10 Ways to Fund Your Business Plan
A great idea sparks most business start-ups, but money is the fuel that keeps those start-ups running. Even if you’re launching a one-person freelance business, chances are you need cash to get off the ground. If you’re starting a bigger company, and especially if you’re founding a high-tech or manufacturing enterprise, chances are good that you need lots of cash. This list shares ten places to turn to when searching for money to fund your company.
Your own pocket
The most obvious place you can turn to fund your new start-up business is with your own cash, credit cards, or personal debt. However, providing your own funding comes with both advantages and disadvantages.
If you get your business up and running by using only your savings, you maintain 100 percent ownership and 100 percent control. But you also take on all the risk: If the company goes under, your money goes with it. If you link arms with investors, you still tap your own pocketbook, but you share the risk — and the rewards — with others. If you seek loans, banks require you to pledge personal assets as collateral to secure the debt. And if you go the venture capital route, most investors insist that you ante up some of your own cash, largely as proof of your commitment, before they’ll add their own.
Friends and family
Turning to friends or family members is a time-honored tradition when starting a small business. Some people borrow money in return for a simple IOU to be paid back in full when the company starts making a profit. Others set up a more formal loan along with an agreement for paying back money with interest on a specific schedule.
Whatever arrangement you reach, make sure that everyone involved understands the terms and knows what to expect and when to expect it. To be on the safe side, put the terms in writing and ask all parties to sign the documents because disagreements over money can spoil even the closest family or friendly relationships.
Customers and prospective customers
This option sounds counterintuitive, but you can turn customers into investors who can help your company get off the ground. For example, community-supported agriculture (CSA) programs pair local farmers with consumers who pay a set fee in advance in return for a weekly load of produce during the summer growing season. Condominium projects often sell units to prospective owners before the builder ever breaks ground. And, increasingly, local businesses reach out to community members, called locavestors, who invest in neighboring start-ups both to earn a return on their investments and to help build stronger local communities.
When considering funding sources, think of people who use and benefit from your company’s offerings. They may be willing to invest in your continued success, especially if you provide a clear reason and reasonable rate of return on their money. Sharing your business idea with prospective customer-investors early in the planning process also offers a useful reality check to test whether they will actually pay for your products or services.
A bank loan
Local branches of most banks are willing to consider loan requests from local businesses. The factors that influence a banker’s yes-or-no loan decision include your personal credit history, your education, expertise, business experience, and the likelihood that you’ll succeed in your business start-up or expansion.
Before you consider approaching a banker, be prepared to make your case by presenting your written business plan along with a loan request that defines how much you want to borrow, how you plan to use the funds, and when you’ll repay the money. Also, be aware that most banks won’t lend unless they can secure the loan against valuable property, called collateral. In many cases, the loan security comes in the form of a second-mortgage on the owner’s home, though if the business has valuable equipment, inventory, or accounts receivable, you can pledge them to secure the loan.
The simplest bank-loan arrangement is a standard commercial loan. In this case, the bank loans you the money, and you pay it back, usually in monthly installments and with interest. But you can find all sorts of variations on this theme, from real estate loans on commercial property to loans secured by your inventory or accounts receivable.
The big advantage of getting a bank loan is that you gain business funding while maintaining all the equity in your company. Bank loans also come with lower interest and longer repayment terms than many other sources of capital. The disadvantage is that loan payments are due on schedule, even if your business runs into hard times. The task of securing a business loan is tougher than ever in the aftermath of defaults caused by the economic downturn. But banks are still lending, and the work you do upfront to convince a loan officer can make your business strategy all the more effective later.
A commercial line of credit
If you need access to money that you don’t intend to need all at once, consider applying for a commercial line of credit. A commercial line of credit is an agreement from a financial institution to extend a specified amount of credit that your company can draw upon, as necessary, to finance inventory purchases or to provide working capital or funds for other cash needs.
With a commercial line of credit, you pay interest only on the funds you actually borrow over the period between when you draw on the funds and when you pay them back. Banks may require that you secure a line of credit, with your company’s accounts receivable, inventory, machinery and equipment, or real estate.
Another way to borrow money from banks is in the form of an equipment lease, which you can use to acquire anything from computers, printers, and copiers to manufacturing equipment, tractors, and trucks. Financial arrangements include lease-to-buy options, equipment upgrade options, and master leases, which cover a variety of equipment under one agreement.
The loan length for these options is usually tied to the lease term, and most banks base their leasing agreements on a company’s established operating history.
A Small Business Administration (SBA) loan
Bravo to the Small Business Administration (SBA), which is a government agency dedicated to helping small businesses that may otherwise have a tough time securing financing from commercial banks. The SBA has a variety of loan programs for small businesses.
When seeking an SBA loan, realize that it’s easier to get funds for business expansions than for acquisitions or start-ups — and that it isn’t free money. For that matter, what’s commonly called an SBA loan is actually a bank loan guaranteed in part (usually in large part) by the SBA, which essentially plays the role of a co-signer. Expect to pay fees and interest and be ready for paperwork, oversight, and the responsibility of personally guaranteeing loan repayment. But because the SBA provides the backup guarantee, loans that banks may otherwise turn down get extra attention.
It sounds like a marriage made in heaven: An entrepreneur with great business idea but no money finds like-minded entrepreneur with money in search of a great idea. In fact, many such partnerships live happily ever after.
But if you’re thinking about forming a financial partnership as a way to get the cash you need, establish an upfront agreement that defines how much control your partner or partners will exercise over the business strategy, planning, and day-to-day operations. And be sure that you get along. It may sound obvious, but a good working relationship with a business partner can help smooth the inevitable bumps on the road to success.
Venture and angel capital
If you need more money than a bank is willing to lend you, or if you’re nervous about taking on all the risk of a major loan, you may want to knock on the doors of venture or angel investors for capital.
Venture capitalists are professional asset managers (in other words, investor groups) who seek a high rate of return on behalf of the investors they represent. When venture capitalists are impressed by a business concept and confident that the management team has what it takes to make the business succeed, they fork over sizeable sums. The catch is that they want something in return, and usually that something is a big role in controlling your business, a major chunk of the ownership, and a clear way to recoup and realize a substantial return on their investment at a specified time in the future.
Venture capital tends to flow when the economy is booming and to slow to a trickle when it hits hard times. But for a truly great idea, you can usually find venture capitalists willing to open their wallets. Check out Gust for free online tools and information from an investor network endorsed by the world’s leading business angel and venture capital associations.
Angels are successful and wealthy entrepreneurs who buy into up-and-coming companies, not only with their money, but also with their expertise and guidance. Angels make funding decisions more rapidly than venture capitalists largely because they operate independently rather than on behalf of a group of investors. Additionally, angels take greater risks than venture capitalists, funding businesses at earlier stages of their life cycles and entertaining smaller financing requests. However, like venture capitalists, angels usually want a piece of the equity pie.
Crowdfunding pools small sums of money from many people, usually through an Internet campaign, to fund anything from disaster relief to music or film productions to business start-ups. It provides a financial lifeline if you lack strong financial statements necessary for successful bank loan applications and can’t call on deep-pocketed family and friends to fill the startup coffers.
The sites require you make a concise and engaging funding request accompanied by an offer of interest to those being solicited (a record or concert tickets from an entertainer, for example). Plus you have to follow the model of the funding platform you choose to use. Some platforms are all-or-nothing, meaning no contributions are accepted unless a minimum pledge level is reached.
All platforms collect a percentage of funds received as their hosting fee, and nearly every successful effort begins with strong momentum from an impressive groundswell of first-day contributions. For example, the Nikola Tesla museum project raised more than a million dollars in the first nine days before going on to meet its full 45-day campaign goal.
Although crowdfunding supporters currently accept their rewards in the form of nothing more than perks or rewards, before long their funding may be treated like equity investments that return financial gains. The 2012 Jumpstart Our Business Startups (JOBS) Act, when finalized, will allow entrepreneurs to raise up to $1 million from large numbers of individuals who choose to make small equity investments in start-ups and small companies.
Until the JOBS act rules for investment-crowdfunding are outlined and approved, however, perks-based crowdfunding remains the preferred way for small businesses to attract funding from large numbers of individuals and avid customers.