10 Proven Ways to Fund a Successful Small Business - dummies

10 Proven Ways to Fund a Successful Small Business

By Eric Tyson

Copyright © 2014 Eric Tyson. All rights reserved.

If your small business start-up is like most others, you probably won’t utilize outside capital. You will bootstrap. (Bootstrapping is the internal generation of initial financing, using primarily your own personal resources, sometimes complemented by various forms of equity investments or loans from family or friends.)

Inc. magazine annually publishes the Inc. 5,000, a listing of the fastest-growing private companies in the United States. A survey of the Inc. 5,000 illustrated the sources of original financing from those Inc. 5,000 companies. Time and time again, bootstrapping sources emerge as the clear-cut winner in the start-up financing competition, even for this exclusive list of fast-track, rapid-growth companies.

If you think about it, it makes sense that bootstrapping is so pervasive and works so well. First, what better way to instill discipline and make things work efficiently than to have a limited supply of funds? Second, because you care deeply about risking your own money or that of family or friends, you have a powerful incentive to work hard and smart at making your business succeed.

So take heart if you think that you need vast sums of cash to start a small business or if you’ve been turned down (perhaps more than once) by outside sources of funding. The entrepreneurial traits of hard work, perseverance, and, yes, good old-fashioned scrounging can help you locate the money that you need to start your business.

Bootstrapping begins at home. If you’re like me and the majority of entrepreneurs, here’s how you go about locating the funds you need to finance your start-up:

  • Take stock of your personal assets and liabilities. Get your personal finances in order and determine where you stand in terms of common important goals such as retirement planning. Only then can you begin to determine what portion of your assets you’ll feel comfortable using in your business.

  • Assuming that your parents and family are financially able to help, gingerly approach them. The family resource is appropriately known as relationship investing or relationship lending. Although relationship investing is a widely used resource for raising money, it’s also the most potentially dangerous. Telling the bank you can’t meet repayment obligations is one thing; telling a close relative that you’ve lost his money is quite another. The good news is that you’ll work that much harder to succeed when family or friends are involved; the bad news is that loss of the investment could damage existing relationships. Proceed with great care and be clear with family as to the risks, including the risk that they could lose their entire investment if your business gets into trouble.

  • Ask friends, especially those friends who can bring expertise to the table along with their money. Be aware, however, that the risks involved when borrowing money from friends are similar to the risks when borrowing from family. The downsides can be just as painful.

  • If the preceding methods aren’t enough, consider looking for a partner (or partners), but be very, very careful. Partners are a roll of the dice — make a good roll, and your business will prosper beyond what it could with you alone; make a bad roll, and your problems could be multiplied.

  • When all else fails, look to outside resources, even though they’re historically unlikely to fund start-ups. Look for angels (affluent investors looking to invest in small businesses and to possibly provide some advice) first before heading for banks, the Small Business Administration, and Small Business Investment Companies. If your idea or concept is compelling enough, and if you’re compelling enough, you may even consider approaching venture capitalists.

Here are some specific sources of bootstrapping capital:

  • Savings, investments, and salable assets: This is always the first place to look. Theoretically, all you’re doing here is simply transferring your assets from one investment (your savings account) to another (your new business). Okay, so you’re increasing your risk by a quantum leap, but you’re also increasing your opportunity for reward.

  • Life insurance: If you own life insurance policies with a cash value, you probably shouldn’t, because term life insurance is a far better deal. Consider cashing in such policies and putting that money to far better use — your business. Note, however, that you may owe some income tax on accumulated interest (in excess of the premiums you paid) from your life insurance policy.

    Ask yourself whether you really need life insurance at all. If you have no financial dependents, you won’t need it to replace your income if you pass away. If you do need life insurance, however, secure good term life coverage before you cancel or cash in your current policy. Otherwise, your dependents will be in trouble if you pass away after you’ve canceled your current policy but before you’ve secured new coverage.

  • Credit cards: Credit cards provide expensive money, perhaps, but easy money as well. No personal guarantees here; no bankers looking over your shoulder. Just sign your name and get on with the business at hand. Given the highly competitive credit card market, be sure to shop around rather than simply accumulating a balance on whatever platinum-hued card currently happens to be in your wallet or pitched through an ad. And when you carry a balance from month to month, always make your credit card payments on time unless you enjoy paying even higher interest rates — in many cases upward of 20 percent.

  • Home equity: Proceed with extreme care when borrowing against home equity. A misstep could cost you the roof over your family’s head. And keep in mind that home prices can go down, and you may find yourself in a situation where you’re unable to refinance and are stuck with a larger, riskier mortgage. Don’t even consider this option until you’ve thoroughly reviewed your overall personal financial situation.

  • The family and friends network: Be sure to make your relationship loans as official as possible — always create a promissory note complete with a fixed interest rate (at least 1 percent over prime to avoid IRS scrutiny), and include cast-in-stone payback terms. Consult a lawyer when larger loans (in excess of $10,000) are required.

    After you’ve tapped out your own resources but before you begin probing family and friends, you should remember the Golden Rule of Bootstrapping: If you aren’t willing to risk your own money, why should anyone else risk theirs, especially family and friends? The purpose of the Golden Rule of Bootstrapping is to make sure that you don’t even think about asking your family, friends, and relatives for money before you’ve contributed yourself. The first question family and friends inevitably will ask is, “How much of your own money are you investing?”