Lets take a look at the pros and cons of taking on finance to fund your startup.
As a small business advisor, I am often asked:
“What is the best way to finance a new business venture?”
This question is usually followed by
“So, do you ever invest in new business ventures?”
The answers, respectively, are:
- there is no “best” way to fund a new business; and
- I do invest in new business ventures, but gee-willikers, I can’t today because I left my cheque book in my other suit.
The truth is there are a variety of ways to finance a new business.
Which way is best for you depends on many factors; Your product, your market, your financial requirements, and your burn rate.
But most importantly, how you finance your business depends your personal and financial situation.
So with that in mind, here are a few of the most common ways to finance a new business without hitting ol’ Peter up for a loan.
Keep in mind that all methods have pros and cons and some (or most) may not work for your specific situation.
No matter what financing method you choose, you should investigate the ups and downs of each.
Don’t jump in with both feet until you’re sure you’ll land on solid ground.
Savings and Investments
The first source you should consider tapping is your own savings and investments.
I’m a huge fan of self-financing when it comes to business.
When you finance your venture with your own money, it means you are not responsible to others should the business fail.
The bad thing is that it if things do go under, it will be your money that goes down with the ship.
If you’re not willing to risk your own capital you certainly shouldn’t be willing to risk anyone else’s.
Friends and Family
After tapping their own savings and investments, many entrepreneurs turn to friends and family for help.
This works well for some, but I live by the following rule:
NEVER borrow money from anyone you have to eat Thanksgiving or Christmas dinner with.
Nothing causes tension in a family like lending money that is never paid back.
And notice I say “lending money” rather than investing money.
Venture capitalists invest money. Your relatives lend you money.
They will expect it back someday even if they say they won’t.
Remember, when a loved one invests in your business they are emotionally investing in you.
It would be tough to tell your parents that their favorite son or daughter lost their life savings because your business went down the tubes.
Another important thing; explain clearly to your family your plan for the business.
Tell them how long you expect to borrow the money.
Give them a clear idea of when you expect to pay them back.
Then keep them updated with regular progress reports.
I financed one of my first businesses on my credit card.
It was an incredibly stupid thing to do.
My business could have failed and left me with a credit card debt that would have taken until the year 2099 to pay off.
Fortunately for me, the business worked and I was able to pay back the debt fairly quickly.
I managed to make enough quick profit to avoid the crippling interest.
But it could have been very different.
If you do decide to finance your business on plastic, keep in mind that you will be paying extremely high interest on the money you’ve borrowed.
Unless you hit it really big, really quickly you will be paying for that money for many years to come.
Bet The Farm
If you are a new business owner with no other income, bank loans are next to impossible to get.
Banks like to see collateral and a track record of business success.
This is why many entrepreneurs use the equity in their homes to finance their business after, they’re refused a bank loan.
While a mortgage makes more sense than financing your business on a stack of credit cards, the financial risks are still there.
You will have to pay back this money whether your business succeeds or not.
However, converting equity to cash is a good source of low interest money to get you started.
One silver lining to the cloud of warnings; the interest payable on a mortgage may be tax deductible (check with your accountant to make sure).
An Angel investor is typically a wealthy individual who invests in start up ventures in return for an ownership share of the company.
Angel investors are usually the first formal investors in a business and provide the seed money to get the business up and running.
Some Angel investors will hand over the money and leave you alone to run your business.
Other Angels consider their investment a license to “help you” manage and make decisions.
If you do accept Angel money make sure the terms are clearly defined on both sides.
Angel money always comes with strings.
Make sure you know whether those strings come in the form of a bow or a noose before you accept an Angel’s funding.
Venture Capitalists (VCs)
VCs are to angel investors as Wolves are to Golden Retrievers.
That’s not to say all VC are big, bad dogs. (Or all Angels are soft and fluffy for that matter).
But VCs do have powerful jaws that can chew up your business and spit it out if things don’t go their way.
VC money doesn’t come with strings.
VC money comes with chains and locks and lots of legal documents.
VCs always have the upper hand in any deal they invest in.
That’s just how VC funding works.
That’s the price you pay to get access to VC money.
If your business gets to the level that VC money becomes a viable option, don’t jump at the first bone a VC dangles before your eyes.
If one VC likes your idea, others will, too.
Present your business to multiple VCs.
Then carefully consider the merits of each offer before you accept any.
Just remember, no matter how you finance your business, use the money wisely.
Don’t rush out and buy top-of-the-range laptops and Hermann Miller chairs.
Have a very clear plan of how the money will be used and how it will be paid back.
Keep your lenders informed of your progress at regular intervals.
Regardless of which type of funding you choose, remember this.
The lower your borrowing, the more you can shoestring the business, the more of the business you will own.
And when it comes time to sell or liquidate, the richer you will be in the end.
Do you have any financing success or horror stories? Tell me about them in the comments below.