Here’s the problem: small businesses often need extra cash to fund their expansion, but struggle to get funding because they don’t have enough of a track record.
It’s a classic Catch-22 situation. Over half of all small business owners say that a lack of financing is restricting their business’s growth opportunities, according to a recent survey.
So in this series of tutorials, we’re going to look at all the different ways a business can raise money, from loans and crowdfunding to angel investors and venture capital.
If you’ve got an idea for a start-up, or if you run or work for a company that needs funding, these Funding a Business tutorials will help you understand what your options are, the pros and cons of each, and the steps you can take to secure funding.
In this first week, we’ll walk through the steps you should take when looking for funding, and introduce the main options available. Then over the next seven weeks, we’ll look at each option in more detail.
By the end of this tutorial, you’ll have a clear idea of which options could be appropriate for your business. By the end of the whole series, you’ll be equipped with the tools and knowledge to move forward with a funding plan and secure the money you need to take your business to the next level.
1. Explore All the Avenues
The worst mistake you can make is to discount certain options before truly exploring them. Many business owners, for example, would assume that government grants aren’t an option. It’s true that grants are mostly for nonprofit organizations, but some are available for businesses too.
State and local governments also have their own programs to aid small businesses, usually either aimed at rejuvenating an economically depressed area or attracting certain types of businesses. It’s always worth checking on your local government website, as well as the federal government’s site, to see if you’re eligible for any grants, and apply for anything you can find.
Once you’ve done that, start working your social networks. You may feel uncomfortable asking your best friend or your favorite aunt for cash, but consider this: 72% of small businesses have successfully raised money from friends and family, making it the largest funding source.
If you follow this route, be sure to formalize the arrangement, to avoid misunderstandings or recriminations down the road. Sites like LoanBack.com can help you create a legally binding loan agreement, with a full repayment schedule for everyone to agree on.
Another option is to look at making changes to your own business practices. Managing your cash flow more efficiently, for example, will free up more cash to invest in the future of your business. You could also look to sell off any non-essential equipment, reduce inventory, and cut expenses wherever possible. Sometimes the best source of funds is in the cash generated by your own business.
2. Fund it Yourself
If none of those are an option, or if you still need more funds, consider using your personal resources. Many people decide to fund a business themselves, either from savings or by using personal credit cards. Some even dip into their retirement funds.
Mark Zuckerberg and Eduardo Saverin, for example, started Facebook in 2004 with their own personal funds. The company soon attracted angel investors, and later was funded by venture capital funding and eventually an Initial Public Offering (IPO), but for the first few months Zuckerberg and Saverin kept the lights on with their own money.
Self-funding is an attractive option for start-ups, assuming you have the money available. It can get the business up and running, and get it to the point where outside investors can feel comfortable handing over their cash. It’s much easier to raise funding when you have an active business with real customers than when all you have is an idea on a piece of paper.
Unless you have very deep pockets, however, it’s not a very viable option for the long term. The cost of major investments in the future of a business can quickly run into tens or hundreds of thousands of dollars, and most of us can’t spare that kind of money.
Putting it on the credit card is a risky strategy, too, because the interest payments alone will eat up a chunk of your profits, and if things don’t work out as planned, you’ll be left with a debt that could take years to pay off. The same goes for depleting retirement funds, or using your home as collateral for a loan. Taking some risk is an inevitable part of going into business, but always consider the worst case scenario, and don’t over-stretch.
We’ll have more detail on self-funding a business next week. In the meantime, here are some of the other options available to you.
3. Get a Loan
“Easier said than done” might be your reaction. After all, as we mentioned in the introduction, loans can be hard to come by when you don’t have a long track record in business. Mindful of the high rate of small business failure, banks are sometimes reluctant to take a risk. The result: almost half of all small businesses have been turned down for much-needed loans in the last four years.
But borrowing money is not impossible. Businesses do it all the time, whether from banks, credit unions or other sources. As long as you can afford the repayments, debt is a good way of raising funds without giving up any ownership stake in your business.
The key to getting a bank loan is to put together an impressive proposal. Anticipate the loan officer’s questions and concerns, and address them up front, presenting your business as a solid, safe proposition. Give a detailed view of your finances and business strategy, and how you plan to repay the loan.
Nevertheless, it’s still difficult, so the Small Business Association also runs a number of loan programs for small businesses that are struggling to secure a traditional bank loan.
There are general programs in which the SBA helps you get a bank loan by guaranteeing the loans in case of default, and also more specific programs aimed at particular groups like veterans or victims of natural disasters. For more information on the types of loans and how to apply, visit the SBA website.
4. Ask the Crowd
Despite what you might think, crowdfunding is not an entirely new concept. The construction of a pedestal for the Statue of Liberty was largely funded by individual contributions from 125,000 people, mostly of $1 or less.
In the last few years, though, the technology has developed to the point where crowdfunding over the internet is a truly viable source of funding for small businesses.
How it works: You list details of how much funding you want, what you need it for and why people should help you. Then people contribute money, in exchange either for special products and perks, or in some cases for an equity stake. A couple of the more established sites, focused more on creative industries, are Indiegogo and Kickstarter, while Crowdfunder.com is dedicated to business investment.
The advantage of this approach is that it gives you access to new funding sources, and can also win new fans for your business. But you’ll need to have a very compelling story or to offer great rewards if you want to convince people to part with their money.
5. Find Me an Angel
Despite what the name may suggest, “angel” investors are not philanthropists looking to give away cash. They’re regular investors on the hunt for profit. But to a small business struggling to find the money to invest, they can certainly seem like angels when they arrive with checkbook in hand. They could invest anything from a few thousand dollars to a few million.
Angels are usually wealthy individuals who invest in promising young companies. They’re willing to take a risk, but expect a high return within a limited time period, say five to seven years. You can pitch your business to angel investors by contacting them through local networks, for example this one for New York, or this one for Silicon Valley.
The advantages of angels are that they’ll often invest when others won’t, and they’re usually experienced business people who can help with coaching or providing access to their contacts. But keep in mind that if you do secure funding, the pressure will be on to provide the returns the angels expect.
6. Venture Capital
Venture capital funding is normally an option at a slightly later stage than angel investors. We’re talking about companies rather than individuals now, and the amounts of money invested are often larger.
Returning to the Facebook example, the company secured $500,000 an angel investor in its first few months, and then venture capital firm Accel Partners came along a year later with a $12.2 million investment.
In return for the funding, Accel got ownership of about 10% of the company, a stake that was worth about $10 billion seven years later.
While the returns are not usually so spectacular, most VC deals work in a similar way. The company provides funding, usually to technology firms or other companies with strong growth prospects, and gets a share of the business in return. The money can really fuel your business’s growth, but be aware that you may lose some control as the VC firm tries to secure a return on its investment.
7. Private Equity
Like venture capital firms, private equity companies will invest in your business in return for a share of ownership. They work a little differently, though.
Whereas venture capital firms focus on finding the next Facebook, private equity firms will invest in a much wider range of businesses, including older companies and firms in any industry, not just technology. They also tend to make larger investments, and take much larger stakes.
So private equity investment can help you turn around a failing business or achieve growth, but you’ll often lose even more control, with the PE firm owning a majority of the shares and calling a lot of the shots.
An IPO is where a company offers shares to the public. The funding advantages are obvious: with potentially millions of people buying shares in the company, a business can raise serious amounts of cash, the kind of money that can transform a business.
The Facebook IPO in 2012, for example, raised $16 billion for the company. That’s exceptional, but even regular offerings raise a lot of funds: the median IPO size is around $100 million.
It’s generally an option, then, for businesses at a later stage of growth than some of the other options we’ve looked at. There are disadvantages, like loss of autonomy and the cost of meeting regulations for public companies, but an IPO can provide the kind of dramatic influx of funds that transforms a small or medium-sized company into a large corporation. It’s a complex process, and we’ll give more details in a dedicated tutorial.
9. What’s Next
Now that you’ve seen a brief overview of what’s available, we’ll look at each of the main options in more detail over the next seven weeks.
The important thing to keep in mind is that each option has its own advantages and disadvantages. We’ve looked at some of these already, and we’ll explore them in more detail in the coming weeks. We’ll also give practical advice on how to secure the funding, and how to manage some of the potential risks in this Funding a Business series.
Next up is a look at self-funding a business. We’ll take a detailed look at how this can help you get started in business, and what the risks and limitations are. For now, this tutorial has given you an overview of the options available to you, and you should have a clearer picture of which of them could help your business get the funding it needs.