Financing Your Small Business
One of the most common mistakes entrepreneurs make is underestimating the costs of their
business and creating a financial plan based on low cost projections. Every entrepreneur has
different costs associated with his or her business. For example, establishing a home-based
business will have little to no cost for acquiring office space; renting office space will entail
low to moderate costs; and building an office will require a high cost. Regardless of your specific
needs, every entrepreneur must take two costs into account: start-up costs and recurring costs.
Start-up costs are all of the one-time costs required to start your business, such as a security
deposit on office space, furniture and equipment purchase, signage, etc. Recurring costs are all of
the costs you encounter monthly, such as salary and benefit expenses, insurance fees, monthly rent,
etc.
Once you have determined your costs, determine whether you will need to borrow money to start
your business. If so, there are several different funding options to consider. Each
funding source brings with it a series of pros and cons that should be weighed in order to find a
lender to meet your start-up needs.
Option 1: Banks
Banks are usually the first place people look when they want to borrow money. Banks offer a
variety of loans and can often advise you as to which type of loan would be best for your needs.
Some loans, for example, require you to make set payments of both the principal and interest,
whereas others require you to pay back only the interest with a lump payment of the entire
principal at the end. The obvious advantage of approaching banks for loans is that banks are
designed for just that purpose. The downside is that if you have a bad credit history or have
accumulated debt, it can be difficult to get approval for a loan at most banks. The best way to
determine whether bank loans are appropriate for your needs is to do your research: locate the
banks in your region, find out what types of loans they offer, and learn what requirements they
have for approving loans.
Option 2: Venture Capital Firms
Venture capital firms invest in small companies in return for equity. They look for companies
with the potential for high-growth and high-profitability. Although some venture capitalists will
invest in companies that are just beginning, they generally seek to fund companies that have been
in business for some amount of time, in order to assess progress, growth, and earned revenues. For
that reason, acquiring start-up funding from venture capitalists can be very difficult; also, the
earlier the stage of investment, the more equity venture capital firms require. If you are serious
about acquiring venture capital funds for your business start-up, look for firms that specifically
cater to business in the start-up phase. If you have a thorough, viable business plan, and your
management team has extensive experience fostering rapid growth in small businesses and creating
substantial profits, you will have a much higher chance of receiving venture capital funding.
Option 3: Angel Investors
Angel investors are individuals who invest their own money in entrepreneurial ventures in
return for equity. Angel investors can be persons you know or persons you don’t know, and can also
work as an individual or be part of an angel group. Angel investors generally invest smaller
amounts of money in companies than do venture capitalists, making them an ideal source for funding
when you have exhausted funding from your friends, family, and self, but are not yet ready to
approach a venture capital firm.
Option 4: Partners
In some cases, funding can be secured by current or potential partners seeking a share of the
business. The advantages to partner financing are that partners considering investment are already
knowledgeable about the business idea and have confidence in its future, and the approval process
may be easier than with a bank or lending firm. The decision you as an entrepreneur must make is
whether or not you are willing to give up a portion of your company in order to obtain this
funding, or whether you would rather go to banks or other lenders and maintain your control?
Option 5: Friends & Family
Many people warn against the risks of borrowing money from friends and family, but there are
also benefits to acquiring loans this way, and it is an extremely popular source of funding for
small businesses. Friends and family already know you, your character, and your history of credit,
debt, and financial management. Nevertheless, even friends and family considering making a loan
should ask to see a business plan to make sure it is well thought out. The terms on which you must
pay back loans from friends and family will likely be more relaxed, and they may not demand
interest on the repayment of the loan. The obvious downside to borrowing from friends and family is
the potential inability to repay the loan, damaging not only your finances but their finances and
the relationships you share with those individuals.
Option 6: Self-Financing
Self-financing is the most popular form of financing for small business owners, and it can
serve to be extremely advantageous when you approach other lenders. By investing your own money and
assets into your business, it demonstrates your faith that your business will succeed. Different
forms of self-financing include borrowing against your retirement fund, taking out personal lines
of credit, and utilizing a home equity loan. The disadvantage to financing your business this way
is that if your business flounders and you are unable to repay the money, you can lose a lot more
than your business. Before putting your home on the line for your business or risking your personal
credit history, carefully consider whether self-financing is the right option for you.
