Funding your business – a beginner’s guide

Published on April 30, 2012 | Webster Bank

So you’re starting a small business or perhaps you’ve grown a business over the last couple of years that has leveled off.  What do you do now?  How do you raise the funds you will need to launch your business or get it growing again? Let me start off by saying that I am neither a lawyer nor an accountant (although I recommend that you retain one or both of these professionals, depending on which fundraising path that you choose).  I am, however, an entrepreneur who has raised money for my businesses using almost all of the tactics below. The first thing to consider is whether you want to raise equity capital or debt capital. To raise equity capital, you can opt to sell a portion of your company and use the proceeds of that sale to help fund the business. One of the greatest advantages of raising money this way is that you don’t have to personally guarantee the investment. If your business fails, you won’t have to worry about investors taking your house. If you don’t have the means to self-fund your business, you can try to get capital from equity investors. In many cases they are silent partners who can give you valuable advice. One potential downside is  that these new partners will stop being silent and become more vocal when times get tough.

Different types of equity investors

Friends and family

Friends and family can be one of the easiest sources of capital because they know you and believe in you. Most business owners go to friends and family first for a capital investment. However, before you decide to ask, thing long and hard about whether you really want to have your mom or Uncle Fred as a partner.

Angel investors

Angel investors are wealthy private individuals – such as doctors, executives or retired entrepreneurs – who like to invest in small companies. They hope to earn a good return on their investment, but are frequently more motivated by the opportunity to be involved in something new and exciting.

Venture capitalists

Venture capitalists and private equity firms are professional investors. They are definitely in it for the money. On the plus side, they can give very valuable advice and, in some instances, even help you run and grow your company. However, they can be merciless if the company does not perform as well as the founder or managing team has led them to believe. They frequently negotiate provisions that allow them to replace executives if certain financial goals are not met. On the flip side of the coin, you can always start or fund the growth of your business using debt capital.

This entails borrowing money from a creditor, investing it in your business and then paying it back over time with the proceeds from your larger and more successful business. Companies or banks that lend you money rarely meddle in the way that you run your company.  However, if you can’t meet the repayment terms of your loan, they have the right to seize your collateralized business assets Ð even your personal assets if you offered them as collateral.

Different sources of debt capital

Personal borrowing

This is the classic way that many entrepreneurs get their businesses off of the ground. They leverage their personal credit cards, take second mortgages out on their house and/or borrow against their 401K to raise funds. The obvious downside is that if your business fails, then you could be paying back this borrowed money for years or even decades.

Banks

Lending money to individuals and businesses is one of the main reasons that banks exist. If you are able to present a strong business plan and have a good track record, banks will gladly lend you the funds to grow your business. Depending on how long your business has been around and how successful it already is, you may be asked to personally guarantee the loan.

Government

The government offers numerous resources for small business capital. There are grants (which have better terms than either debt or equity financing) and there is the Small Business Administration (SBA). The SBA works with banks to guarantee certain loans. This partnership helps business owners who wouldn’t otherwise qualify for a loan to obtain the funding they need. The SBA credit enhancement can also help your business qualify for better loan terms, such as a long payback period or deferred interest at the beginning of the loan.

Crowdsourced funding

There is one additional source of both equity and debt capital worth mentioning.  In the last 5 years we have seen the concept of “crowdsourced funding” come to the forefront.  This is where large groups of individual investors use crowdfunding networks to identify small businesses looking to raise equity or debt capital.  The individual investors might have different risk tolerances or specialized knowledge that make them more willing to lend to certain types of small businesses. For example, a retired dentist’s unique background and experience might make him more willing to lend to young dentists looking to start dental practices than a traditional bank might be.  As a small business owner looking for funds, crowdsourcing can be a godsend because it is another source of capital that may look more favorably at your business’s risk. However, there can also be a downside, as crowdsourced funds can demand a premium (e.g. a higher interest rate on a loan). Regardless of which path you choose to take when funding your company, there is a plenty of good news. In 2012, the levels of both equity and debt funding have been on the rise. If the economic challenges of the last few years have deterred you from raising the capital that you need to grow your company, now is the time to get back in the market and re-evaluate your funding options.