Sources of Capital- A Quick Guide to New Business Financing

There are many sources of capital for starting a business (or funding an existing one), but not all kinds are a good fit for each type of business.

This post is a quick run through of each of the major types, pros and cons of each, the amounts available, the time frame and requirements to get your hands on the cash, and the overall chances of securing each type of funding.

These are the basic types of financing available:

Your Own Money

Obviously the easiest, fastest least hassles kind to get. You may feel limited by the amount, but often it is better to scale back and start something that works with what you have, so you can get started now, than try to raise a much larger sum going down one of these other routes. The vast majority of small businesses (and this includes almost all of our bookkeeping clients) are started using this type of funding.

Family

This depends entirely on your situation. The pros are that you don’t need good credit, an application or anything else. The con is that if you can’t pay it back, you wish you’d never borrowed it from this source in the first place. A lot of clients who can’t fund the whole thing themselves go here to make up the balance.

Friends

This is just like family, except they will probably be harder to convince, so your chances of getting go down accordingly.

Bank- Collateral

This is easy to get if you have a home or other asset you can borrow against. The downside is you must start paying it back right away, and if you can’t you may have put a very valuable asset at risk. Not a decision to make lightly.

Bank- Line of Credit

This requires higher interest and is for a smaller amount than a collateralized bank loan, but you don’t need assets to borrow against. You are still liable, however, so if you do have assets, they will be attached and you will have to make good one way or another on the loan.

Bank- SBA

This is a poor choice for starting from scratch businesses, but an excellent choice for acquisitions or franchise deals. It is also very good if you are buying the land and/or building you are going to be using for your business.

Credit Cards

Easy to get but high interest. If you do use them, try to only use them to buy things that retain their value. For example, using it to buy inventory is less risky because you can always resell the inventory to pay off the credit card, even if you have to lower the price some. Using a credit card to buy advertising, pay payroll or by something else which retains no value is a more risky proposition, since you will have no asset to fall back on to repay the borrowed money if things don’t work out.

Crowd Funding

This is a relatively new avenue and there are lots of cool success stories, plus this is a low risk avenue and low cost to pursue. The main point to pick up on there is “story”. If you have something cool to talk about, or better yet, demonstrate on video, then you might have a decent chance of raising some cash.

It helps to have a track record, a tangible deliverable and need an amount of money that fits the typical fundraising profile of these kinds of sites. Raising $400K to open a restaurant is probably not going to happen (since you are only going to get local people who can actually enjoy the fruits of their investment, and it’s too much money for this site). On the other hand, a cool app, a gadget or a cause related product or service might do very well.

Leasing

Leasing won’t put money in your pocket, but you can use it to effectively lower the amount of money you need to get started. You can lease all kinds of equipment, vehicles, etc. Lowering how much you need to get started is as effective a strategy as raising capital when it comes to getting off the ground.

Angel- Amateur

This is often who people think of when they say silent partner. In reality, these investors can be much more than silent partners, it just depends on their specific requirements. The best angel to find is someone who is very familiar with the type of business you are starting.

For example, to get an investor for a new restaurant, you should seek out successful restaurant owners who may have an interest in investing some of their cash into a new place, without them having to take on all the responsibility of running it. That way, they will be a great source of info as well as cash, and will understand much better the risks and rewards of the investment that someone with no specific knowledge.

The usual way to pay these investors back is either with a buyout agreement after a certain number of years, or by selling the business altogether after a certain number of years and splitting the gains. Either way, this agreement should be in ironclad writing before any money changes hands.

Angel- Professional

This specific type of angel only invests in deals they think a venture capitalist would be interested in funding once the business gets a little further along. They often fund very early stage ideas, and provide the money that builds the prototype, pays for patents, and gets the first few customers on board.

At that point, they will look for another round of funding from a venture capital group. Because of this, they will only consider types of businesses that a venture capitalist will invest in- high growth businesses typically in the high tech or bio tech fields.

Venture Capital

Venture capitalists won’t consider a business that doesn’t have at least a nine figure ($100,000,000+) potential valuation, which rules out 99.9% of small businesses. Even if you do fit that requirement, your chances of getting venture capital are relatively tiny.

You might be the next youtube.com or Snapchat App with a billion dollar payday after only a couple years work, but the odds are very long. To figure out if pursuing venture capital is worth your time, we’ve got another article coming soon on using venture capital to start your business.