“Making money requires money.” The adage is somewhat accurate. You’ll need some money to cover your costs until you start making money to start or grow your business empire. That could take two months or two years and cost $200 or $200,000. There is always a way to get the money, but you need the right approach for you.
There are three sources of money, each with its own advantages, disadvantages, and costs. Over the course of your business, you will probably use two, if not all three, of these options, and you need to be familiar with each one in order to determine which one will be most effective for you today, tomorrow, and in five years.
Method 1: Self-Financing: When business owners have money on hand, they usually start by looking at their own bank account as a simple way to get money. There are two distinct approaches to self-financing, each with its own set of considerations. In the beginning, there are two kinds of self-financing: lump-sum and working from scratch Second, self-financing can come from you personally or from your current business, which helps finance another venture, product line, business, or venture.
When you have a fixed amount of money that can be used to finance a business venture from the sale of a business or investment, an inheritance, personal savings, a 401(k) cash-out (rarely a good idea), or other sources, you have lump-sum financing. You can view and track the amount you have available as a one-time investment because it is relatively fixed.
Most small businesses use bootstrapping all the time, usually without realizing it. Bootstrapping is the practice of financing a new or expanding business with cash flow from other sources. Your day job, your spouse’s or partner’s business, a profitable business or product line, or passive investments (such as real estate, mutual funds, and bonds) could be the other source.
Self-financing works when you need money quickly, have a lot of money on hand, are comfortable taking risks, or have a small amount of money. It also works when a profitable company can cover the cost of investing in a new venture until it succeeds; assuming that adequate cash flow projections and tracking have been carried out to guarantee that the new business is not a never-ending source of profit.
#2 Strategy: Debt financing is borrowing money that must be repaid to the lender, typically at interest rates. Debt financing may involve using both your personal credit and the credit and security of the business to obtain a loan or line of credit, just like self-financing.
The majority of business owners are able to easily obtain personal debt financing. You can get credit cards, a home equity line of credit, or a loan without telling the bank about your business if you have good credit. You might be able to get a loan from a friend or family member who knows about your business, but they might not have the same strict requirements as a traditional bank.
Banks and credit unions also offer loans, credit cards, and lines of credit to businesses. Small businesses that may not be able to obtain credit without the SBA guarantee can get loans that are secured by the Small Business Administration (SBA) through banks that offer lines of credit. People and businesses with lower credit scores can get financing from a variety of sources through alternative debt financing options like Prosper.com. However, the interest rates on these private loans are typically higher than those on SBA loans.
#3 Strategy: Giving up ownership (equity) in your company and potential future profits in exchange for today’s capital is known as equity financing.
Private investors who make bets on emerging businesses or silent partners are examples of types of investors. Angel Funding involves wealthy individuals and organizations purchasing stakes in small, high-growth businesses for a few hundred thousand dollars. Investment banks and venture capitalists typically seek out businesses in which they can make significant investments of millions of dollars.
You will likely require more sophisticated financial reporting than what is covered in this book if you intend to seek private investors, angel funding, investment banks, or venture capital. You’ll also need more accountants and lawyers.
Which type of financing should you pursue?
One kind of financing probably isn’t right for you right now. For any given business, you will probably use two or even all three kinds of financing, and your decision may change over time as your company grows and adds new ventures. If you don’t have cash or another source of income (for yourself), don’t have a good personal credit rating (debt), or your business doesn’t have an exit strategy (equity), you might be able to eliminate certain options.
You must keep track of the benefits (RoI) and costs (interest, fees, and lost profits) of each financing option for each choice. As your company expands, you may need to add or change financing options because your current ones are too expensive, exhausted, or do not yield a sufficient return.