The biggest question on most would-be business owners’ minds is, “Where will I get the money to start my business?” There are plenty of options — but some are better than others.
Startup Funding Sources
Here’s an overview of the good, the bad and the ugly ways to finance your new business.
Friends and Family
Friends and family are the number-one source of startup financing for most small business owners. In a Small Business Trends survey in 2017, 26% of respondents said they considered friends and family their most reliable source of capital. After all, if your friends and family don’t believe in your business, who will?
You can either borrow money from your friends and family or make them investors and give them a stake in your business. If you borrow money, make sure you treat it as a loan just as you would with a loan from a bank or credit union. Draw up loan documents (you can find templates online) and commit to repaying the money on a set schedule with interest.
Getting an investment from friends and family may seem like a better idea than borrowing because you don’t have to pay the money back. But keep in mind that if your friends and family members become shareholders, they may feel entitled to take a bigger role in directing your business then you’re comfortable with. Do you really want Uncle Joe telling you what to do with your website? Of course, if you do have a friend or family member whose business experience and advice could be valuable, taking them on as an investor could be a good idea.
Personal Credit Cards
Nearly two in 10 (19%) business owners in our survey think credit cards are a reliable source of financing. However, as a startup business owner, your business does not have any credit history of its own, so if you plan to use credit cards as a financing method, you’ll have to use your personal credit cards at first.
Using credit cards for business financing can be risky if you don’t manage your debt carefully. The best way to use credit cards is to pay for things you know you’ll be able to sell for a profit, which you can then use to pay off the credit card balance. For instance, if you’re starting a landscaping business and you need to buy gardening tools, plants and seeds for your first job, you could charge the purchases on a personal credit card and use the proceeds from the job to pay it off. Be aware, however, if you don’t get paid before the credit card payment is due, you could end up incurring interest and get in over your head.
Using your personal savings to start a business allows you to avoid going into debt or giving away any equity in your business. Investing your own money can also be a good motivator for success: when you’re playing with your own money, you may be more likely to plan carefully and less likely to take unnecessary risks than you would if someone else is footing the bill.
If you don’t have personal savings you can tap into, look for ways you can raise cash to put towards your business. For instance, if you have two cars, could you sell one for startup capital? Perhaps you have a collection of vintage Star Wars figurines or some old savings bonds you could convert to cash. Of course, you can also delay your startup a bit and build up your savings while you plan for your business launch.
Microloans are small loans, sometimes as little as a few hundred dollars, often designated to assist business owners who have limited work experience, live in underserved communities or are starting businesses that will help give back to the community. If you need a small amount of money, such as $5,000 to $10,000, a microloan could be the perfect solution. Kiva and Accion are two well-known microlenders. Microloan.org Is a portal that matches entrepreneurs with micro-lenders nationwide. The SBA also offers microloans through specially designated intermediary lenders; the average SBA microloan amount is about $13,000.
Bank and SBA Loans
The first place you think of going for startup capital might be the bank. In reality, it’s very rare for startup businesses to receive a loan from a bank or even an SBA guaranteed loan (loans made through participating banks and partly guaranteed by the SBA). Some 75% to 80% of SBA loans go to established companies, according to LenCred founder Tom Gazaway.
Why is it so hard to get a bank loan? In order to help make sure they’ll get their money back, lenders typically want to see things a startup business doesn’t have: a documented track record of success, financial statements showing adequate sales to service the loan, and a strong business credit history.
You may have a better chance of getting a startup bank loan if you can demonstrate some degree of business success, such as signed orders from customers, and if you have a strong personal credit score. You may also have more success with online lending sources, which sometimes have more lenient criteria for loan approval.
If you expect to finance your start up through crowdfunding, it’s time for a reality check. Although crowdfunding sites generate a lot of buzz, very few businesses actually get financing this way. (In reality, 63.71% of Kickstarter projects failed as of August 2018.)
Successfully crowdfunding your business requires a lot of hard work, including a well-thought-out media campaign to attract attention, a tantalizing offer for your contributors and an exciting product that has the potential to generate lots of buzz among consumers (such as a new tech gadget). Get the scoop about crowdfunding.
Venture capital investments are setting records—but unless you are starting the next Facebook, don’t expect VCs to finance your business. Just 0.5% of entrepreneurs get capital from venture capitalists, reports Scott Shane, A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University. Venture capitalists expect a return of at least 10 times their investment, seek companies with huge growth potential and will expect to take a lead role in managing your business (which probably isn’t something you want anyway).
Angels are wealthy individuals who invest their own money in small businesses, either individually or as part of angel groups. However, angels generally don’t invest in businesses at the startup stage. They’ll want to see proof your business is already successful with a strong potential for growth that can bring them a big return on investment. Learn more about what an angel investor looks for when investing.
Are you buying a franchise business? If so, you may be that rare startup that’s able to get a bank loan. Franchisees are considered more fundable than the average startup because the franchisor is there to help them through the risky startup stages. Since you’ll be working from a proven franchise system, not your own business plan, lenders can feel more confident they’ll get their money back. In addition, many franchisors have approved lending sources to which they direct new franchisees.
Grants and Awards
Contrary to what you may have heard, the government doesn’t hand out free money to start businesses like candy. Most grants are for nonprofits; the grants for for-profit startups that do exist are few and far between, and generally require your business to meet stringent criteria. The Small Business Innovation Research (SBIR) & Small Business Technology Transfer (STTR) programs provide grant money for firms doing research that can lead to commercially viable technology. If you’ve got a lot of patience, you can search for federal government agency grants at Grants.gov. Also check out these grants for small businesses.
Where Not to Get Startup Money
There are a couple places you should never turn for startup money. Don’t put your home or your financial future at risk to start your own business. If you take out a home equity line of credit or get a second mortgage on your home to finance startup, you could end up losing your home (and destroying your credit rating in the bargain). By the same token, don’t borrow from your retirement plan to launch a business unless you are nowhere near retirement and feel confident you can rebuild your nest egg if need be.
By looking in the right places, you can find the startup money you need. It just takes time, patience and the willingness to get creative.