By Doug and Polly White
Q. Could you walk through some options for businesses that can’t fund solely on the friends/family model but aren’t yet mature enough to be getting bank loans? How can they cross that “valley of death?” What are some pros and cons to the different options?
A. Funding a business is a nontrivial topic. A thorough discussion would take much more space than we have here. However, we will endeavor to provide an overview that we hope will help start you thinking.
There are only two ways to externally fund a business, debt or equity. When debt is used to fund a business, 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, under certain circumstances, the lender can force the company into liquidation.
When using equity to fund a business, the investor receives an ownership stake for his/her cash. The benefit is that there is no obligation to repay the investor. The downside is that you will have to give up a part of the ownership of your business. This can include 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 which enables further growth.
Self-funding – Many entrepreneurs fund their businesses themselves. They may use savings or personal debt (such as a second mortgage or credit cards). Alternatively, they may sell assets to generate cash for the business (e.g., a second home or a boat).
Friends and family – You mention this source of funding in your question. Obviously, friends and family can provide either equity or debt funding.
Angel Investors – These people are typically affluent individuals who are willing to invest in businesses. Increasingly, angel investors are forming investment groups to spread risk and pool research.
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 typically benefit the business by aligning resources. For example, a property management company might make a strategic investment in a property maintenance company because it can 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.
Small Business Lenders – Many organizations are interested in lending to small businesses. Google “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.
SBA Loans – The Small Business Administration has many programs, but in general, it is providing 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 will 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.