10 Ways to Fund Your Small Business Equity? Debt? Which one is right for you? (Hint: think carefully before taking loans from friends and family).
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During the life of most any business, the owner will need to seek out cash to help with its growth or to keep it going through a rough patch. So, planning how to fund a business is hardly a trivial or brief topic. Indeed, a thorough discussion would take much more space than we have here.
However, we can provide an overview we hope will help start you thinking about your business' options.
First, there are two ways to externally fund a business: debt and equity. When debt is used, the investor receives a note for his or her cash. The note spells out the terms of repayment, including timing and interest. The benefit of using debt is that you retain ownership of your company. The downside is that you have an obligation to repay. If you fail to meet your commitment, the lender, under certain circumstances, can force the company into liquidation.
Then there's equity. An owner who uses equity to fund a business turns over an ownership stake to an investor in return for the latter's cash. The benefit is that there is no obligation to repay the investor. The downside is the owner has to give up a part of the ownership of his or her business. This can entail losing some control over the company.
There are many different sources of equity and debt funding. We'll briefly consider several examples.
Bootstrapping -- The business funds itself. As the business grows, it throws off cash that enables further growth. We know a company that distributes and installs VoIP (voice communications) technology systems. The owner had approached us for an angel investment. After we looked at his books, sales funnel and business model, we turned him down. Instead, we suggested that the owner bootstrap his business. We reasoned that the sales in the pipeline would be sufficient for the growth he planned. He didn't need outside cash, and we suggested he not sell part of his company.
Self-funding -- Many entrepreneurs fund their businesses themselves. They use savings or personal debt (such as a second mortgage or credit cards). Alternatively, they sell assets to generate cash (e.g., a second home or a boat) for the business.
Friends and family -- Obviously, friends and family can provide either equity or debt funding. While this may initially seem like a good source, be careful about selling part of your business to this group. Unfortunately, businesses fail. The loss of capital can then cause hurt feelings, ruin friendships and make for unpleasant family gatherings. Be sure that your investors know the true risks.
Angel investors -- These people are typically affluent individuals willing to invest in businesses. Increasingly, angel investors are forming investment groups to spread risk, and to pool research. We belong to a couple of these groups. Search online for local angels or talk to your chamber of commerce. Your local chamber may know who is interested in funding new ventures and ideas in your area.
Cloud funding – There are a number of groups that will allow you to pitch your ideas to investors via the internet. Typically, when this type of funding is successful, multiple investors will contribute funds to the idea. Be aware that there are restrictions on how cloud funders can operate.
Partners -- Taking on a partner can be a source of funding. The partner may or may not become an employee of the business. Strategic partners can benefit the business by aligning resources. For example, a property management company might make a strategic investment in a property maintenance company because it could eventually feed work to the maintenance group.
Venture capital -- These firms provide early-stage funding, but are typically looking to make relatively large investments and take a significant share of the company -- often a controlling interest.
Crowdfunding – These are primarily web-based projects and allow individuals with a business, idea or project to reach out to thousands of potential investors through various platforms. Investments can be debt, equity or rewards-based. There are hundreds of crowdfunding platforms, so you will need to do your homework before launching into this arena.
Small business lenders -- Many organizations are interested in lending to small businesses. Try Googling "small business loans" to see the plethora of results. Most lenders will want the loan to be secured by assets of some type, and rates may be high. An owner spoke to us about a short-term loan he was considering. He said the rate was 3 percent. However, the term was 30 days. We had to explain to him that the annual interest rate for the loan was actually 36 percent, because the calculation was actually: 3 percent/per month X 12 months/per year = 36 percent/per year. This was quite different from the 3 percent he had assumed.
SBA loans – The Small Business Administration has many programs, but in general, these loans require a guarantee that the loan will be repaid, to enable businesses to get loans from traditional lenders.
Banks – Traditional banks make small business loans. However, they typically require a track record and will often want the loans secured with assets.
There are more options for funding small businesses than we can cover here. However, with a good business plan and much persistence, funding can be secured.