Joe Johnson, Ph.D.
Entrepreneur. Investor. Startup Expert.
How you choose to finance your business matters. Whether you elect to seek outside capital from VCs, borrow money from friends and family, float your business debt on personal credit cards, or secure an SBA-backed loan, the terms and consequences of these financing decisions will have important and lasting ramifications for the future of your business. Achieving an understanding of your funding options is an essential first step toward both making informed choices about financing your business and reducing the number of surprises down the road.
In this series, I’ll be introducing multiple methods of financing a burgeoning business. Not every one is appropriate for every circumstance. To determine which method is best for you and for the future of your startup, you should consider:
- Your industry
- How much money you require
- Whether you’re willing to take on debt
- Whether you’re willing to provide potential investors with equity
- How quickly you need the financing
- How frequently you may need financing going forward
- How you intend to use the money
- Your personal credit history
- The credit history of any co-founders
- The current stage of your business
Not all financing methods are appropriate for all industries. For example, you’ll find that many crowdfunding sites specifically state that their platforms cannot be utilized by marketing companies. If you’re attempting to start a new marketing firm, you’ll have to look elsewhere to finance your business. As you investigate different funding methods, take care to ensure that each is appropriate for your industry.
Additionally, you should consider the state of your industry and whether any cyclical events might create challenges. For example, a landscaping business will often suffer from cash flow issues during slow seasons and may benefit from financing that helps to alleviate this cyclical burden – namely, a business line-of-credit.
How Much Do You Need?
Reaching a determination of how much you need can be difficult. Not only must you consider your operating expenses over a specific period of time, when you’ll be able to begin repaying the loan, and your expected income, but you must also account for taxes, interest, and/or fees. While crowdfunding $10K might sound like a great way to pay for your initial manufacturing costs, the $800 – $1000 in fees, the costs of running a campaign, and the taxes due on any funds received may equate to your coming up short when trying to cover that initial run. Borrowing or asking for too much has its own problems, as well. Not only will some lenders charge higher interest rates, but they may decide not to fund you at all because you aren’t fully aware of your own requirements.
To arrive at a determination of how much is needed, you’ll have to clearly specify the money’s purpose and exactly how it’ll be spent. Additionally, you should have a clear picture of your financial future to illustrate your expected earnings and either buttress your business growth projections or demonstrate how you’ll be able to repay your lenders.
Are You Willing to Take on Debt?
Having maxed-out credit cards is not fun. Neither are monthly loan payments. One or both, however, may be necessary in the short-term. Consider whether you’re willing to assume debt (and exactly how much) in order to help make your business a reality. Keep in mind that funding isn’t free. In order to understand just what a line-of-credit will cost, make the effort to accurately calculate how much interest you’ll be paying over the term of any loan you’re considering.
Are You Willing to Give Up Equity in Your Business?
Seeking investors may be a useful way to fund your business, though it isn’t for everyone. When individuals invest, they almost always receive an ownership stake (equity) in your business. Depending on the negotiated terms, they may also receive a seat on your board and have a say in operations. Does ceding that level of control align with your vision for the company?
How Quickly Do You Require Funding?
Each funding method has its own timeline. While bootstrapping with your own money allows you to move forward immediately, applying for credit, running a crowdfunding campaign, or seeking investors do not. Before committing to one type of funding (and you shouldn’t limit yourself to only one), consider how quickly you’ll require the funds. If you’re aware of cyclical funding needs or know that you want to expand in the future, start planning in advance of those events in order to ensure that you’re able to take optimal advantage of the funding method that best suits you and your business.
How Frequently Do You Need Funding?
If you’re seeking a one-time infusion of capital vs. a consistent line-of-credit, your approach and funding methodology will likely vary. Be clear on what you need as you investigate the different financing methods in order to determine which is the most appropriate. For example, if you need to purchase supplies for a new project and require capital immediately, you may choose to factor one of your invoices so as to generate a quick infusion in order to begin the next project. If you find yourself in this situation consistently, it might be more efficient to apply for a business line-of-credit so that you’ll save money on fees and interest over time.
How Will You Use the Money?
Some loans and financing options may only be utilized for specific purposes. Ensure that the funding methods you’re investigating will enable you to use the funding as you require – whether you need to purchase machinery, lease space, or manufacture goods.
What is the State of Your Credit Report?
While you’re seeking funding for your business, there’s an excellent likelihood that your personal credit history will matter. Asking for loans or gifts from friends and family or running a crowdfunding campaign can help your fundraising efforts regardless of the state of your personal credit. However, seeking funding from banks and investors will almost certainly involve an inquiry into your personal credit unless you’ve been in business for over three years and have amassed a substantial business credit history. Any partners or co-founders will likely also be scrutinized, especially if they’ll be jointly liable for any debt assumed.
At What Stage is Your Business?
Often, funding needs are greatest during startup and expansion. Some funding methods may be more suitable at one stage than another. For example, the maker of a new family game may find that they need to take a loan or bootstrap while they develop the concept and then crowdfund production as a means of determining the idea’s viability as they line up pre-orders. You may need to seek funding to start your business, to expand, to remodel, to cover slow periods, or for other reasons. Verify that any funding you’re considering is truly appropriate for your needs.
Funding, as a business necessity, isn’t solely about obtaining starting capital, but is also of critical importance for sustaining and growing an endeavor over time. To best capitalize on one’s current cash flow, it’s recommended that business owners regularly review their business plans and amend them as necessary to keep pace with operational innovations. This can help you to ascertain where financing and efforts should be concentrated in order to help realize your business projections. Employing a trustworthy accountant will also be of inestimable assistance in reaching a determination of just how much borrowing is needed. For smaller-scale startups, however, this may not be an immediate priority, so long as someone on the team possesses sufficient fiscal savvy.
Cash flow issues present a major risk to startups – 82% of failed businesses cite cash flow issues as the primary reason for their failure. Having a thorough understanding of your cash flow and taking the necessary steps to anticipate and plan for leaner times are both essential facilitators for business success. Likewise, familiarity with your funding options during those times can help you to maintain the necessary competitive edge and allow you the time required to seek any desired funding.
It is absolutely essential that you have a business plan or business model canvas prepared before you begin to seek funding. The business plan will help you better explain to potential backers just how you intend to spend the requested funding. Not all financing applications will require a business plan, but you should have one prepared in any case. Your business plan serves to articulate your way forward. To better understand how much money you require and exactly how you intend to allocate it, find the answers while writing your business plan as you exhaustively research your industry, the current market, and your competitors.
Startup Funding Statistics
According to the SBA, 57% of small business owners utilize their personal savings to initially fund their businesses. Approximately 8% fund their ventures with a bank loan, while another 8% make use of one or more personal credit cards. The same study reported that fewer than 2% of startups secure funding via equity financing. Statistics are unclear regarding the number of businesses which were denied loans or utilized loans from alternate sources, such as friends and family.
While it’s useful to know these numbers and to understand the general state of business financing, you should still proceed as you believe best for your business. For more clarity on your specific industry, consider locating an entrepreneur willing to act as a mentor or to speak with you about their experiences with startup funding.
Types of Funding Covered
In this series, I’ll be touching upon the following types of startup funding:
- Debt Financing
- SBA-backed Loans
- Traditional Bank Loans
- Business Line of Credit
- Credit Cards
- Loan from Friends or Family
- Peer-to-Peer Lending
- Purchase Order Financing
- Equity Financing
- Equity Crowdfunding
- Bootstrapping/Personal Equity
SBA Small Business Finance FAQ https://www.sba.gov/sites/default/files/Finance-FAQ-2016_WEB.pdf
About the Author
Dr. Joe Johnson is an entrepreneur, investor, and startup expert. He is the founder and principal of GoodField Investments and the GoodField Foundation (www.GoodField.com).
Joe has a Ph.D. in Entrepreneurial Leadership and an MBA. He is the author of the upcoming book on The Science of Why Most Entrepreneurs Fail and Some Succeed.
Most importantly, he is the incredibly blessed husband of one amazing wife and father of six wonderful children. He resides in Bradenton, Florida. For more information on Dr. Johnson and his work, go to www.JoeJohnson.com.