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Financing Options for a Small Business: Finding the Right Funding

A while back, we were approached by “Brian,” an entrepreneur who
started a company with a combination of funds from his personal savings
account and credit cards. He was looking for a venture capital
investment, but part way into his pitch, it was clear he was heading
down the wrong path.

As in Brian’s case, it’s no mystery
that funding is front and center in the minds of entrepreneurs.
Financing options for starting a business abound, but what we’ve
noticed is that people often go after the wrong type of funding for
their kind of business. This can lead to undesirables like a shift of
control that’s out of your hands, feuds between you and your
financiers, a waste of one of your most precious resources – time, and
other nasty consequences.

With this in mind, we thought
you might want to consider applying the “Goldilocks Principle” to your
funding quest…choosing the type that’s “just right.” To help you, we’ve highlighted various financing options that might fit your business.

Debt Financing

The
vast majority of new small businesses are funded with debt financing
via financial institutions. If you pass muster, banks can provide you
with a loan or line of credit that comes with a repayment schedule and
an interest rate. They will look carefully at your company’s cash flow,
collateral and the liquidity of your assets. You’ve got to have a
sensible, written business plan, and you must know your financial
situation inside and out. Note that one way to increase your odds of
success is to establish a relationship with your banker prior to your
loan request.

“In addition to showing a successful
track record in managing their business, we also consider the
customer’s existing account relationship with the bank as one of many
factors in making lending decisions – and this can also include their
personal banking experience with us,” said Brad Baumann, assistant vice
president, regional business banking representative at Washington
Mutual. “Of course, we are always interested in attracting new
customers as well and would consider their previous history with
another financial institution.”

Upside:

  • Don’t have to give up equity
  • Available to companies that can’t get equity funding

Downside:

  • Must pay interest
  • Limited networking or “business savvy” value
  • May require personal collateral such as home

Grants

Especially
if you’re in the technology game, consider securing a grant through the
Small Business Administration’s Small Business Innovation Research
(SBIR) Program. There are also numerous state, regional and minority
grant opportunities available. By working together with a government
agency in a Cooperative Research and Development Agreement (CRADA), you
can also optimize resources and cost-effectively perform research (thus
requiring less funding). These programs are designed to help fuel the
innovative fires at small businesses. Having been on the receiving end
of these grants, here’s our bottom line: Billions of dollars of “free
money” should not be overlooked.

Upside:

  • Free money
  • Investors love the “leverage” that grants provide

Downside:

  • Highly competitive
  • How you use the funds is strictly defined

Equity Financing

While
debt funding is most common, there are still tens of thousands of
companies financed each year by private or “institutional” investors in
exchange for an equity ownership stake. They range from the less
sophisticated “friends and family” type, to high net-worth private
investors known as “angel investors,” all the way up to the
sophisticated professional investors called venture capitalists.

Friends & Family

When
you can’t get debt financing, consider asking your rich Aunt Harriet
for a little help. As a jolt of startup funding for many a family-run
business, small business financing from friends and family
typically comes in small amounts without a lot of hassle or legal
expense, but be careful. Always stay professional and go heavy on
communication. Depending upon your priorities, realize that business
has risks, and preserving your relationships with friends and family is
at least as important as your business opportunity.

Comfort zone: generally less than $50,000.

Upside:

  • Convenient, no nonsense
  • Fewest contractual strings attached
  • Available quickly

Downside:

  • Limited one-time source of funding
  • Be ready for an ugly Thanksgiving dinner at your in-laws if you lose their money

Angel Investors

Do
you believe in angels? We do. With approximately 250,000 high net-worth
private investors in the US who fund over 30,000 small companies each
year, you might be seeing wings yourself. “Angels” have earned their
name by typically being friendly and patient about their investments
and by providing their business wisdom and valuable relationships along
with their money. They often like to invest in groups, each taking a
piece of the deal.

Comfort zone: $25,000 to $1 million.

Upside:

  • More than money, they invest business smarts and networking opportunities
  • Relatively patient about their investments

Downside:

  • Often difficult to find
  • Can be hard to manage the divergent interests of a large group of angels

Venture Capitalists

If
you are beyond the startup phase, have initial revenues coming in, a
quality team in place, and a clear path to eventually sell the business
or go public in an IPO, you could be ready to approach the funding pros
- venture capitalists (VCs). But because they funded the dot-com and
biotech bubbles and were badly burned, VCs now have higher standards
than ever. Still, they remain a serious player in the investing world.
Keep in mind that their funding is very time-sensitive. VCs look to get
their money and profits out as quickly as possible. They are a great
source if you’re planning for meteoric growth and will require further
business financing in the future to achieve it.

Comfort zone: $250,000 to $10’s of millions. Must be a “fast growth” company

Upside:

  • Invest smarts and networking in addition to money
  • Typically have more money if you need more to grow

Downside:

  • Must be a “fast growth” startup business
  • Must be interested in selling the business or going public within three to five years
  • Must be prepared to share control

Strategic Investors

If
you need to get to market quickly or perhaps short-circuit the “no
name, no credibility” game, strategic investors can help. These equity
financiers get their name because they come from within the industry
you are targeting and find what you’re selling to be “strategic” for
their business objectives (such as somehow complementing or enabling
the products or services they sell). But beware! They can swamp your
business with opportunity, seduce you into reallocating your company’s
resources in a lopsided way, restrict you from dealing with their
competitors as your customers, and even cancel their business
relationship with you on a whim! Be sure you know what you’re getting
yourself into. Did someone say “lawyer”?

Upside:

  • Enhances your credibility in the industry
  • Money can come with access to benefits like manufacturing, distribution, and marketing

Downside:

  • Can force you to recalibrate your entire business to serve them
  • Dependency can be risky
  • Can prohibit you from selling to their competitors

Our bottom line: Choose Wisely

Just
like Goldilocks, you’ll have to make a choice. Some small business
financing options will be too complicated and some too risky. Others
will offer too little or too much. But if you do your homework and ask
for the right amount from the right source at the right time, you will
secure the financing for your startup that’s “just right” and be well
on your way to business success!

 

  ABOUT THE AUTHOR:
StartupNation Writer
StartupNation Writer

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