct impact their program has had on the performance of their participants using randomized control trial evaluation, they can point to several performance indicators that point towards positive outcomes for startups that join the program. In particular, VCO participants have created more than 45,000 jobs since 1986 and raised over $20 billion. Each year, 60-80% of participants raise capital in their first year and in 2017 alone, an estimated 1,150 jobs were created. On top of this, VCO can point to a high long-term survival rate with more than 80& of participants created before 2008 still being operational in 2018.
Read the full case study on the Cooperative Venturing Program by clicking here and you can also search GEN Atlas for other venture capital programs.
7. Tax Incentives
The tax code remains one of the most powerful levers at the disposal of government policymakers. Tax incentives for startup investment are designed to encourage individuals and companies to invest in early-stage businesses, fostering innovation and economic growth. These incentives can significantly reduce the financial risk associated with investing in startups and provide a boost to both investors and the startups themselves.
One of the common forms of tax incentives is direct tax credits. These credits allow investors to deduct a percentage of their investment from their tax liability, effectively reducing the amount of tax they owe to the government. Capital gains tax relief is another significant incentive. This benefit applies when investors sell their stake in a startup at a profit. In many cases, if the investment has been held for a certain period, the capital gains tax that would normally apply to the profit can be significantly reduced or even waived entirely. This is seen to encourage long-term investment in startups. Additionally, investors can also be provided loss relief which allows investors to offset losses incurred on startup investment and rollover relief that allows investors to reinvest profits from a previous sale without incurring tax penalties.
Many countries have established specific investment schemes that offer tax advantages to individuals specifically investing in startups and small businesses. These schemes often combine several of the above incentives, providing a comprehensive package of tax benefits.
Case Study: Tax Incentives for Early-Stage Investors
In July 2016, Australia introduced new tax incentives for early-stage investors that included a 20 percent non-refundable carry-forward tax offset on amounts invested in qualifying early-stage innovation companies (ESICs) (capped at AUD 200,000, approx. $ 130,000, per investor per year) on an affiliate-inclusive basis; and a 10-year exemption on capital gains tax for investments held as shares in an ESIC for at least 12 months (provided that the shares held do not constitute more than a 30 percent interest in the ESIC). Both the company receiving investment and the investors must be eligible. A company qualifies as an ESIC if it passes the “Early-Stage Test” and either the “100 Point Test” or the “Principles-based Innovation Test”. In addition, a company may seek a ruling from the Australian Taxation Office as to whether its circumstances meet the principles-based test of an innovation company.
Research has found that in the first two years following the tax changes, roughly AUD $630 million (approx. $409 million) was invested in ESICs. Several academic and tax policy specialists have evaluated the tax changes and found that they corresponded with an increase in early-stage investment in Australia, however, it was not possible to control for other factors and demonstrate this increase was a direct result of the tax changes. Moreover, they found that the Australian system remained less attractive than that of the UK with the effective annual return on net investment after three years is lower in Australia relative to the UK (18.5% vs. 38.6%).
Read the full case study on the Tax Incentives for Early-Stage Investors policy by clicking here and you can also search GEN Atlas for other tax incentive policies.
8. Business Angels
Business angels, also known as angel investors, are affluent individuals who provide capital to start-ups or early-stage companies in exchange for ownership equity or convertible debt. Unlike venture capitalists, who are typically part of professional firms and invest pooled money, business angels invest their own personal funds. One of the distinguishing features of business angels is their approach to investing. They look beyond immediate financial return, often seeking to contribute to the success of the business through mentorship, strategic advice, and providing access to their extensive professional networks. This hands-on involvement can be invaluable for entrepreneurs, offering insights and expertise that help navigate the challenges of growing a business.
The benefits of angel investing are twofold. For entrepreneurs, it provides not only the much-needed capital but also access to a wealth of knowledge, experience, and networks that can propel their business forward. For the angels themselves, it offers the potential for high financial returns and the personal satisfaction of contributing to the success of new innovations and helping entrepreneurs achieve their visions. Public policy that seeks to increase the overall input from business angels generally focuses on incentivizing investment through tax policy, co-investment funds, promotion of networks and associations of business angels, and programs that train potential angel investors.
Case Study: INVEST Grants for Business Angels
The INVEST Grants for Business Angels program in Germany is a funding initiative designed by the Federal Ministry for Economic Affairs and Climate Protection to support start-ups by facilitating their access to private venture capital. The program aims to encourage business angels to invest in innovative startups by offering financial incentives that include an acquisition grant and an exit grant. For the acquisition grants, business angels receive 25 percent of their investment tax-free if they invest at least €10,000. Each investor can receive grants of up €400,000 in total with a cap of €200,000 per investment. Once the investor is ready to cash out on their investment, they are compensated with 25 percent flat-rate tax reduction.
The program can demonstrate that as of January 2022 it has approved over 15,000 investments that total €1.15 billion, with an average investment of €75,000 per startup. Moreover, the funding has successfully been targeted at innovative startups with 75% of all investment going towards companies from the ICT sector. An evaluation of the program found for each euro granted it had induced an additional investment in young companies of 50 percent. At the time of the report this represented a total investment of €28.7 million at a cost of €19.2 million.
Read the full case study on the INVEST Grants for Angel Investors program by clicking here and you can also search GEN Atlas for Angel Investor programs.
9. Micro Grants
Micro grants for startups are essentially small, financial awards given to early-stage companies to support their initial growth, development, or specific projects. Like regular grants they do not need to be repaid, nor do they require the startup to give up any ownership stake in return. The sole difference is in the size of the grant awarded with micro-grants sometimes being as small as a couple of hundred dollars to build a prototype or to help with marketing. Micro grants can be particularly impactful in affording individuals the opportunity to test their feet in the waters of entrepreneurship who might otherwise lack the confidence to go all in for their business concept. The sources of micro grants are varied and can include government programs, non-profit organizations, private foundations, and corporate initiatives. However, they are more typically offered at a local or regional level and can be an attractive tool for local government due to the lower cost of administering.
Case Study: The John Cracknell Youth Enterprise Bank
The John Cracknell Youth Enterprise Bank (JCYEB) is a micro grant scheme for young entrepreneurs and enterprising young people aged 13-21 living in Hull and the East Riding of Yorkshire. The JCYEB distributes a range of micro grants to young people as seen fit by the board members of the bank. The bank aims to plug a funding gap for young entrepreneurs left by traditional lenders and council support services in the face of reduced budgets and wider fiscal constraints. Grants typically range from around £300 to £1,000 and the bank typically distributes around £21,000 per year though this varies considerably depending upon the volume of applications.
The JCYEB has encountered challenges in tracking the long-term impact of their program due to the absence of formal structures and dedicated research staff. Despite this, they have carried out limited impact studies on three occasions. The initial study, conducted in the early years of the organization, revealed that 70% of the companies that received grants were still operational after a year. A subsequent analysis in 2017 indicated that over 50% of the supported companies were still in operation after a decade. Lastly, between 60-65% of the recipients of market test grants were still operational over a six-year period.
The JCYEB asserts that it has upheld one of the most advanced youth enterprise ecosystems in the UK. They highlight the disappearance of neighboring ecosystems due to funding withdrawal in 2010, while emphasizing their own sustained provision of separate funding. This has allowed them to maintain an efficient ecosystem exclusively for young individuals with a successful strategy and plan, even during challenging periods.
Read the full case study on the John Cracknell Youth Enterprise Bank by clicking here and you can also search GEN Atlas for other Micro Grant programs.
10. New forms of financing
Technological and regulatory innovations have led to a raft of new forms of alternative financing methods that many startups and SMEs are utilizing but that are not available in all jurisdictions due to existing regulations. These methods can offer a more timely and flexible approach to raising money, especially for companies operating in the very early stages of development. Policymakers seeking to ensure that entrepreneurs have a full range of financing options available to them should ensure that their regulatory systems do not restrict the most popular forms of alternative financing.
Crowdfunding
Crowdfunding has become one of the most popular forms of alternative financing with Crowdcube, a British investment crowdfunding platform, alone facilitating the raising of over £1.4 billion for more than 1,300 startups. This funding has been achieved through the platform's equity-based crowdfunding model, which allows entrepreneurs to secure funding directly from the general public in exchange for equity in their businesses. The platform operates on an "all or nothing" model, where a business receives the funding raised only if it reaches its investment target, and a commission is charged on successful funding campaigns.
In order to allow equity to be distributed through this mechanism many governments have been required to amend legislation. In Oregon, the state’s regulators helped craft an Intrastate Offering Exemption that allowed businesses from within the state to raise capital from local through the issuance of securities and without having to register their securities with federal authorities, provided they comply with certain state regulations. This allows startups and SMEs to use crowdfunding to solicit investors who provide capital in return for securities issued by the company while staying exempt from the more stringent securities registration required at the federal level.
Convertible Notes
Convertible notes are a form of short term-debt that can convert into equity in certain conditions, typically during a future fundraising round at a specified discount or valuation cap. This approach has advantages and disadvantages for both investors and startups. However, it often proves to be a faster and simpler arrangement than equity, as it defers the negotiation of valuation and intricate investor rights. Investors in convertible notes often receive the potential for equity at a discount, providing an incentive to invest in early-stage companies.
Bahrain became the first mainland jurisdiction in the Gulf Cooperation Council (GCC) to allow the use of convertible loans. This was achieved by amending the country’s Commercial Companies Law to legalize the use of convertible notes for SMEs and startups. By offering convertible notes, Bahraini startups can now raise funds more simply, cheaply, and quickly without having to establish a valuation at an early stage.
Patient Capital
Patient capital refers to a long-term investment approach that prioritizes sustainability and growth over immediate financial returns. Notable examples of patient capital include pensions, sovereign wealth funds, and university endowments. Although patient capital is generally considered a traditional investment mechanism, it has not historically been accessible for startups.
Expanding access to patient capital for more entrepreneurs can offer a number of benefits. In particular, exploring alternative funding options beyond the conventional venture capital route can alleviate the intense 'growth at all costs' mindset typically imposed on entrepreneurs. When founders obtain financing from patient capital investors who align with their ethos or long-term objectives, they can concentrate on crafting strategies for sustainable expansion. This approach allows them to divert attention away from the constant cycle of raising funds or inflating their company's worth.
In 2018, the UK Government published the Patient Capital Review, which explore the barriers that growth companies encountered when seeking long-term capital. The report found that the UK entrepreneurial ecosystem was providing significant financial support at the earliest stages of development but startups were struggling to scale due to a lack of long-term capital. As a result of the review the Government disclosed its strategy to allocate over £20 billion in development financing to cutting-edge companies over the coming decade. This strategy encompasses the creation of a fresh £2.5 billion investment fund called the British Patient Capital Fund, which will invest in tandem with private sector entities. In addition to this, in 2023, nine of Britain’s biggest pension funds committed to allocating at least 5% of their assets into British startups and VC firms by 2030.