Many budding entrepreneurs have sound business ideas but lack the capital to get their new venture off the ground. You could start a business on a shoestring budget, but then you would probably lack the working capital to make the business viable. So, how do you raise the cash to pay for start-up costs and give yourself a reasonable cash buffer to see you through the first six to twelve months of trading? Here are ten ways to finance a small business start-up.
- Borrow from Friends and Family
Your first port of call to raise money for a start-up business might be your friends and family. However, you should be aware that turning friends and family into business partners or debtors can be fraught with problems. 84% of all new businesses fail within the first two years of trading. So, it would be best if you made it clear that there is a possibility that the people you borrow money from may lose their investment. You must also be confident that your personal relationships with the people you borrow from would survive the failure of your business.
- Use Personal Credit Cards
Personal credit cards can be useful in an emergency. However, the high interest rates on credit cards make them an expensive way of providing long term financing for a business. If you max out credit cards or don't make the minimum repayments, you will also damage your personal credit rating, and you will lose a crucial financial safety net that you might need for yourself if your business fails.
- Find a Business Partner
Setting up a new venture with business partners has its pros and cons. On the plus side, business partners may be willing to finance the company. Still, the relationship does not have the same potential personal drawbacks as going into business with close friends or family. Business partners may also bring expertise to the company that you do not possess. On the other hand, though, you will have to dilute your equity in your new business, and you will not have 100% control over how the business is run.
There have been many successful businesses that obtained initial funding via crowdfunding sites like Kickstarter.com. You will need to offer investors something in return for their money, like an exclusive offer or one of the first batch of your new, innovative product. Even so, the cost of obtaining finance on crowdfunding sites is much lower than traditional financing. However, there is no guarantee that you will raise the funds you need, and crowdfunding is not a long-term financing solution.
- Get Bank Loan
Borrowing from banks has become much more challenging since the financial crash of 2007/2008, and banks are always more reluctant to lend during a recession. Some banks are still willing to lend to start-ups, but you will need a watertight business plan to borrow from a bank, and a good credit rating. A bank will probably ask for some form of collateral against a loan, such as your home.
- Apply for a Micro Loan
Microlenders, which are not-for-profit financial organizations, will often lend to businesses that banks will not. Microloans are generally available for smaller amounts, from $500 to $50,000, that the big banks would not be interested in lending. Microlenders often require less information than banks do, and the underwriting criteria are usually more flexible. However, the interest rate on microloans may be higher than bank interest. Three examples of microlenders are LiftFund, Opportunity Fund, and Accion New Mexico.
- Use Your 401(k) Funds
It is possible to invest funds from your 401(k) in your new business without incurring penalties. You would need to set up a C Corporation and an appropriate retirement plan. The process isn't overly complicated, but it would be advisable to get professional advice before you go ahead with moving money from your 401(k). And, of course, you should carefully consider the implications of losing your retirement savings if the business were to fail.
- Apply for an SBA Loan
Small Business Administration (SBA) loans are available to small businesses that cannot fund their enterprise any other way. So, part of the qualification criteria for an SBA loan is proof that a bank has turned you down. The SBA does not provide the loans; it guarantees up to 85% of the amount borrowed. So, you will need to apply to a commercial lending company that handles SBA loans. SBA loans are not a guarantee that you will get your funding, though. You will still need to demonstrate the viability of your business and your ability to repay the loan.
- Apply to an Angel Investor
Angel investors are individuals or consortium of businesspeople who invest in start-ups. Angel investors will often invest in businesses that other lenders will not be prepared to finance. An Angel investor will expect a share of equity in return for their investment, and they will usually be looking for their money back in 5 to 7 years plus an annualized internal rate of return ("IRR") of 20% to 40%. One of the significant advantages of Angel funding is that you usually gain a business mentor in addition to the financing.
- Consider Invoice Factoring
Invoice factoring will not help you raise the initial capital to launch your business. However, factoring your sales invoices will help you maintain your level of working capital. Invoice factoring companies buy your sales invoices from you at a discount. You can offer customers credit, but you receive most of the cash from sales almost immediately. Factoring helps to smooth out the peaks and troughs in cash flow, and it frees up money that you can spend on continuing to grow your business.
Unless you have substantial personal savings, the above are the main ways of raising funds for a start-up. Most likely, you will need to consider more than one of the above options. The crucial thing to bear in mind is that it is not only the initial start-up costs that will need to be covered. You will also likely need to fund your working capital for at least the first year of trading.