Unless you’re already independently wealthy, obtaining financing to launch a new business takes thoughtful planning and lots of time and effort. This blog article briefly introduces many of the alternatives and weighs some pros and cons of the most common alternative funding sources.
If your startup costs are not great, you might consider tapping your own personal resources to seed your new business or jump start business growth. The upside of this is you retain complete control. Also, your willingness to invest in yourself may prove beneficial to attracting outside financing down the road. The downside is you assume all risk. Some more specific resources to consider are personal savings, sale of personal assets, credit cards, home equity loans or lines of credit, traditional bank loans, and retirement accounts.
If you don’t have sufficient savings, or you are unable to qualify for a traditional bank loan, you may consider any number of other lending sources. Each option has its own benefits and drawbacks.
>> Friends or Family – Family members and friends may be less stringent in their lending requirements than traditional banks. They also may be more willing to agree to a lower interest rate and more flexible payment terms. However, mixing friendship with business, even close friends, can be a recipe for heartache if expectations are not later met. If your plans are less successful than you anticipate, relationships can suffer.
>> Small Business Administration (SBA) Loans – SBA loans are not actually loans from the government, but guaranty programs for loans made by financial institutions. Interest rates depend on the lender, the size of the loan, and your credit history. SBA loans are generally considered more available to existing businesses with years of financial paperwork demonstrating viability.
>> Angel Investors – Angel investors are wealthy individuals who like to invest in startup ventures. In return, they ask for an equity stake in the new business. Typically, angel investors are familiar with the industry, and therefore feel comfortable conducting their own vetting process. Sometimes financing can come with guidance on how to run the business, which may be welcomed, or may be unappreciated. Their business experience and contacts may also open doors for the aspiring entrepreneur.
>> Crowdfunding – crowdfunding websites have opened the power of the internet to individuals to make appeals for funding. Not only has it opened the market to borrowers, but to lenders who can participate in lending at a level with which they are comfortable. If you choose this route, do your diligence on the lending terms. Obviously, the broker is going to take a cut to finance its operations. Much is the case for any traditional lending source. Know and understand the rules of the platform you choose.
>> Peer-to-Peer Loans – Similar to crowdfunding, peer-to-peer loans offer lending outside a traditional bank or investment company using a lending platform. While they typically offers lower interest rates, fewer fees, and greater flexibility than traditional lending sources, the process is generally more formal than crowdfunding. Similar to traditional lending, credit scores and loan applications are part of the process.
>> Business Incubators – Whether hosted by venture capital firms, government agencies, or universities, Business Incubators can be an attractive lending option for those willing to participate in what is typically a stringent application process. In return they offer funds and dedicated assistance.
>> Community Development Finance Institutions (CDFIs) – CDFIs are nonprofit organizations that may offer lending options to those who can demonstrate viability but may not qualify for traditional lending because of insufficient collateral or poor credit ratings.
>> Strategic Partner Financing – Partner financing involves obtaining funds from an existing industry partner in exchange for special access to your product or services, or a percentage of the income. If your company has something to offer that the existing industry does not already have, or is not available to your strategic partner, you may find this a good fit.
>> Factoring – Factoring, or invoice financing, also involves a lending arrangement with someone in your industry. This company provides funds and uses as collateral your outstanding accounts receivable. As invoices are paid, the lender is repaid.
>> Grants – If your business if focused on science or research, government grants from the U.S. Small Business Administration’s Small Business Innovation Research and Small Business Technology Transfer programs may be an option. You must meet federal research and development goals and show potential to succeed in the commercial market.
>> Venture Capital (VC) – Venture capital firms make direct investments in exchange for an equity stake in the business. VC firms typically invest in a business anticipating cashing out their equity stake when the business eventually holds an initial public offering (IPO) or is sold to a larger existing business. VC lending attracts borrowers with insufficient collateral to acquire the funds they need from traditional sources, but have high growth potential.
>> Convertible Debt – Convertible debt is when a business borrows money under an agreement to convert the debt to equity in the future. A potential benefit of convertible debt is that it doesn’t strain cash flow while interest payments are accruing. A potential drawback is you relinquish some ownership or control of your business.
Takeaway
If you are looking to start or grow your business, consider one or more of these funding sources. Need further assistance in planning your business future? Contact CASHMAN LAW today for a free consultation to see how we might help you explore the outcomes of different styles of company financing.
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