Startup Business Financing
Finding funding for your new small business
The reality, though, is that for most entrepreneurs, you must prove your concept first before anyone will put up that kind of money. But most businesses require some sort of initial capital for things like inventory, marketing, physical facilities, incorporation expenses, etc. According to the U.S. Small Business Administration (SBA), "While poor management is cited most frequently as the reason businesses fail, inadequate or ill-timed financing is a close second." Sometimes it comes down to simple cash flow--many companies have closed their doors because they just couldn't make it another few months until the money came in.
When exploring your funding options, there are several factors to consider:
- Are your needs short-term or long-term? How quickly will you be able to pay back the loan or provide a return on their investment?
- Is the money for operating expenses or for capital expenditures that will become assets, such as equipment or real estate?
- Do you need all the money now or in smaller pieces over several months?
- Are you willing to assume all the risk if your company doesn't succeed, or do you want someone to share the risk?
The answers to these questions will help you prioritize the many funding options available.
Fundamentally, there are two types of business financing:
- Debt financing - You borrow the money and agree to pay it back in a particular time frame at a set interest rate. You owe the money whether your venture succeeds or not. Bank loans are what most people typically think of as debt financing, but we will explore many other options below.
- Equity financing - You sell partial ownership of your company in exchange for cash. The investors assume all (or most) of the risk--if the company fails, they lose their money. But if it succeeds, they typically make a much greater return on their investment than interest rates. In other words, equity financing is far more expensive if your company is successful, but far less expensive if it isn't.
Because investors take on a much higher risk than lenders, they are typically far more involved in your company. This can be a mixed blessing. They will likely offer advice and connections to help grow your business. But if their plan is to exit your company in 2-3 years with a substantial return on their investment, and your motivation is the long-term sustainable growth of the company, you may find yourself at odds with them as the company grows. Be careful not to give up too much control of your company.
Let's take a closer look at the many options available for startups.
Friends and family are still your best source for both loans and equity deals. They are typically less stringent regarding your credit and their expected return on investment. One caveat: structure the deal with the same legal rigor you would with anyone else or it may create problems down the road when you look for additional financing. Prepare a business plan and formal documents--you'll both feel better, and it's good practice for later.
Credit cards are a great tool for cash flow management, assuming you use them just for that and not for long-term financing. Keep one or two cards with no balance on it and pay it off every month to give yourself a 30 to 60-day float with no interest. And the low introductory rates on some cards make them some of the cheapest money around. Managed well, they're extremely effective; managed poorly, they're extremely expensive.
Bank loans come in all shapes and sizes, from microloans of a few hundred dollars, typically offered by local community banks, to six-figure loans by major national banks. These are much easier to obtain when backed by assets (home equity or an IRA) or third-party guarantors (e.g., government-sponsored SBA loans or a cosigner). If you obtain a line of credit rather than a fixed-amount loan, you don't start paying interest until you actually spend the money.
Leasing is the way to go if you need big-ticket items such as equipment, vehicles, or even computers. Your supplier will help you explore this.
Private lending represents a viable alternative when the bank says "no". Private lenders are looking for the same information and will conduct similar due diligence as the banks, but they typically specialize in an industry and are more willing to take on higher-risk loans if they see the potential.
Crowdfunding is an alternative and increasingly popular way for startups to raise funds. There are three types of crowdfunding: reward, debt, and equity. Make sure you know which type of crowdfunding is most suitable for your business, and how much you are willing to pay the crowdfunding platforms for their transaction fees.
There are many channels available to you to raise capital. All of the above approaches have numerous variations. Put together a solid business plan, talk to a financial adviser, and just start asking. Someone will eventually say "Yes".