March 18, 2016
Being able to adequately fund your business is key to helping your business survive until you have sustainable revenue and often can be the difference between being able to stay in business, or not.
Every business has a few different options when it comes to funding and which option is best for your business depends on the answers to various questions such as: (i) What stage is your business in?; (ii) How much funding does your business need?; and (iii) What is your intended use of the funds? These are only a few of the questions that you will need to address to determine which funding option is best for your business.
Here are five options for you to consider as related to funding your business:
- Bootstrapping – This term is often used to describe self-funding your business. Many people use personal savings, income from a “day job”, or liquidate investment accounts. Others take on even more risk by using credit cards resulting in accumulating personal debt. Self-funding allows you to retain all of the equity in your business and you are beholden to no one, but you will be depleting savings and investments that will not be recouped if your business does not succeed and you could be putting your personal credit at significant risk.
- Friends and Family Funding – Obtaining funds from friends and family is only viable if you have friends and family who are financially able to provide you with a loan or invest in your business. For those who do have funds, you will have to explain why they should invest in your business and how they will generate a return on their investment, or what the plan is for paying back their loan. While this option will offset bootstrapping, you will have to give up equity in your business if it is structured as an investment, or pay interest if it is structured as a loan. In addition, there could be significant detrimental effects to your personal relationships if the business does not succeed and you are unable to either pay them back or generate a return on their investment.
- Getting a Loan from a Bank – This option will depend on the condition of your personal and business credit, as well as whether you have any assets of value that the bank can use to secure the loan. There are various loan options that a bank can provide to your business including utilizing loans through the Small Business Administration (SBA). However, SBA loans typically require that you personally guarantee them; therefore, you will be putting your personal assets at risk. No matter which type of loan you seek from a bank inevitably there will be interest associated with the loan and it will be secured by either your personal or business assets, or both. The pros are that you will avoid giving up equity in your business and will also avoid detrimentally impacting personal relationships if your business fails. The cons are that getting a bank loan is not easy and will require a significant amount of time and effort to secure. In addition, you will end up paying interest as well as putting personal and business assets at risk as security for the loan.
- Seeking Angel or Venture Capital Investment – While I have lumped these two items into one option, please note that what an angel investor will be looking for and what a VC firm will look for might be quite different. Being able to get an investment from an angel investor or VC firm is not easy and will require that you develop a solid pitch explaining how you will deliver a significant return on investment. Many small businesses are solid in terms of providing for a nice income for an owner-operator, but investors are only attracted to businesses that can scale dramatically and be sold in 3-6 years for a very high return on their money. If you are seeking angel or VC money, it’s important that you work with financial and legal professionals to assist you in developing this presentation because you may only have one chance to convince either an angel investor or VC firm to invest in your business. The biggest pro to this option is that you are able to use “other people’s money” that is not secured by you or your assets, limiting your risk. Also, the angel investor or VC firm can advise your business as you move forward into the future and often times they will want to be part of your board of directors. Their involvement and advice could significantly help your business achieve its full potential (it could also result in you being pushed out of your own company depending on the investment terms). The biggest con is giving up equity; the VC firm or angel investor will typically want a larger ownership interest with more preferences than you may give to an investor who is a friend or family member.
- Crowdfunding – This option is the newest of all the options presented and there are a number of sub-options for your business as related to the type of crowdfunding you should pursue. Crowdfunding is the process by which you can utilize certain crowdfunding websites for soliciting funds for your business from the public at large. The four major types of crowdfunding are: (i) Equity based crowdfunding; (ii) Donation based crowdfunding; (iii) Lending based crowdfunding; and (iv) Reward based crowdfunding. I will lump reward and donation based crowdfunding into one category wherein these types of crowdfunding are what have been around the longest and essentially comprise of seeking funds from people who either believe in the cause you are trying to address in your business (donation crowdfunding) or seeking funds from people who are interested in the product or service your business is offering and in exchange for a sum of money they are given a gift by your business (Reward based crowdfunding). Lending based crowdfunding is an alternative to seeking a loan from a bank or a friend/family member. There are lending based crowdfunding websites which allow you to source your loan from the public at large and this is a growing area as related to connecting both lenders and businesses seeking loans. Equity based crowdfunding is the newest form of crowdfunding and it involves seeking investment from investors in exchange for equity in your business. There are different options as related to equity based crowdfunding and which option makes the most sense will be dependent on the amount of funds your business needs. It is important to consult with a legal professional when it comes to equity based crowdfunding who can help guide you through the different options available as well as ensure that you are complying with all the SEC rules and regulations associated with equity based crowdfunding. The biggest pro associated with crowdfunding is that it expands your potential options for loans or investment to the public at large and you are not limited to only reaching out to people or banks that you know. The biggest con associated with crowdfunding is that there are potentially significant costs associated with preparing an effective crowdfunding campaign no matter which type of crowdfunding you pursue.
This Blog was written by Hunter Business Law Attorney Ajay K. Singh. Profile