It costs money to start a business. Financing a business is one of the first and most important financial options that most business owners seek. How you choose to finance your business could affect the way you structure and run your business.
Determine how much financing you will need
Every business has different needs, and no financial solution is a one-size-fits-all solution. Your personal financial situation and your vision for your business will determine the financial future of your business.
Once you know how much startup money you will need, it’s time to find out how you will get it.
- Investors
- Bank and money
- Loans
Finance your business yourself with your own funds
Also know as bootstrapping, self-financing allows you to leverage your own financial resources to support your business. Self-financing can come in the form of turning to family and friends for capital, using your savings accounts, or even tapping into your 401k.
With the self-financing, you are in full control of the business, but you also bear all the risks yourself. Be careful not to spend more than you can afford, and be especially careful if you decide to use retirement accounts early. You could face costly fees or fines, or damage your ability to retire on time – so check with your plan administrator and personal financial advisor first.
Get venture capital from investors
Investors can give you financing to start your business in the form of venture capital investments. Typically, venture capital is offered in exchange for a shareholding and an active role in the company.
Venture capital differs from traditional financing in several important ways. Typically venture capital:
- Focus on high-growth companies
- Invests equity in exchange for equity instead of debt (not a loan)
- Take higher risks in exchange for higher potential returns
- It has a longer investment horizon than traditional financing
Almost all venture capitalists will want, at the very least, a seat on the board of directors. So be prepared to give up some control and ownership of your business in exchange for financing.
How to get venture capital financing
There is no guaranteed way to raise venture capital, but the process generally follows a standard order of basic steps.
1. Find an investor
Look for individual investors – sometimes called “angel investors” – or venture capital firms. Make sure you do enough background research to know if the investor is reputable and has experience working with new companies.
2. Share your business plan
The investor will review your business plan to make sure it meets your investment criteria. Most mutual funds focus on one industry, geographic area, or stage of business development.
3. Go through a due diligence review
Investors will examine your company’s management team, the marketplace, products and services, corporate governance documents, and financial statements.
4. Solve the terms
If they want to invest, the next step is to agree on a term sheet that outlines the terms and conditions for the fund to make an investment.
5. Investment
Once you agree on a term sheet, you can get the investment! Once a hedge fund has invested, it becomes actively involved in the business. Venture funds usually come in rounds. As the company reaches milestones, new rounds of financing are made available, with price adjustments as the company executes its plan.
Use collective funds (crowdfunding) to finance your business
Crowdfunding raises funds for a business of large numbers of people, called “crowdfunders.” Crowdfunders are not technically investors, because they do not receive a share of ownership in the business and they do not expect a financial return on their money.
Instead, donors expect to receive a “gift” from your company as a thank you for their contribution. Often times, that gift is the product you plan to sell or other special perks, such as meeting the business owner or getting their name on the credits. This makes crowdfunding a popular choice for people who want to produce creative works (like a documentary) or a physical product (like a high-tech cooler).
Crowdfunding is also popular because it is very low risk for business owners. Not only are you able to retain full control of your company, but if your plan fails, you typically have no obligation to pay your group fund providers. Every crowdfunding platform is different, so be sure to read the fine print and understand all of your financial and legal obligations.
Get a small business loan
If you want to retain full control of your business, but don’t have enough funds to get started, consider a small business loan.
To increase your chances of obtaining a loan, you should have a business plan, an expense sheet, and financial projections for the next five years. These tools will give you an idea of how much you will need to ask for, and will help the bank know that they are making a smart decision by giving you a loan.
Once you have your materials ready, contact banks and credit unions to apply for a loan. You will want to compare the offers to get the best possible terms for your loan.
Use Lender Match to Find Lenders Offering SBA Guaranteed Loans
If you are having trouble getting a traditional business loan, you should look for SBA-guaranteed loans. When a bank thinks its business is too risky to lend money, the SBA you can agree to guarantee your loan. In this way, the bank has less risk and is more willing to give your business a loan.
Use Lender Match (https://www.sba.gov/funding-programs/loans) to find lenders who offer SBA-guaranteed loans.
Small Business Management Investment Programs
Small Business Investment Society (SBIC)
The SBIC They are privately owned investment funds managed under license and regulated by the Small Business Administration. They use their own equity, plus funds borrowed with an SBA guarantee, to make equity and debt investments in qualified small businesses. Learn more about SBICs to see if your business could qualify.
Small Business Innovation Research Program (SBIR)
This program encourages small businesses to participate in federal research and development that has the potential for commercialization. Find out if SBIR’s competitive award-based program makes sense for you.
Small Business Technology Transfer Program (STTR)
This program offers funding opportunities in the federal field of innovation research and development. Small businesses that qualify for this program work with nonprofit research institutions in the early and middle stages of startup. Find out if the STTR program makes sense for your business.
How to get financing? example.
You don’t need a treasure map to find funds: When Johan and Katy didn’t have enough money to open their auto repair shop, they got a loan backed by the SBA to help start your business.
Johan and Katy calculate their startup costs to figure out how much money they need to get their auto repair shop up and running.
They can afford to pay for some of the start-up costs themselves. However, the self-financing effort has limits, as they don’t want to take money out of their retirement accounts.
After speaking with a financial advisor and discovering that they are still 60 percent short of their financing goal, John and Kelly look for investment capital. They contact various firms, eventually getting a meeting to present their business plan.
An investment company offers 20 percent of its financing objective in exchange for partial ownership of the company. Johan and Katy secure another 10 percent by starting an online crowdfunding page. Many residents are eager to have an auto repair shop in town, and they visit the site to donate.
But Johan and Katy are still 30 percent short of their funding goal. Many investors and banks have not invested because they think there is too much risk. Next, John and Kelly learn about SBA-backed loans and get the money they need by connecting with lenders through SBA’s Lender Match tool.
The SBA loan guarantee provides an incentive for these lenders to do business with Johan and Katy.