How can you finance your small business?
One of the most formidable aspects of starting or growing a business is identifying and securing the appropriate amount and type of funding to achieve your goals. With so many ways to raise money out there, the process can seem really opaque and complicated.
So, let's make things a little clearer by discussing the primary ways new and growing businesses can raise the capital they need to make it to the next level.
The most fundamental way a business can get started is by the owners raising the money themselves. Even with loans, most banks require at least a 10%-20% down payment from the owners ("skin in the game") in order to secure the loan. Now there are a variety of ways that down payment can be secured, but the concept is still the same: a business owner should have a financial stake in the long-term success of their business. The primary benefit of self-funding is that you retain complete control of your company, and have no debt. The downside is that you've also taken on all the risk, so if the business fails, there is no back stop.
Friends and Family
The next way entrepreneurs get their businesses started is by raising money from those most likely to say yes: friends and family. While it's not always the best idea to mix family or friendship with business, those closest to you can provide a good source of funding without the pressure of traditional investors or bank loans. Including friends and family means you distribute the risk among more people, can often get more favorable terms than through traditional investors, and friends and family with a stake in the business are usually going to be huge cheerleaders. The key is to make sure that everyone understands their role and the particulars of the deal before any money exchanges hands. Just because they're family doesn't mean there shouldn't be a contract. It may seem overly formal, but it can save a lot of headaches later on!
The most common form of financing is lending. This could come from traditional banks or digital-only lenders like Kabbage, as a fixed loan or a line of credit, but the common thing is that lending includes the exchange of capital for a set period of time at a pre-determined interest rate. Debt is usually the most straight-forward, and cheapest, way to secure funding for your small business but it does come with repayment terms that need to be included in projections.
Since the advent of the hugely popular TV show, Shark Tank, America's understanding of the angel investment process has definitely increased. While the show takes some creative liberties, the basics are correct. Essentially, Angel Investors are wealthy individuals who make relatively small, early stage investments in companies with the intent of selling their shares in the company within 3-7 years. The investment timeline and exit strategy are specific to each Angel and each investment, but in general they're looking to invest $25K-$500K in a company, with the hope of realizing a 3-10x return on their money in 3-7 years. Angels have several important benefits: they often come with expertise that can help your company grow; they usually know other wealthy investors; and they are often open to more flexible funding terms than you'll get from a bank.
While the terms angel and venture capital are often used interchangeably, venture capital usually refers to funds that invest in growing private companies. Because venture capital funds often have strict prospectus to which they must adhere, knowing the investment strategy of a particular fund is key to receiving funding. Venture capital funds are usually looking for investments north of $1MM and are looking to make large returns on their money, so only true growth companies tend to be eligible for venture funding.
The El Dorado of financing is the Initial Public Offering (IPO) whereby a private company offers shares of the company to the public, usually through an investment bank or other intermediary. If you're reading this, you almost certainly aren't in the position to go public just yet.
While the options for financing a new or growing company are limited largely to those listed above, the combination of funding and the specifics are different for every company. If you'd like to know more about your small business' funding options, reach out to us for a free business evaluation.