May 27, 2018
Every startup has one major need in common: money! Financing a startup takes a great deal of overhead, often before any revenue streams have come to fruition. That means while your fledgling company is spending money left and right to get up and running, it’s likely not bringing anything in.
Not to worry, there are plenty of different ways to finance your startup. Whether you borrow money, leverage your savings, use credit, or go another route, it’s important to understand your options and the pros and cons of each before you choose.
While these are far from the only ways to finance your startup, here are three of the most popular methods today’s entrepreneurs choose.
Traditional bank loans
The notoriously high rejection rate of bank business loans combined with the proliferation of online lenders has made traditional business lending seem like it’s not even worth the time and effort. But plenty of small business owners still turn to local and national banks, as well as the Small Business Administration (SBA), to help them finance their operations.
“Traditional bank loans typically offer better terms and build credit, but the arduous [process] that comes along with this type of financing often overextends time-to-credit necessary to meet the small business’s needs,” added Matt Schaffnit, CFA, co-founder and COO of Lending Technologies Corp.
Alternative lenders provide quicker, smaller, more flexible loans through an online application and transfer process. Depending on your credit score, you can be approved for a loan in a matter of minutes and have your money in just a day or two.
While having all these options can be great for businesses that may not qualify for a traditional bank loan, it also means you’ll need to be much more diligent about researching potential lenders and their reputations. Sabrina Parsons, CEO of Palo Alto Software, said that although online lenders will make a lot of promises about their funds, some are just “sharks” out to take advantage of small business owners.
“These sharks will charge business owners to ‘qualify’ for a loan and to have access to their lenders,” Parsons said. “[Also, some alternative] loans can come at a very high interest rate, and business owners need to understand the implications of these types of loans.”
Schaffnit said the biggest trend in alternative lending is consolidation, and he believes this trend will persist.
“Newer alternative lenders are learning that managing net interest margin is more important than they realized,” he added.
He further noted that if the Trump administration follows through in lightening the regulations on lending, it could have a positive effect on small businesses’ ability to access capital from more traditional and thus more affordable sources.
“However, we also foresee an overall increase in regulations trending over time,” said Schaffnit. “We believe these side effects will be net-positive.”
Funding your business out of your own pocket – commonly known as bootstrapping – is the simplest but potentially most difficult financing route. On the one hand, you are in total control of your finances; you don’t have to make any payments to lenders or share equity with investors. On the other hand, you’re on the hook for every penny you sink into the company, and if it fails, your personal funds are going down with it.
“We see entrepreneurs end up in a position where growth and revenue is strong, but because of long payment cycles, they are short on cash to meet payroll, purchase supplies or acquire inventory,” said Ed Castano, principal product manager at TriNet. “Understanding your options, whether it be a bank line of credit, invoice financing, purchase order financing or something else, can be the difference between expansion, stagnation or layoffs for a small business.”
Bootstrapping is more about necessity than preferred method of financing, according to Schaffnit. More often than not, there is simply no other source of funding available to bootstrappers because they are too early-stage or lack the scalability for loan or venture financing, he said.
Tens of thousands of startups have turned to venture capitalists and angel investors to get off the ground, and their ranks are only increasing. A 2016 Gust report on startup funding saw the number of funding applicants submitted in the second half of that year increase almost 6 percent from the same time in 2015.
Schaffnit noted that venture-type fundraising typically only works for high-growth businesses or businesses that have proven track records and significant revenues, so it is not typically an option for the vast majority of small businesses.
Christopher Hale, founder and CEO of Kountable, a platform that connects entrepreneurs in developing countries with investors based on a “social capital” score, said that investors are really looking for how close a business gets to the underlying economic activity of a community. Investors will look at some of the same thing lenders do – cash flow, market opportunities, the founding team’s experience, etc. Entrepreneurs in the modern world have one more trick up their sleeves: their digital footprints.
Kountable uses a social capital measurement called a K score, and it takes online activity into account when evaluating entrepreneurs.
“[Kountable gathers] a number of different data points, [but] we’re not looking at the traditional definition of creditworthiness,” Hale told Business News Daily. “The K score measures performance capability, [which] is fairly easy to identify in one’s digital footprint.”
In an age when new Kickstarter and GoFundMe campaigns emerge every day, crowdfunding is quickly becoming a go-to option for businesses that want to raise money without the pressure of formally pitching investors. Success stories of entrepreneurs who raised tens of thousands – even hundreds of thousands – of dollars in just a few weeks seem to be a dime a dozen.
In a 2017 blog post, Crowdfund Campus outlined three trends to watch out for in the years ahead:
1. Niche platforms. Campaigners are moving away from mass-market platforms to those that draw a specific crowd. Niches such as gaming, education, music and sports are all forming their own platforms to better serve both those crowdfunding and those investing.
2. Smarter investors. Potential investors are no longer as free with their money, just in case another recession hits. Educating these investors should be a high priority for entrepreneurs looking for funding.
3. Blue-chip crowdfunding. Large blue-chip corporations are learning that crowdfunding is the best medium for authenticating ideas, garnering support and determining demand with very little risk.
Looking for other ways to finance your entrepreneurial dream? Here are six Alternative Financing Methods for Startups:
Online lenders have become a popular alternative to traditional business loans. These platforms have the advantage of speed, as an application takes only about an hour to complete, and the decision and accompanying funds can be issued within days. Analysts estimate that the marketplace lending industry could reach $150 to $490 billion in loans issued by 2020.
Angel investors invest in early-stage or startup companies in exchange for a 20 to 25 percent return on their investment. They have helped to start up many prominent companies, including Google and Costco. Mark DiSalvo, CEO of private equity fund provider Semaphore said, “You are likely to get an investor who has strategic experience, so they can provide tactical benefit to the company they are investing in.”
Venture capital is money that is given to help build new startups that are considered to have both high-growth and high-risk potential. Fast-growth companies with an exit strategy already in place can gain up to tens of millions of dollars that can be used to invest, network and grow their company frequently.
Brian Haughey, assistant professor of finance and director of the investment center at Marist College, said that because venture capitalists focus on specific industries, they can generally offer advice to entrepreneurs on whether the product will be successful or what they need to do to bring it to market. However, venture capitalists have a short leash when it comes to company loyalty and often look to recover their investment within a three- to five-year time window, he said.
Through this process, a service provider will front you the money on invoices that have been billed out, which you then pay back once the customer has settled the bill. This way, the business can grow by providing the funds necessary to keep it going while waiting for customers to pay for outstanding invoices.
Eyal Shinar, CEO of small business cash flow management company Fundbox, said these advances allow companies to close the pay gap between billed work and payments to suppliers and contractors.
“By closing the pay gap, companies can accept new projects more quickly,” Shinar told Business News Daily. “Our goal is to help business owners grow their businesses and hire new workers by ensuring steady cash flow.”
Mentioned above, crowdfunding on sites such as GoFundMe, Kickstarter and Indiegogo can give a boost to financing a small business. These sites allow businesses to pool small investments from a number of investors instead of having to look for a single investment.
Make sure to read the fine print of different crowdfunding sites before making your choice, as some sites have payment-processing fees, or require businesses to raise their full stated goal in order to keep any of the money raised.
Businesses focused on science or research may be able to get grants from the government. The SBA offers grants through the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) programs. Recipients of these grants are required to meet federal research-and-development goals, and have a high potential for commercialization.
Need help getting through the confusion of raising capital? Louis Mamo & Company offers business consulting services that can help you wade through the myriad of options to help find the best solution for you. Contact us to arrange a no obligation discussion.
Sources: Business News Daily, Forbes, CNN Money and Fox Business News