If you have a great idea for a business and your second thought is to immediately seek small business financing, hold your horses for a moment and ask yourself — why?
You need to get three different answers to some small business financing questions before moving forward. If you think that funding is the best option rather than bootstrapping it with your personal resources, be careful!
Outside funding brings its own crop of distractions. Here are things you need to know before pursing small business financing.
1. You Won’t Write the Deal
If this is your first business, then you don’t have a financial track record, which puts you in a beggar’s position. The investor you seek funding from has the power and may deploy an agreement that puts you at a disadvantage, either by valuing your company less than you think it should be valued at, or by charging you a higher cost of capital.
2. You’ll Be Chasing the Funding Instead of the Customer
At this stage of building a business, there are few things as important as your customer. Once you divert your interest from your clientele to pursue funding, you will distract yourself from building your business. Building a customer base requires focus and dedication; getting funding requires the same. Since you have limited time, it will be a real challenge. Customers are the linchpin of your success. Ignore them at your own risk.
3. You Could Undervalue Your Company
When you seek money from outside sources, you have to place a specific monetary value on your company based on its assets and intellectual property. It is easy to make a substantial mistake that you’ll only be able to determine after the fact. It is difficult to calculate the value of an emerging company, and this may make getting funding a challenge.
4. You Might Partner With the Wrong People
Partnerships are like other relationships. When you partner with an investor in haste, you put your business at risk. The offer to fund your enterprise rarely comes without strings, so make sure you understand your financier better than you understand your spouse. If that sounds like a tall order, then you may not be ready to take the leap with complete confidence. There is a lot at stake, so use caution.
5. You’ll Learn More Without Funding
Bootstrapping is a valuable exercise. A true entrepreneur builds a business to learn something: about the market, about the customer, about the product and himself. When you build your business without a cushion, you get to learn expensive lessons. They are often the most valuable. Running a business will build your instincts and help you hone your talent.
6. Funding Often Masks Underlying Problems
An excess of cash can hide critical deficiencies in a business model. An infusion of capital won’t fix all your problems. If your staff isn’t properly trained and you’re getting customer service complaints, money won’t remedy that; effort will. It’s sometimes easier to see these issues and fix them if you don’t have too much money between you and the problems.
7. You Could Lose Control of Your Company
Once you’ve put your most devoted efforts into building your company and secured outside funding, you’ll have to appoint a Board of Directors, but most likely your investors will have financial and board control. Investors like to work with executives they know. You, as a fresh entrepreneur, represent an unknown territory. Backers don’t know how you’ll react to success or difficulty and may want to remove you as the CEO.
If you see your business opportunity as a way to cash in quick, you may not have the stamina to bring your business venture to success. Investors rarely invest in an idea and they don’t invest quickly. It could take 18-24 months to secure a deal. The reality is that funding brings as many problems as it appears to solve.
While there are other options for small business funding, explore them carefully and avoid making commitments under duress.
Republished by permission. Original here.
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Hi Melinda, I agree with you. In my opinion it is better to prove your business model without external funding (and an unproven business idea from an unproven business person is really hard to get finance for). Once you have proved your business model you may not need financing. However, once you have a proven business model, if financing will help you scale quicker then it MAY become a worthwhile option so that you can grow your business faster. Finance also has its place in small business assisting with cash flow issues.
Hi Nigel. Thanks for reading. You’re spot-on. You’ve got to have a proven business model, whether you seek funding or not, but at that point, you’ve got options.
Hi Melinda, This information is useful for companies that already grew or have a solid business plan to become a medium-big company, but there are many many smaller companies, with only 1-4 employees that have different finalceial needs. In those cases the problem is not to appoint a board of directors, but simply to stay alive.
I´m from Spain, and one of the biggest issues here is the long payment terms of the invoices. That forces to smaller companies to find funds in the short term, to “stay alive” until they receive the payments (after 60-90 days). In many cases they need to ask for quick short term loans, with high interest rates, to pay their most urgent bills. In these cases, a key factor for these smaller companies to succeed is to compare and take the right decission, as the rates are very different from company to company. This usually happens only during the first months of these smallest companies… but those are the critical months to define if they will be viable or not, and this “short term-high risk” financing is key for them.
Once they pass this initial phase, they will be ready to search for external long term funding… but the information they get during these hard times is really valuable to evaluate the rest of points you highlight.