Starting any business can be challenging, but the quick growth and turnaround times commonly associated with entrepreneurial ventures come with their own particular set of challenges. You’re entering a fast-paced and cutthroat segment of the economy with both high risks and high rewards. To start your journey as an up and coming entrepreneur, you’ll need to take stock of your financing options.
If your business plan prominently features explosive growth, a liquidity-rich exit strategy, or even an initial public offering (IPO) within five years or so, this article is for you. For other prospective business owners who are looking to build something on a smaller scale, we have you covered with some broader resources for entrepreneurs.
Why Financing Can Be Hard For Entrepreneurs To Find (& Why That Shouldn’t Stop You Anyway)
Entrepreneurs face a few serious obstacles to getting financing, but if it were easy more people would be entrepreneurs, wouldn’t they?
The biggest issue is, of course, risk. You take an enormous one by starting a new, unproven business. Well over 50% of startups fail. Those aren’t great odds for the more conservative lenders out there, so right from the start, you’re going to be dealing with a smaller pool of lenders than is available to established businesses.
Related to that is the fact that bank consolidation has resulted in fewer traditional lenders, which means fewer opportunities for funding. The loss of community banks, in particular, has had a negative impact on lending. Online lenders have partially stepped into the void, but many are focused on very short-term lending.
In particular, the high growth startup model (though much romanticized in the media) is rarer than you might think. Fewer than 1% of businesses successfully raise venture capital.
Finally, social barriers ranging from prejudiced lending practices to geographic concentration of resources can greatly affect your chances of getting financing.
That said, “difficult” doesn’t mean “impossible.” With some creativity, diligence, and relationship-building, you’ll have a good shot at overcoming the odds.
6 Types Of Financing For Entrepreneurs
Now that we’ve gotten the cautionary tales out of the way, it’s time to look at some types of financing entrepreneurs can tap.
1) Venture Capital
If any funding source has become more closely associated with entrepreneurship in the public than venture capital, it would be news to me. There’s a certain mystique to being successfully being funded by groups that believe your business idea could take off.
Venture capital firms pool money from sources ranging from wealthy individuals to banks to pension funds. Each firm tends to specialize in a particular industry or type of company. Once they’ve raised an agreed-upon amount, they’ll shop around for businesses in which to invest.
A venture capital fund frequently disburses its funding over the course of several “rounds,” the first of which is called the seed round. As the name implies, this funding is meant to get your business off the ground. Successive rounds, called series, may become available as your business grows. Series A funding, for example, may be used to scale up a business that is already offering a product and has a customer base. Series B funding is similarly focused on growth.Â Finally, Series C funding focuses on helping mature companies expand into new products, or even acquire other companies. Different venture capital firms tend to specialize in specific phases.
- Specialized Financing:Â Venture capital firms develop some expertise in the industries they’re investing in, which can be handy if you need advice.
- Well-Connected: The venture capital circuit is pretty small and interconnected. Once you get your foot in the door, you can often use their connections to your advantage.
- Eager To Work With Startups: Where many lenders are reluctant to work with businesses who have little more than an idea and a plan, venture capital firms may take a risk on big ideas.
- No Debt:Â While you are giving up equity in your company, you don’t have to worry about “paying off a loan.”
- Geographic Concentration:Â The majority of venture capital supported startups are in California, Massachusetts, New York, and Texas. Some states have no active venture capitalist firms. Even within the states that do, they’re frequently concentrated within a few cities (San Francisco, New York City, Boston, for example). That doesn’t mean you can’t get venture capital funding elsewhere (Cincinnati, Salt Lake City, and Atlanta all have some VC activity, for example), but there’ll be fewer firms in the mix.
- Loss of Control: Accepting venture capital funding means giving up equity in your business. In some cases, it may even mean giving up some decision-making power to the firm.
- It’s Just Hard To Get: As mentioned earlier, fewer than 1% of startups successfully raise venture capital. For all the hype VC gets, it’s actually a really small part of the business funding picture.
2) Angel Investors
Though sometimes used interchangeably with venture capitalists in casual conversation, angel investors aren’t quite the same thing. Whereas venture capital usually involves a firm aggregating funds from a number of different sources, an angel investor is an individual–typically wealthy–who is looking for a risky venture with a potentially high rate of return. Like a venture capital firm, an angel investor is usually looking for equity in your company in exchange for funds.
While word-of-mouth is still a common way to get hooked up with an angel investor, over the past decade or so there have been attempts to form networks of investors through hubs like AngelList and ACE-Net. Some angel investors even pool their resources and function like a venture capital firm.
- No Debt:Â You’re giving up equity in your business instead of taking a loan.
- Eager To Work With Startups: Whereas banks may be wary, angel investors are looking for the type of investment opportunity a startup can provide.
- You Just Need To Convince One Person: While this is not always an advantage, you can hone your pitch to the investor rather than having to worry about a committee evaluation.
- Loss Of Control: Again, you’re giving up equity which can also mean loss of decision-making power. With angel investors, there can also be an added risk of lack of expertise, which brings us to …
- Potential Lack Of Expertise:Â Unlike venture capital firms, an angel investor may not be intimately familiar with your industry or product.
3) Debt Financing
For brevity’s sake, we’re combining bank loans, microloans, online loans, and personal loans. While there are advantages and disadvantages to each of these, in the end, we’re still talking about taking on and servicing debt in exchange for a lump sum of cash. While it’s difficult to get a loan before you’ve established a steady source of income, it’s not impossible, particularly where programs like microloans are concerned. These programs provide relatively small amounts of money with reasonable interest rates and long term lengths that can give you enough time to get your business up and running.
- Retain Control: You’re not giving up any equity to a third party.
- Flexible Exit Strategy: You’re on your own timetable for selling or making an IPO.
- Building Credit: If you manage to service your debt regularly, it’ll make getting funding in the future easier.
- Interest:Â Your debt earns it and you have to pay it off. This can be a drag on your growth down the road.
- Risk Of Default:Â Starting a business is risky, and there’s a very real chance you won’t be able to pay your debt. If that happens, you’ll want to know how much personal liability you have, as well as the effect it’ll have on your credit.
- Borrowing Amounts May Be Low:Â You’re probably looking at five-figure amounts or less when it comes to loans that are available to startups.
Another financing strategy is to not seek outside financing at all. That means working with your own savings and resources and taking a lean, minimalist approach to your business operations. When you do hit a growth phase, it’ll be funded by your business’s own revenue.
- Retain Control:Â You don’t owe anyone anything, so you have complete control over business decisions.
- Your Business Strategy Matters:Â You’ll only grow if your model works.
- No Obligations:Â You have no debt or third-party timetable to adhere to.
- Lack Of Funds: There’s a reason the old cliche “you’ve got to spend money to make money” persists. You may run into roadblocks that could be removed by money you don’t have.
- Slow Growth:Â You won’t be able to scale quickly, which may put you at a disadvantage if you have competitors.
- Time Investment:Â You’ll probably have to take on tasks you’d otherwise be able to delegate if you had employees.
Among the newer ways to get a startup off the ground is to crowdfund it. Crowdfunding is typically associated with pre-purchasing products, but some newer services are offering so-called “equity crowdfunding.” As the name implies, you’ll be giving up some equity in your company in exchange for funding from a pool of investors.
- No Debt:Â Crowdfunding doesn’t come with any debt obligations.
- High Funding Amounts Possible:Â Crowdfunding can be hit or miss, but when it works, the hauls can get pretty big.
- You Don’t Have To “Know The Right People”:Â If you’re not socially connected to wealthy investor networks, crowdfunding can be a way to still raise large amounts of equity financing.
- Loss Of Control:Â You’re giving up equity, which means you may also be giving up decision-making power.
- Crowdfunding Campaign:Â Crowdfunding requires a sustained effort to get eyeballs on your business.
- Platform Fees:Â Crowdfunding platforms have to make money too, so expect to be some kind of fee or to have them take a cut of the funds you raise.
- It’s Still New:Â Some investors are still wary of equity crowdfunding.
6) Grants & Subsidies
Most parts of the country have programs in place designed to encourage entrepreneurship. These can take the form of tax incentives, subsidies, grants, or some kind of infrastructural support. You should familiarize yourself with the ones that apply to your type of business and take advantage of them when you can.
- Free Money:Â While grants and subsidies may come with obligations, they aren’t debt or even loss of equity.
- Builds Local Connections:Â Becoming a pillar of your community, so to speak, can open up additional opportunities down the road.
- Can Be Time-Consuming: Grants, in particular, have involved, competitive application processes that may require a lot of your attention.
- Obligations:Â Accepting this kind of help may come with strings attached. You may be expected to stay within a certain city or county for a certain number of years or hire X-number of employees.
Entrepreneur Financing Tips From The Experts
What better source of advice is there than people who have successfully undertaken the same journey you’re about to attempt?
Make Sure You Really Want Angel Investment
Entrepreneur Tim Berry, founder of Palo Alto Software and bplans.com, cautions founders to make sure they actually need and want angel investment prior to seeking it out. If you don’t need it, you’re better off without it.
Believe In Your Vision
In an episode of The Jordan Harbinger Show, angel investor Jason Calacanis says he can tell when an entrepreneur believes in their own vision and when they’re bluffing, a skill he compares to playing poker.
Getting A VC Firm’s Attention Is Part Of The Interview
Marc Andreessen, co-founder of VC firm Andreessen Horowitz, says that a founder’s ability to network their way into a meeting with a venture capital firm is a good barometer for their ability to forge other important business relationships, such as those with customers, suppliers, and even the media.
Understand The Motivations Of Your Potential Investors
Scott Kupor, author ofÂ Secret of Sand Hill Road, advises founders to consider what an investor is hoping to get out of their relationship with the startup. The right investor will be the one whose objectives align with your own.
Get Started On Your Entrepreneur Financing Journey
You had your vision in place. Now you have a sense of how you might finance it. If the odds seem daunting, remember that the rewards are also great.
None of these options sound appealing? Check out some additional ways to finance your startup. And if you’re looking to finance smaller, short-term expenses for your business, you’ll want to take a look at our top business credit card options for startups.
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