Starting a New Business

Which Funding Type Is Right For You?

Starting up a small business and looking for funding? There are three primary ways to fund your business: bank loans, private equity, and speculative investments. But within those three groups, there are variations. For instance, bank lenders may be mortgage lenders, line-of-credit lenders, straight loan lenders, or a combination. So let’s look at all these possibilities. One or more of them may be the right fit for your business.

First, let’s take a look at traditional bank financing. Banks specialize in investments that are secured by solid assets like buildings, vehicles, equipment, and inventory.   Banks tend to be ultra-conservative and parsimonious about lending, but even so, the rates are usually the best you’ll find among your options.

Mortgage Lenders

While you may think of mortgage lenders as land-grabbing carpetbaggers hovering over your home, if you are buying land and buildings for a business, you should think of your mortgage lender as an investment partner. They do not generally want to repossess your business, so they have every interest in helping you succeed.

Working with a small local bank or credit union may be the best route to go, as you are more likely to get personalized service, free guidance, and a much faster response.

Small-Business Loans

The Small Business Administration offers guarantees to lenders who want to finance small and startup businesses at reasonable rates. In fact, if you are turned down for an SBA loan through one lender, you can turn right around and apply at another bank. Every bank has a different comfort level with small-business loans, so keep shopping until you find one that is right for you.

Line-of-Credit Lenders

When you are thinking of banks, don’t forget to approach line-of-credit lenders that will offer you rotating lines of credit to help cover your production or operating costs. They will, of course, want to look at all of your financials to assess your viability as a business, but they will only ask for your inventory as security. The amount of money available to you from a line of credit will go up and down based on the amount of inventory you have on hand. This way, if your business does go belly up, the line-of-credit banker knows they can have a fire sale and recover their investment.

Personal Investors

If you’re just starting out, personal investors–also known as private equity–can give you the pre-startup cash you need to prepare business plans, prototypes, models, a website, and pay for marketing. If you can gather 20 family members and friends who are willing to invest $100 to $1,000 in your venture, that’s a pretty considerable stake. Look beyond your family and immediate friends. Your lawyer, dentist, gym buddies, and auto mechanic could all be potential investors.

Treat your private investors with respect and make sure each one gets a customized loan agreement. This also protects you from personal investors who may get a little too intrusive in the day to day management. For personal investors who are interested in large and long term investment, spanning years or decades, you might consider forming an LLC to acknowledge them as partners.

Crowdfunding

Crowdfunding is a creative way to gather hundreds of mini-investors together. Generally used to fund extremely outside-the-box ideas, creative arts and media, or nonprofits, crowdfunding sites like Peerbackers, Kickstarter, and Indiegogo can also be used to attract startup capital. The general concept is that you promote your startup venture or new project, and offer a series of rewards for mini-investments. Really successful crowdsourcing campaigns have been known to raise over $200,000–although at that level you should be prepared to spend some serious bucks first on videos and viral marketing to promote your offer.

Angel Investors

This is the group that every business dreams of having. Angel investors are individuals who are willing to personally invest a significant sum in your business in exchange for a significant and generally speedy return.

These investors are generally looking for big, amazing, powerful ideas. Angel investors may expect a rate of return of 25 percent or more, or could expect to quintuple their investment in just five years. An angel investor may also expect to own anywhere from 5 to 25 percent of your business. This type of funding tends to be best for companies that make products that can be cheaply produced and widely distributed, or software and mobile applications that either fill a specific need or have the potential to go viral.  Before asking for an investment, be prepared to tell them exactly what you are asking for, and why. You should also be able to tell them what their risk is, and what their recovery and fail-safe might be.

Venture Capitalists

Venture capitalists are firms that manage and re-invest other people’s money. Venture capitalists may have access to deeper pockets than individual angel investors, but they also have higher expectations. They are seldom interested in low-growth companies, and they may demand a seat on the board or other controlling interest.

Diversity among all your investors is important because you may be able to tap the well for talent as well as money. When you need services or connections, look to your investors for help first. They may be able to help you with legal advice, accounting, labor management, equipment sharing, and more. Generally, when individuals invest in your business, they really care about it and want you to succeed, so they’ll do everything they can to smooth your path.

When you take on investors, you are taking on a team. Choose your team carefully, and not just for the amount of funding they can provide and the rates they charge. Your funding partners may also be able to provide you with personalized service, mentorship, and strong guidance.

Chapter 3.
How to Choose the Right Location for Your Small Business12 min