Raising Capital – 7 Potential Funding Sources and What They Look For
Raising capital for your business? Here are seven potential sources of capital you should consider.
# 1 Self-Funding
Self-funding is where you either fund from savings or from ongoing cash flow that perhaps you have from another venture.
In terms of what you are looking for as the sole investor in the business, I’d say the most common motivation is control. You do not want to give up equity ownership in your business, so you decide it’s better to risk you own capital, or to take on debt, than have other equity players in the business. This is typically the approach taken when the amount of capital required is not too large (relative to your resources) and you have a relatively high confidence level in the success of the venture.
# 2 Friends and Family
This is where your friends and family hear that you’re getting a new venture off the ground and want to get in on the action. It could also be the case that you go to them with your idea and convince them that it would be a good idea to invest.
While this is one of the most common sources of funding, it is also one of the riskiest. This is the case because you are risking more than just a business relationship; you are also risking a personal relationship. It is very important that you are completely up-front with prospective family and friend investors. You owe it to them to tell them that, while you will do everything in your power to make the venture successful, they could very easily lose all the money they’ve put in. It is also important that you have a clear, written agreement with these investors, as you would with any other investor, regarding the terms of the investment. You need to cover whether it is a debt or equity investment and the exact investment terms and conditions. There are several potential “gotchas” with these investments, from a tax and other regulatory perspective, so make sure you have competent legal counsel.
# 3 Credit Cards
This approach involves using whatever credit limit you may have on credit cards to fund your start-up and early stages of your business. This is a much more common source of capital than most realize or would be willing to admit.
The “investor” in this case is still you, as you have full responsibility for repayment of whatever credit limit you may utilize for funding. This is the case even if you open business credit cards in the name of the business because many creditors will require a personal guarantee from the owner or company officer. The credit card company typically will charge a higher interest rate than most other (credit, at least) funding sources. The credit card company is not looking for any equity ownership in your business, rather they just want the amount they lent you paid back with interest. This source of capital needs to be used responsibly and not on frivolous purchases. Remember that even if your business is not successful, you will need to pay back these debts, or risk ruining your credit record.
# 4 Home Equity Credit Line
This source of funding involves taking a loan, in the form of a credit line, against the equity you have in your home. This was very common at one time; it is less common in times when homeowners don’t have a lot of equity in their homes.
In this case, your home is the security for the loan you are using to buy, start, or grow your business. It starts to get a bit more serious here, as your home is the security and is directly at risk. That said, this is a very common source of capital for entrepreneurs. Again, as with the other forms of personal funding of your business, you’ll want to be very careful to make sure that you are making expenditures that will create and/or increase future earnings, not making frivolous purchases.
# 5 SBA Loan
This is a bank loan that is guaranteed by the SBA. The SBA’s guarantee of all or a portion of the loan makes it possible for the bank to lend to borrowers to whom they may not otherwise lend, or at least not with interest rates at such low levels.
This is a very common source of funding for early stage companies. In reality though, from the perspective of the entrepreneur, it is not all that different than other forms of asset-based lending. The entrepreneur still has to have a very good credit record and has to have sufficient assets to secure the loan. Do not think that by getting an SBA loan, you will not be on the hook if the business fails; you will. The main advantages for entrepreneurs of SBA loans are that they may get approved for certain projects or loan amounts that they may not otherwise, without the backing of the SBA. Also, it is likely that on an SBA loan you will have an appreciably lower interest rate than you would on a non-SBA-backed loan.
# 6 Angel Investors
This type of funding occurs when through your contacts or those you make, you manage to get in front of a group (or one) of wealthy individuals that invest in early-stage companies. Such investors are typically called “angels” or “angel investors”.
Angels tend to be relatively selective about the types of ventures they invest in. That said, there is a very wide range of sophistication among angel investors, along with which the level of selectivity varies widely. You will want to make sure you have concise investor pitch that flows. You will want to make sure that all angel investors from whom you will receive funding meet the Accredited Investor standards. For this reason, and in order to make sure the terms and conditions of the investment make sense, again you will want to make sure that you have competent legal counsel involved. Don’t even consider doing a deal with angel investors without having a good attorney watching out for your interests. Also, although in the beginning of your venture it may be tempting to take money from whoever will give it to you, do your due diligence on all prospective investors and make sure they are people you think you can work with and communicate with. This will be particularly important when all does not go exactly as planned. As you know, it hardly ever does.
# 7 Venture Capital
In order to obtain venture capital funding, you present your business plan or growth plan to professional early stage investors known as venture capitalists. This source of investment is appropriate for a relatively narrow segment of the startup company population and very few companies end up being funding by venture capital.
It is important to remember that venture capitalists are professional investors. It is key to know what venture capital investors look for. They raise money from what are known as limited partners, usually pension funds and other institutional money managers, then invest that money to earn as much return as possible for their investors. The venture capitalist then shares in the gains they are able to achieve. They are also paid a management fee for their efforts during the life of the fund, which is typically 7-10 years. So as you can see, venture funds are designed to invest, grow and harvest in a finite, relatively short period of time, thus they must choose their investments very carefully. For this reason, venture capitalists are typically interested in companies that are further along, that are already on a reasonable growth trajectory and need money for expansion and further growth. They usually like technology companies that have a proprietary (patented or patentable) product or business process. Unless you have something truly exceptional in the techology space that’s a bit further along, other than with a few venture capitalists that are willing to look at seed deals and deals outside the technology space, you are not likely to find success seeking funding from these investors.
While this list of seven potential funding sources for startup and early-stage companies is by no means exhaustive, it gives you an idea of several of the most common funding sources and what they’re looking for in their investment targets.
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All the best as you work to start and grow your venture!