At some point, you will have the guts to chase your wildest dreams, and look to expand the revenue of your startup exponentially. News-worthy venture capital rounds, credit cards, grants, and loans are not the only ways to fund your expansion. Most of these lending choices either have onerous repayment terms, or will hand partial ownership to your investors. In many of these cases, “sharing doesn’t mean caring.”
Personal equity and bank loans are the main sources of financing for startups. Around 57 percent of startup owners use even their personal savings as start-up capital. Even worse, a quarter start with no start-up capital. This approach is most common with inexperienced entrepreneurs who have no employees.
Here’s how to break down the other sources of funding when starting a business:
- Personal credit cards: 8 percent
- Bank loan: 3 percent
- Other personal property: 6 percent
- Home equity: 3 percent
- Business Credit Card: 2 percent
Startup financing is normally done through either equity financing or debt financing.
Money from a venture capital firm doesn’t need to be repaid, because it offers capital in exchange for partial ownership.
How to secure equity financing? We will later look at the different kinds of capital available.
You might need additional cash for:
- Launching a new company
- Purchasing real estate
- Hiring staff
- Buying essential equipment
- Investing in a specific product,
- Expanding a business
Let’s take a look at two strategies concerning business financing: dilutive and non-dilutive financing.
- Dilutive financing calls for an exchange of equity, or ownership, in the company
Ex: an investor who gives money to a startup in exchange for company shares.
- Non-dilutive financing allows founders to retain full ownership.
Ex. You get a credit card and go crazy.
You may ask why would anyone ever want to give up a piece of their company? Because they might be scared by tomorrow’s rising interest rate and macroeconomic uncertainty.
An alternative option that costs you nothing. You get a business grant that you are not obliged to repay.
A note to keep in mind: some business loans require lenders to start payments the moment they receive the money. The other loans can cause extreme frustration due to the paperwork.
Check out the stats: while most businesses of all types start without external funding, female-owned enterprises are more likely to do this than male-owned startups. Significantly more men than women use bank loans to raise money for their startups, 6.6 percent versus 0.6 percent. However, we are not sexist and do not recommend choosing either of the options.
Before we dig deeper, let’s differentiate between startup financing and startup funding.
Financing implies obtaining or providing money or capital for expenses. Funding is money provided, especially by an organization or government, for a particular purpose.
Startup financing requires funding a business through equity financing or debt financing.
Let’s talk about equity. Money from venture capital doesn’t need to be reimbursed because it offers capital in exchange for partial ownership. Investors take that risk because they believe in the company. And they also want to become crazy rich when their equity will one day be worth exponentially more than their initial investment.
Debt financing: everything credit-wise involves interest. You are obligated to repay the lending organization for the risk.
You can be a startup that can do both. Neither is a monogamous relationship, after all.
What are the options for Startup Financing?
To raise the capital, you will have to:
- issue equity,
- achieve positive cash flow.
Debt includes credit cards, corporate bonds, mortgages, leases, and notes.
You can do it publicly through a debt issue, or privately through an institution like a bank or government. Private debt financing mainly involves taking out a loan.
Drawbacks: The banks will have to be paid back by the debtor at some point. On the flip side, the length of loan is always negotiable, it can be short term or long term.
In 8 out of 10 cases, interest is tax-deductible for businesses. However, if you fail to repay lenders, you must declare bankruptcy or default. As a result, you will mess up the borrower’s credit rating, thus harming the ability to raise further future capital.
Recent stats: about 2/3rds of small business owners are in debt.
Look at the do’s and don’ts, before considering going into debt:
- Have a business plan. Simple? Yes. Do you have a good one? Not sure. Lay out a written road map for the firm, including marketing, financial, and operational key points. If you think your marketing budget will be $100, add 20%. Because of the unwritten financing rule, you always spend more than anticipated. A business plan will help you think through your strategy, determine how much money you need to borrow, and help potential lenders succeed as well, when you pay it off on time.
- Ditch optimism. Yes, you have to believe in your idea, but a more conservative view of your financial prognoses will not only help the lenders but will also guarantee that you do not have higher debt than the actual value of your company assets.
- Invest in yourself. You will appear more trustworthy to actual lenders if you invest your own money.
- You are not your business. Hear us out, when you use a personal credit card or home equity for seed money, you risk losing everything and living in a cardboard box. Even after successfully repaying previous debt, you might not have a high credit score as a result of this. We suggest using business credit cards and business financing, so you might lose your company, but not your home.
The verdict: Deb financing can be less costly than net earnings or equity financing.
Equity represents the value of repaying a company’s shareholders if all the assets were liquidated and the company’s debts were paid off. By exchanging shares with external investors for capital, business owners can use this equity for financing.
Common variations on equity:
- A stock or any other security representing an ownership interest in a company.
- A sock. Just kidding. But it rhymes, doesn’t it?
- Shareholders’ equity. On a company’s balance sheet, the amount of funds granted by the owners + the enclosed earnings & losses.
- The value of securities in a margin account minus what the account holder borrowed from the brokerage in margin trading.
- Real property value. In real estate, the difference between the property’s current market value and the amount the owner still owes as a mortgage. It is the amount the owner would get after selling a property.
- The amount of money remaining after the startup compensates its creditors. This is called liable capital.
The most common equity financing comes from venture capitalists and private equity firms. You give up complete control of your company since investors obtain voting rights that can weigh in on business decisions.
As well, you also share the future profits with them.
Need a reminder of why you should even consider this option? That ownership means you’re not required to pay back the investors’ money.
You get off the anxiety train and have time to build your business without the pressure of monthly payments.
Remember the phrase: “If I go down, you go down with me?”. Same here. If your company goes bankrupt, investors lose out too.
Keep in mind that equity doesn’t come with tax benefits.
Net Earnings Financing
Also called net income is the gross earnings minus mandatory deductions, such as state and federal income tax and social security contributions.
Or, to simply put it: your company makes a profit, so you can use it to fund other business opportunities.
With net earnings financing, founders grow a business or fund new projects without giving equity or taking out debt.
If you did give up some of the shares early on, this is a chance to reward investors and shareholders with dividend payments, or buy back shares to regain ownership control.
Reality check: while the net earnings model is the most cost-effective way, the truth is that a startup cannot always use its income to invest in itself. Most companies need help to create a product or service worth selling.
This option is available only when you are cash flow positive. So let’s see how to get the funding you need to build:
- A customer base,
- Increase revenue,
- Become a financially viable business.
How to Get Financing For a Startup Business
Some startups require more financial aid than others. Don’t get $100,000 just because you can. This is a committed relationship, and you don’t want to get stuck with unnecessary interest and other payments. Here are a few choices for financing:
- Business term loan. Small business owners can borrow a sum of cash from banks, online lenders, or financial institutions. They come with fixed repayment terms, most of which also have fixed interest rates.
- SBA loan. Basically, the government backs you with low-interest rates and variable funding amounts. SBA also offers microloans that are explicitly issued to startups. They come with eligibility requirements, so take your time to find the right one for your business.
- Business credit card. The same logic as with a personal credit card, a business card can be used to make everyday purchases for your company. If you are just starting, get ready to work up to a higher credit limit. On the bright side, a business card enables you to get points and rewards for business trips and expenses, which you can reinvest in your business.
- Finance your equipment. Buy the retail fridge, Xerox, or computer by making small monthly payments to lenders. Your business owns them once you pay the total amount. Everyone does it, and 43% of financing comes from banks.
- A business line of credit. Business owners can receive this short-term loan without fixed repayment terms. You can get a $1,000-$250,000 line of credit and use it for rent, machinery, inventory, hiring, or other business expenses.
In the last year alone, the FRB provided small businesses with 61,000 loans amounting to $44.8 billion here.
- Personal loan: Here, you can rely on your personal credit history. Personal loans range from $1,000 to $50,000 and are available from banks and credit unions.
- Crowdfunding. Get ready to find multiple backers to give a company money in exchange for equity, an early bird product, service, or even nothing at all. Check out Kickstarter, Indiegogo, and GoFundMe and the rate of successfully funded startups. It’s a low-cost method of raising capital, however it might force you to invest millions in your marketing or PR team. And be mindful that there is a risk of ruining your reputation by overpromising and under-delivering.
Before choosing any of the aforementioned, get your P&L, Cash Flow, and Balance Sheet in order. Or don’t, and see what happens. You can master the art of delegation and give these tasks to people who love Google sheets and graphs. Use Fuelfinance, for example. Book a session, and quit killing yourself trying to crunch the numbers.