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7 ways to fund your startup
If you’re an independent consultant working from home, your startup costs are likely to be minimal. However, “If you’re going to produce a product or have employees or an office, you’re probably going to need some money,” asserts David N. Feldman, author of The Entrepreneur’s Growth Startup Handbook: 7 Secrets to Venture Funding and Successful Growth. “It’s a very important aspect of starting a business. Undercapitalization is probably the main reason businesses fail.”
Here are seven possible funding sources for entrepreneurs seeking startup cash.
Feldman refers to this as the bootstrap method. “You pretty much do it yourself by using your own funds,” he explains.
When it makes sense: Early in the process of starting your own business, it might be difficult to find others willing to invest in your idea, no matter how much you believe in it. “In many cases, you may need to get the ball rolling on your own,” says Nathan Beckord, startup consultant and co-founder and CEO at startup management software company Foundersuite.
Pros: Because you’re not giving away equity in exchange for funding, you retain full control of your business. You also don’t have a loan and interest to pay back.
Cons: You could lose your savings, home or whatever else you put on the line to fund your idea. “Most startups do fail, and that’s a big risk,” says Beckord.
This funding method involves asking members of your family and social circle to invest in your business.
When it makes sense: “When you’re starting a business, it is often hard to impress professional investors,” says Feldman. “It will be easier to convince people who already know you to [give it] a shot.”
Pros: According to Feldman, you can generally value your company a little higher with people who like you versus with people who are professional investors. “In addition, you are less likely to worry about them suing you down the road if things go badly [because] they care about you.”
Cons: Professional investors are more likely to offer you additional rounds of funding in the future, and they don’t take it personally if the business fails—unlike friends and family who might end up pretty unhappy if you don’t succeed.
Entrepreneurs can raise capital through debt financing, which, simply put, means borrowing money, usually from a bank, in the form of a loan. The business owner is then obligated to service this debt, paying back the loan—plus interest—on a predetermined schedule.
When it makes sense: Beckord advises entrepreneurs to consider a business loan if they plan to carry an inventory or need to pay for things before they themselves get paid. The loan can help bridge this gap in cash flow.
Pros: “The advantage of debt is that you’re not giving up control of your business,” says Beckord. “You’re maintaining ownership, and that’s a big deal.”
Cons: The downside, however, comes when you can’t pay your loan back. “If your business isn’t the type that is going to be generating cash flow for a while, a [loan] might not be the right [funding] instrument for you.”
The U.S. Small Business Administration (SBA) offers guaranteed loans to eligible entrepreneurs through a network of local lending partners. This source of funding may be an option when private financing sources turn you down.
When it makes sense: If you don’t have connections with investors, it might be hard to get a meeting with one so you can pitch your idea. But “When you go to the SBA, they look at everyone who comes in,” says Feldman.
Pros: “SBA loans tend to have pretty favorable terms,” he adds. “They want to help small businesses.”
Cons: “The negative of SBA loans is they [might] require not only you but also your spouse to sign a personal guarantee,” explains Feldman. For some startups, the risk of losing personal assets if the business defaults on the loan is a strong deterrent.
Equity investors invest capital in a business in exchange for shares of ownership in the company. Angel investors typically provide funding to startups early in the game, and venture capitalists most often provide larger-scale funding to more established businesses.
When it makes sense: “If you have a high-growth business and you need a lot of outside capital, it really makes sense to raise money by selling equity,” says Beckord.
Pros: Angel investors are a lifeline for some startups struggling to take off. “The great part about them is that they’re there and willing to come in with money at the early stage,” says Feldman. “Venture capital money is good because venture capitalists are professional investors, which means they know how to help companies grow.” They also might pony up additional rounds of financing, sometimes making them important long-term partners.
Cons: This startup savvy comes at a cost, though. In addition to having ownership in a company, both angel investors and venture capitalists may have significant power to veto major business decisions and sit on the board of directors. This adds up to a loss of control for the entrepreneur.
Relatively new on the scene of startup funding, crowdfunding is when individuals make what essentially amounts to a donation to support a project in exchange for some kind of perk, often a sample of the final product. Entrepreneurs seeking funding create a project, which they post to any number of crowdfunding websites, such as the popular Kickstarter and Indiegogo. The entrepreneurs promote their projects to garner support in the form of financial pledges. If they meet their funding goal, the project moves ahead and the entrepreneur owes the agreed-upon perk to those who pledged.
When it makes sense: Crowdfunding works well for defined projects with limited scopes.
Pros: “The upside to crowdfunding is you’re not giving up equity in a company,” says Beckord. “It’s not even debt—you don’t have to pay it back.”
Cons: The downside, however, comes when there is a hiccup in your plan. “The only risk is when people aren’t able to deliver [their perk],” Beckord notes. Then, they must refund the pledges they can’t honor with the agreed-upon perk. The fallout may lead to financial and legal woes—and perhaps even worse, a damaged reputation.
Today, enterprising entrepreneurs can raise funds in small increments for projects in exchange for a perk via crowdfunding. In the not-too-distant future, they’ll likely be able do the same thing in exchange for shares of equity. In fact, this particular brand of financing is already legal in Italy. In the United States, the Securities and Exchange Commission is in the process of finalizing rules that would allow companies to sell shares over crowdfunding websites, a move that would open up a new world of opportunity for capital-hungry businesses.