There are many ways to fund your startup, from your personal checking account to an infusion of cash from a venture capital group. Here’s a look at the pros and cons of a variety of funding options for startups.
Friends and Family
A lot of companies got started with seed money from friends and family. But there are a few problems here, both personal and legal.
Investor Paul Graham points out:
“The advantage of raising money from friends and family is that they’re easy to find. You already know them. There are three main disadvantages: you mix together your business and personal life; they will probably not be as well connected as angels or venture firms; and they may not be accredited investors, which could complicate your life later.
The SEC (Securities Exchange Commission) defines an ‘accredited investor’ as someone with over a million dollars in liquid assets or an income of over $200,000 a year… A startup’s life will be more complicated, legally, if any of the investors aren’t accredited.”
Graham adds another good reason not to ask friends or family for money. “It wasn’t because they weren’t accredited investors that I didn’t ask my parents for seed money, though,” he says. “The reason I didn’t take money from my parents was that I didn’t want them to lose it.”
To borrow money from friends and family legally and successfully, treat the loan like any other. Get the terms in writing and pay interest. As an example, two online services that provide these services are LendFriend and LendingKarma.
Use Your Own Money
“If you believe in your ability to make a business succeed, you should be able to put your own wealth behind your beliefs,” notes Forbes contributing writer Luke Landes. “It’s risky to put your own financial well-being on the line, but how could you expect your family, friends, or a bank to have faith in your ability and invest in your goals if you’re unwilling to invest in yourself?”
You’ll need to learn the basics of frugality if you’re bootstrapping. There is a significant difference between frugally building a business and frugality in your personal experiences. “Frugality at home saves on expenditures. Frugality in business protects cash flow,” advises Katie McCaskey, owner of a neighborhood grocery.
Microfinance
Sometimes you only need a small bridge between your personal cash and operating capital. One of the best places to look for money is through a local microlender who specializes in small loans. Many communities have this lending capacity and the terms are more favorable than those offered by the banks or online lending clubs. Find one near you through the Opportunity Finance Network.
Crowdfunding
This is a relatively new way to get investors that employ the Internet to pool the resources of individuals to finance an initiative. The Hongkiat.com staff writer Alvaris Falcon explains:
“The concept is simple — you post your project to a large group of site users, or ‘potential investors,’ and they will fund your project with money if they are interested in the project. You can start a crowdfunding exercise for free as you will only be charged when your project has raised some funds or the full amount. There’s nothing to lose and this is great for publicity.”
Three popular crowdfunding sites include Kickstarter, Indiegogo, and RocketHub. Again, a willingness to display you’ve put in your own money as part of the venture will increase the likelihood others will make a “gift” investment.
Crowdlending
Crowdlending is similar to crowdfunding, but with one critical key difference: Unlike crowdfunding — which offers “gifts” of cash in exchange for future perks — crowdlending is an actual loan that must be repaid with interest.
It works like this: You apply for a loan at a crowdlending website. You supply details about the loan and your credit history. Member lenders of the crowdlending site review your application. Loans can be funded by a group of other very small investors, ranging from three to 300 (or more) people.
Interest rates are determined by your credit worthiness as well how the money will be used. For example, you may pay more for a loan to consolidate other debt than you would for a loan on a piece of equipment that could be liquidated, if necessary, to repay the group of lenders.
One example of the sites that specialize in crowdlending is Prosper.
Small Business Loan
Another way to get needed capital is through a small business loan. Forbes contributor Tanya Prive points out:
“The SBA (Small Business Association) is dedicated to representing small business in the Federal Government. Tireless advocates for the little guy, they are a great resource for anyone starting out in the business world, offering information, advice, and potentially even funds. [...] While they do not offer the loans themselves, the SBA is a key facilitator in the process. Utilize their website as a resource for finding the right avenue for you and your business.”
Small business loans must generally be backed by collateral such as a home, vehicle, or other redeemable asset. For small amounts of money or for those without hard assets a microloan is a better option.
Angel Investors/Venture Capitalists
Beyond the initial startup phase more established businesses are better positioned to attract venture financing. That is because these businesses have a demonstrable track record of selling or making a product, and, critically, demonstrable profitability.
While venture capitalists bring much needed capital in, the downside of angel investors or venture capital is that they usually want part ownership. As Entrepreneur contributing writer Vanessa Richardson points out, “If you give equity to investors, you’ll always have to answer to others.”
This can include, but is not limited to, giving investors or their family members vanity job positions. You give up more negotiating power — and more ownership — with every speculative venture capitalist dollar accepted and invested.
Go to the Bank (or Credit Union)
Then there’s the time-honored tradition of going to the bank to get a loan. The Wall Street Journal writer Emily Maltby writes:
“Some 39% of business owners with less than $5 million in annual revenues said a bank loan would be the best way to raise capital [...] according to a [2012] survey of 2,851 owners of small businesses conducted by Pepperdine University.”
While this may be a tried-and-true fundraising method, don’t neglect to investigate options at your local community bank or credit union. These institutions often offer better rates than big bank conglomerates and help keep dollars local to your community, too. Bankers will expect to be paid back, but you won’t have to compromise your company’s vision or direction as you might have to when you accept venture capital.
Finally, consider this: Where there’s a will, there’s way. Just because you don’t have all the financial resources you need right now doesn’t mean it should stop you. Just get started. With time, and proof of progress, the money will appear. Good luck!
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David Soyka has covered business topics for The New York Times, Industry Today, and many other renowned publications. David is currently a freelance journalist covering small business advice for Vistaprint, a leading provider of personalized checks and other custom marketing products for small businesses across the globe.
