One of the most challenging decisions you have to make for your business—and one you’ll have to make again and again—is how to fund it while it grows. Every business has expenses for equipment, inventory, staff, product development, technology, and real estate, yet few can completely finance their own needs.
The good news is there are many options—either debt financing (loans for you to pay your expenses), equity (selling a piece of your business in exchange for funds), or some combination of the two. The not-so-good news is the terrain can be complex and risky. Here we’ll cover the range of options and discuss the pros and cons of each.
Generally, the safest way to fund your business is to set money aside for that purpose, then pull from savings. For existing businesses, keep a tight rein on spending so that you can save up for the larger funds you will later need to spend outright or use as collateral for a loan.
When managed well, using credit cards can be an immediate source of funding, help build up your credit score, and extend your cash flow. However, if you are unable to pay in full each month, the interest you pay will quickly add up, making this an extremely expensive way to fund your business. Use this method judiciously.
Be sure to shop for the right card for you. Look for the lowest rates and little to no annual account fees. If you expect to pay your bill in full each month, the rate will be less important to you, whereas reward programs and protections may be very useful. You can earn flight miles, cash back, gift cards, and more.
Your Personal Network
Giving those you know an opportunity to invest in your company can be a great way to fund your business. You might offer family or friends an equity stake or set up their investment as a business loan. Either way, be selective and thoughtful about who you ask and explicitly define terms. If the business goes under or you can’t pay back the loan on time, your relationship with that person may be damaged permanently. Also, know that any investor you bring in will likely become very involved in your business, something you may or may not want. No matter which avenue you go, discuss expectations including the upside and downside, and above all, get it in writing. Hire an attorney to draft the terms and be sure all parties sign it before proceeding.
Business term loans (specific $ amount of funding with set periods of repayment and interest) and lines of credit (funds available to use as you need it up to a set amount) are great financing tools that banks and credit unions make available to established businesses. Lines of credit are particularly helpful sources during times when cash flow is soft, due to seasonality or slow-paying clients.
Because you must have considerable assets and healthy cash flow to qualify, banks are not a great source for unstable businesses or start-ups, unless connected with a proven commodity. They are looking to fund solid and growing businesses. The application process can be cumbersome, requiring a detailed business plan, financial and cash flow statements, and other documentation.
While the SBA (Small Business Association) doesn’t directly issue loans, they can help you get business loans. The SBA agrees to act as a partial loan guarantor so that their financial partners (banks, credit unions) will give you a loan with really good terms, one you wouldn’t likely be able to get from those sources on your own. Unfortunately, 90% of SBA loan applications are considered to be too risky and are rejected.
Do your homework to see what type SBA fits your company and need. There are general purpose loans and larger loans for equipment and real estate. There are also loans for special situations fitting certain applicants, such as veterans and members of the military applying for a business loan or a need benefitting a rural community. Once you know where you fit, then talk to the SBA.
Crowdfunding sites are online platforms providing businesses a viable and low-risk way to raise funds from a potentially large group of people—with the operative word being potentially.
For businesses planning to launch a new product with the potential for strong public appeal, reward-based crowdfunding sites like Kickstarter have successfully raised thousands or even millions of dollars in exchange for giving investors pre-sale versions of the product, discounts, or perks. Products that are creative, unique, and are novel and intriguing tend toward greater success with this form of financing. Tech gadgets and creative projects rule here—matter of fact, these are the only pitches that Kickstarter allows. Kickstarter is an all or nothing game. While it’s great when it works, the majority of campaigns do not hit their goals, meaning $0 in funding.
Then, there’s equity crowdfunding. Partially due to the fact that there are only half as many publicly traded companies to invest in than there were a few decades ago, equity crowdfunding sites have become viable investing and financing options (depending on the side of the fence you’re on). These private equity sites are for businesses willing to offer small stakes in their business to a large number of investors for as little as $500. If your venture is not successful, you owe investors nothing. If it is, the investors reap a share of the profits. You control how much you want to raise (it’s not all or nothing as in some reward-based platforms), what you want to sell, for how much, and all terms. Because the investor’s goal is to make a profit, each one becomes a brand evangelist for your business, inching you closer to success.
The downside of equity crowdfunding, especially at larger funding levels, is the number of hoops you must jump through. It is a highly regulated industry. The SEC regulates the maximum you can raise, currently at $1.07 million without an audit. Companies interested in raising up to $50 million are considered mini-IPOs. Here a securities attorney, a two-year audit, and much more complex preparation is required.
When considering crowdfunding platforms, compare the fees and policies, how your proposal will get noticed, and the amount of time it will take you to apply and develop presentation materials to be on their site.
Though family and friends are technically a type of angel investor, true angel investors are affluent individuals—or groups of the same—who actively seek businesses to invest in, usually in a startup or expansion phase. They are private funders generally with $100,000, $500,000 or more to invest that are looking to become 20-50% owners of select businesses in exchange for their investment. You can often locate these individuals through local business associations, chambers of commerce, or social networks such as LinkedIn. However, you find them, you’ll need a strong pitch deck and business plan.
Venture Capitalists (VC)
These are companies similar to angel investors except that they are professionally managed firms using pooled investment funds instead of one individual using their own. VC firms offer more money than most angel investors in exchange for controlling interest in the business. VC firms are usually interested in highly profitable industry sectors such as IT and pharmaceuticals with an eye toward taking the company public to reap big returns. As with angel investors, you’ll need a strong pitch deck and business plan.
How to Proceed
No matter which sources you decide to use to finance your business, here’s a few tips:
Plan ahead and build a strong and thorough case, and you’ll find the financing source that best suits your needs.