To grow, a startup must obtain funding from various sources, including banks and venture capital. Everything certainly has its differences and its own positive and negative sides.
Generally, startups obtain funding from banks and venture capital. The funding is used for various purposes, depending on the startup’s development stage. Some use it to hire more employees or Human Resources (HR), increase the burn rate for promotions or marketing strategies, expand the company domestically and internationally, and develop or innovate products and services.
So, what are the differences between funding from banks and venture capital? Come and read the full explanation below!
Also read: What is Venture Capital? Definition, Benefits, How It Works
Position Difference
The Differences Between Funding from Banks and Venture Capital
The first difference is the position in the relationship between the party that funds and is funded. For bank funding, the bank is the debtor, while the company is the creditor. Banks provide loans to startups, so companies are automatically the fund borrowers in this funding relationship.
On the other hand, the position of the borrower and the lender in venture capital is relatively more equal. Venture capital is the fund provider, and the fund recipient is a startup company. In this case, venture capital is an investment company that funds startups, while startup companies that receive funds are referred to as business partner companies (PPU). As a result, the two have a coworker relationship.
Also read: 5 Main Role of Venture Capital on Startup Business
Different Types of Funding
The next difference between financing from banks and venture capital is the type of funding. When companies receive capital from banks, the funds obtained are in the form of loans. Like loan funds in general, in addition to the loan principal, loan interest must be paid back. The loan interest rate depends on government regulations. Usually, the loan interest rate does not harm the company receiving the funds, whether high or low. However, funding from banks is far more limited than venture capital because it is public money, so there are limits to where the money can be invested.
In venture capital, the funds given to startup companies are in the form of equity participation. This capital is included in the business capital. Unlike a bank, in this case, the fund is not a loan but similar to a grant with a certain agreement.
Also read: Types of Venture Capital You Need to Know
There are several types of funding from venture capital firms, namely:
- Direct equity financing: This method involves taking several shares from the concerned PPU. This method is also known as equity financing or direct financing. The funding is in the form of equity participation, so the PPU already has to be in the form of a limited liability company.
- Semi-equity financing: This method is done by purchasing convertible bonds issued by the PPU. Venture capital firms and PPUs prefer this method because it is more flexible.
- Profit sharing: In addition to the two methods above, there is also a way of funding businesses through profit sharing. This method emphasizes the profit-sharing aspect of the profits obtained by startup companies. The method of profit-sharing funding is a change made to accommodate financing constraints for business entities that are not yet legal entities. If the business runs smoothly, the investor will get reciprocity in the form of profits, called capital gain.
Also read: 12 Best Venture Capital in Southeast Asia
Risk Difference
In addition to differences in positions and financing types, there are also differences in risk. The risk here is borne more by the donor. The bank bears the risk if the company that borrowed the funds is unsuccessful or is not disciplined in repaying the loan, such as bad credit. Whereas in venture capital, the biggest risk is that the money will not be paid back because the company is going bankrupt. Both certainly damage the funders, both banks and venture capital firms. Moreover, both cannot be controlled by the donor. It all depends on the startup’s ability to profit from its business.
Venture capital firms are at higher risk because they usually target startups that do not have access to banks yet. This is because venture capital is an institution that collects funds from numerous investors. They are willing to fund a business despite its high-risk profile. Consequently, they also expect great reciprocity. For this reason, venture capital is also usually more selective in funding startups. The most frequently seen aspects are mainly business ideas to reachable target markets.
Also read: The Top Venture Capital Firms in the World
Time period
Lastly, the difference between bank funding and venture capital is the period. The refund period depends on the initial agreement for capital loans from banks. There are short, medium, and long-term loans. Whereas at venture capital firms, the options are more limited, namely over a period of five to ten years.
If a company borrows capital from a bank, the contract settlement can be done in two ways: First, by refunding. Second, by canceling the loan contract. At venture capital firms, on the other hand, the loan contract will be automatically terminated when the venture capital firm divests.
Also read: 6 Characteristics of Venture Capital You Need to Know
That is the difference between funding from banks and venture capital. In general, it can be concluded that funding from banks is more rigid and limited, while venture capital funding has a larger potential in terms of amount. However, keep in mind that both also have their risks. For that reason, before deciding on where to look for funding sources, first understand the advantages and disadvantages, okay!
