A quick search will turn up all kinds of startup or small business financing options, each with its own advantages and disadvantages. Whether you’re more comfortable with borrowing from your family or from a bank, this list should help you figure out what will work best for you depending on your specific business needs.
They say if you want something done well, you should do it yourself.
That could be why self-financing is the number-one method used for most business startups. Funding your own business shows future potential investors that you’re committed long-term and that you’re ready to take risks; what better way to show them you’re confident in your business plan than by investing your own money in it? Besides, they’ll want to know how much of your own money you’ve put into your venture before they give you any of theirs.
Whether you’re investing in the form of cash or collateral on your assets, this is an option that should be properly considered. Start by doing an inventory of your assets and resources (there may be more than you think!). Assets may include vehicles, retirement savings, equity in real estate, collections, and of course savings accounts or personal lines of credit.
The most valuable aspect of financing your own startup is that you don’t have to give up equity or control—your idea remains yours, and so does your new business.
Another avenue to explore is bootstrapping. Bootstrapping happens when a business uses its own resources and short-term debt (instead of long-term) to fund growth. This could include methods as simple as leasing equipment or space instead of purchasing it, getting employees to work for equity instead of cash, or asking for extended payment terms from willing suppliers. This is the time to put those negotiation skills to good use.
Funding raised through your personal network is often referred to as love money. This could mean your business startup funds are coming from a spouse, friend, sibling, or even someone from your church group. Banks and investors consider this “patient capital,” as the intention is to pay it back as your business profits increase.
The decision to lend money and the terms of the agreement are usually based on qualitative factors and the relationship between the two parties, rather than on a formulaic risk analysis. This is an important option for people who may not meet the requirements financial institutions or more formal investors demand from borrowers: banks want collateral and venture capitalists want big returns and a role in business decisions.
Remember, love money is still a business loan, and should be treated as such. Be prepared, be respectful, and be as professional as you would in any other business scenario. Make sure all parties are comfortable with the terms and that the lender especially is comfortable with flexible repayment terms. And get everything in writing!
For some people, approaching family and friends that they’ve built a close and trusting relationship with is easier than trying to get a foot in the door with a bank or venture capital investor. But if you’re considering love money, be mindful of the complications that may also arise when borrowing from people who are part of your personal life. There’s nothing worse than ruining a holiday arguing about money you owe your uncle.
Angel investors are experienced business people with a lot of money and time on their hands that choose to invest both into new businesses, in exchange for equity. They are often looking to invest during the commercialization stage—not concept—and their involvement in your business can later carry a lot of weight in the eyes of potential future investors.
The success rate for companies seeking angel investments is only around five percent. What does this mean for you? It means you’ve got to be as prepared as you possibly can before you even think of approaching an angel. Their time is valuable and your first chance at them will likely be your only.
Angels are looking to multiply their investments five to ten times in order to offset the high risks of startup financing, so they’re looking for companies that aren’t just presenting them with great ideas, but with great teams and proven track records. Often leaders in their own fields, they know their stuff, so prepare for due diligence. Angels don’t only provide funding; they also share their experience, knowledge and network of contacts, which can be even more valuable.
Venture capital is private equity financing provided by firms or wealthy investors to startup companies and small businesses that have high growth potential (or have demonstrated high growth early on based on number of employees, annual revenue or both). They differ from angels mainly in their investment numbers; usually starting in the area of $1 million. Their higher investments comes with more demands, including promises of higher return and more equity and say in your business decisions.
Like angels, venture capitalists make their entrance during the stage when your company begins to commercialize its innovation. (Approximately 80% of venture capital goes into the infrastructure required to grow a business.)
Venture capitalists want to come in early, help you reach your potential in a short period of time, and then leave once your business has reached a sufficient size and credibility. This sort of funding is not for everyone—most of this financing is provided to technology-driven business in areas like information technology, communications and biotechnology.
Venture capital is essential for startups that can’t acquire cash from banks and capital markets because of the rules and structures in place to protect them from the high risks involved.
Government grants and subsidies
Government grants and subsidies are a great way to fund a new business, as most of the time repayment isn’t necessary (when conditions are met, of course). Sounds like easy money, right? Unfortunately, that’s not often the case. Between the hefty competition and strict criteria usually associated with this kind of funding, grants and subsidies aren’t that easy to secure.
A lot of time and effort goes into applying for this type of investment, including things like:
- A detailed project description
- An explanation of the benefits of your project
- A detailed work plan with full costs
- Details of relevant experience and background on key managers
- Completed application forms when required
Resources for more information
- Grants.gov: Use this comprehensive site to learn more about available eligibility and application processes for various grants administered by different government agencies.
- USA.gov: This government site provides resources for starting small businesses and links you to GovLoans, which provides information on all sorts of federal loans available for businesses.
- Small Business Innovation Research (SBIR): This competitive awards-based program enables small businesses to engage in federal research/research and development and awards grants to stimulate high-tech innovations.
While a bank loan may seem like the most common source of financing, it can prove rather difficult for a new entrepreneur to qualify for one. Banks prefer to loan their money when it’s not high risk, mainly to people with proven track records and businesses with a history of profit and stability.
Even if you do qualify, sometimes the conditions are far more demanding than what you’d feel comfortable agreeing to. So where does that leave you and your startup dreams? It may be hard, but it’s not impossible.
Before you apply for your own small business bank loan, make sure to shop around. All banks offer different plans, terms, advantages (and disadvantages), and services. Make sure you know what you need and then look for the right bank to fulfill those needs.
Beyond good credit and a great idea, you should be prepared to present a solid business plan. Acquiring that loan could be the difference between getting your business off the ground and spending another year looking for funding, so go hard, and good luck!
The information and tips shared on this blog are meant to be used as learning and personal development tools as you launch, run and grow your business. While a good place to start, these articles should not take the place of personalized advice from professionals. As our lawyers would say: “All content on Wave’s blog is intended for informational purposes only. It should not be considered legal or financial advice.” Additionally, Wave is the legal copyright holder of all materials on the blog, and others cannot re-use or publish it without our written consent.