Once you’ve got a handle on how much it will cost to get your small business up and running, it’s time to figure out where that startup money is coming from. From investments to loans, there are myriad options for financing a new business. Let’s take a look at the most common of them, including some pros and cons to consider for each form of financing.
The simplest way to finance your business is to pay for everything yourself. (Notice we said this is the simplest way, and not the “easiest” or even “most realistic.”)
Depending on the type of business you’re starting, and how much capital you have access to, you may be able to self-fund. If you can do it, self-funding gives you full ownership and control over the business without exposing you to any financial risk beyond losing your startup money. You’ll also avoid the pressures associated with accepting outside investment; self-funding means your business can grow organically, at whatever pace makes sense for you, your goals, and your finances. Keep in mind that self-funding can be tricky to navigate since you’re setting your own direction, as others have shared in their own experiences.
You may have heard the term bootstrapping before, but what does it mean? Bootstrapping is very similar to self-funding, but usually refers to investing time and effort into getting your business off the ground as opposed to money.
A common example is software companies whose founders invested unpaid time building early versions of their products. Founders of a company like this might say they bootstrapped the operation until they were able to ship a product and start generating revenue. There’s definitely a learning curve to bootstrapping and it’s worth heeding the advice of others who have tried it.
Most people who start businesses can’t afford to fund everything out of pocket. So they take out one or more loans to cover expenses. This is known as debt financing — you’re taking on debt in exchange for the capital you need right away. Debt financing almost always carries interest, meaning that you’ll owe more than you borrowed. The interest functions as the price you’re paying for immediate access to money you can pay back over time.
A big upside of debt financing is that you don’t give up any ownership or control of your company. This is unlike equity financing, in which you sell profit shares and, sometimes, voting stakes in your business. But you are liable for paying back all of your debts, whether or not your business ultimately makes money.
Here are the two most common types of debt financing:
Many small businesses take out a loan, or multiple loans, to finance startup expenses. Banks, government agencies, and private finance companies offer multiple types of loans designed specifically for small business needs. These range from simple short- and long-term loans to business lines of credit, equipment and invoice financing, and merchant cash advances. While terms vary across the different types of loans, note that in almost all cases the loans will carry interest. You can learn more about the steps involved in applying for a loan here.
A less common way for small businesses to finance startup costs is through the issuing of bonds. Investors can purchase these bonds, which are kind of like legal IOUs, from companies who promise to pay that money back, usually with interest, after a set period of time.
Selling shares in your company to raise funds is known as equity funding. Ever seen the TV show, Shark Tank? The deals offered on that show are equity deals. You’re giving up equity — partial ownership of your business — in exchange for money.
Access to capital that you don’t have to pay back is, of course, the headline when it comes to equity funding. But it’s not just about the money. Different investors have different incentives for investing, and also have varying interests in getting involved in the actual running of the company. The right investor could do more to help your business with their expertise and industry connections than money alone could ever manage. On the other hand, the wrong investor could create problems for you if their motives don’t align closely enough with your own.
Equity deals can be structured to give investors profit sharing interests, voting rights, or both. Investors who back a company early on typically receive more favorable equity terms (eg, bigger bang for their buck) than those who come onboard later.
A few types of equity funding common to startups include:
Angel investors back startups and other small, early-stage businesses in exchange for shares in the company. Angels are usually family or friends of the business owners, or wealthy individuals or groups (‘syndicates’) who typically invest less than $500,000 with favorable terms.
A newer form of investment, crowdfunding lets individuals invest small amounts of money in a company, with the idea that lots of small contributions can add up to a significant fund raise. Kickstarter and IndieGoGo brought rewards-based crowdfunding into the mainstream, but donation and equity-based crowdfunding are other viable options, depending on what type of business you’re starting. Crowdfunding is a young, but quickly growing form of financing, predicted to become a $300 billion industry by 2025.
Rounds of funding that startups take from venture capital firms, usually referred to as “Series A,” “Series B,” “Series C,” etc. Typically, series investing starts after early-stage funding from individuals (“Angel” and/or “Seed” rounds), and represents a company’s first foray into institutional investing.
There are many ways to finance a new small business. Whether you ultimately choose to self-finance or take outside investment, the most important thing is to find the options that work best for your particular business plans and financial situation.
Remember, too, that plans change and unexpected circumstances and opportunities will come your way. Your financing plan can evolve over time to match the evolution of your business, so if you are considering outside financing, don’t feel pressured to take out loans or pitch investors right away. There are many paths to success, so gather information, talk to your trusted advisors, and get to work. New doors will open for you as your business grows and gathers momentum.