Financing for small business start-ups
The number one question I am asked as a small business start-up consultant is: Where do I get start-up cash?
I am always glad when my clients ask me this question. If they are asking this question, it is a sure sign that they are serious about financial responsibility to get started.
Not all money is the same
There are two types of initial financing: debt and equity. Consider which type is right for you.
Debt financing is the use of borrowed money to finance a business. Any money you borrow is considered debt financing.
The sources of loans for debt financing are many and varied: banks, savings and loans, credit unions, commercial finance companies, and the US Small Business Administration (SBA) are the most common. Loans from family and friends are also considered debt financing, even when there is no interest attached.
Debt finance loans are relatively small and short-term and are made based on your guarantee of repayment of your personal assets and equity. Debt financing is often the financial strategy of choice for early stage businesses.
Equity financing is any form of financing that is based on the equity of your business. In this type of financing, the financial institution provides money in exchange for a portion of the profits of your business. This basically means that you will sell a part of your business to receive funds.
Venture capital firms, private investors, and other professional equity financing firms are the standard sources of equity financing. If handled properly, loans from friends and family could be considered a non-professional source of equity financing.
Stock financing involves stock options and is generally a larger and longer-term investment than debt financing. Because of this, equity financing is most often considered in the growth stage of companies.
7 top sources of funding for small business start-ups
Investors are more willing to invest in your startup when they see that you have put their own money at stake. Therefore, the first place to look for money when starting a business is your own pocket.
According to the SBA, 57% of entrepreneurs turn to personal or family savings to pay for the launch of their business. If you decide to use your own money, don’t use it all. This will protect you from eating ramen noodles for the rest of your life, give you a great borrowing experience, and strengthen your business credit.
There is no reason why you can’t get an outside job to finance your start-up. In fact, most people do. This will ensure that there will never be a time when you are not getting paid and will help eliminate most of the stress and risk of getting started.
If you are going to use plastic, look for the lowest interest rate available.
2. Friends and family
Money from friends and family is the most common source of non-professional funding for small business start-ups. Here, the biggest advantage is the same as the biggest disadvantage: you know these people. Unspoken needs and attachments to results can cause stress that would justify turning away from this type of funding.
3. Angel Investors
An angel investor is someone who invests in a business venture, providing capital for start-up or expansion. Angels are wealthy, often entrepreneurial people who make high-risk investments with startups in the hopes of getting high rates of return on their money. They are often the first investors in a company, adding value through their contacts and experience. Unlike venture capitalists, angels don’t typically pool money in a professionally managed fund. Rather, angel investors often organize into angel networks or angel groups to share research and raise investment capital.
4. Business partners
There are two types of partners to consider for your business: silent and working. A silent partner is someone who contributes capital for a part of the business, but is not generally involved in the operation of the business. A working partner is someone who contributes not only capital for a portion of the business, but also skills and manpower in day-to-day operations.
5. Business loans
If you are starting a new business, chances are there is a business bank loan somewhere in your future. However, most business loans go to small businesses that already show a profitable track record. Banks finance 12% of all new small businesses, according to a recent SBA study. Banks consider financing people with a strong credit history, related business experience, and collateral (real estate and equipment). Banks require a formal business plan. They also take into consideration whether you are investing your own money in your startup before granting you a loan.
6. Start-up financing companies
Seed finance companies, also called incubators, are designed to foster entrepreneurship and foster business ideas or new technologies to help them be attractive to venture capitalists. An incubator generally provides physical space and some or all of these services: meeting areas, office space, equipment, secretarial services, accounting services, research libraries, legal services, and technical services. Incubators involve a combination of advice, service, and support to help new businesses develop and grow.
7. Venture capital funds
Venture capital is a type of private equity financing that is typically provided to growing startups by professional outside investors with institutional backing. Venture capital companies are real companies. However, they invest other people’s money and much larger amounts (several million dollars) than start-up companies. This type of equity investment is usually best suited for fast-growing companies that require a large amount of capital or start-ups with a strong business plan.