On the other hand, venture capital provides only 7 percent of funding for private companies, according to OffRoad Capital Corp. in San Francisco, an online financial services company. This means that the number-one source of money for start-ups is family and friends. But that's just the tip of the iceberg when it comes to financing options. You also have these alternatives:
Angels are individuals who seek out new businesses to mentor and invest in (usually $25,000 to $500,000) in return for equity ownership. Not as demanding as VC firms, angels nevertheless expect high returns (25 percent). They generally favor businesses with which they are familiar and that are located nearby. They're best found through friends and angel networks.
Banks offer the least expensive route (about 2 percent above prime), but they take the least risk. Consequently, bank loans are difficult to come by for start-ups that lack assets and/or profitable histories.
Commercial finance companies take on higher-risk loans than banks; therefore, they're good if your company is high-growth and will continually need its loan ceiling raised, if your credit history is spotty, or if your company has a high debt-to-worth ratio with a strong cash flow. Interest rates and fees are about 2 to 10 percent higher than banks.
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Credit cards are used by nearly one-third of start-ups. If you carry a balance, using credit cards is an expensive alternative (12 to 21 percent in annual interest), but they're easy to get and use, and they ease the bookkeeping burden.
Factoring is a practice whereby you sell your receivables for a discount before they are due. Widely used in most industries, factoring is relatively expensive (10 to 20 percent), inasmuch as you are paying for the cost of the capital, the extra risk and the paperwork.
Lease financing works well if you need funds for business equipment. Finance companies, banks and many vendors will arrange lease financing.
A line of credit is a revolving bank account that allows you to draw funds against a given total established by your bank. These accounts are usually secured with accounts receivable and/or inventory as collateral.
Personal assets include savings, stocks, bonds, pension plans, life insurance policies and real estate. Many entrepreneurs who own homes secure equity loans and use the proceeds to start a business--in which case, technically, you are financing your business, not the bank. Keep in mind that you could forfeit your house if you default on the loan.
The SBA guarantees loans to small businesses made through authorized lenders. There is no set maximum or minimum, but funds typically range from $25,000 to $1 million. The money may not be used to pay off creditors, cash out investors or invest in real estate, among other restrictions.
|Find out more about the SBA and check out the article, SBA Loans From A To Z.|
Venture capital firms invest in high-risk businesses with the potential for rapid growth and high returns in a short time. Typically, they expect to exit in three to seven years with annual returns of 25 to 40 percent or more.