Starting up your own business and building on a business idea is not always easy. It involves a series of steps, starting with research, networking, paperwork and sometimes most importantly, the process of obtaining funding.
Young entrepreneurs in their 20s with little job experience often have a hard time finding funding sources, which brings us to the all-important business plan. Including accurate financial projections as well as defined goals and objectives of the business is crucial to communicate with potential investors and financial partners. Once estimates have been made and all the big and little expenses involved have been calculated, funding can be sought out.
There are several ways of raising capital to secure the required amount of money to start a new business. Each of the available fund-raising options has their pros and cons, and it is important to understand them before choosing the appropriate option. For example, small or family businesses may be funded through personal or family financing whereas larger organizations may require venture capitalists or bank loans.
Self-financing is known to be the easiest and quickest way of financing a project. Using your own money leaves you with no worries in sharing control over the operations and decision-making in the business, as well as repaying the borrowed amount. It eliminates the need of going through the process of persuading investors or applying for a bank loan. In addition, it forgoes the sometimes difficult process of adding new partners and shareholders with whom profit has to be shared. Often businesses need to grow to meet their own needs as well as their partner’s profit goals and return of investment. However just like any other financing option it also has its drawbacks. Financial resources will be limited to the entrepreneur’s savings and this limits the size of the business, and rate at which it can grow. Moreover, in the unfortunate event that the business sinks, not swims, the entrepreneur may be liable for the amount contributed as well as any personal assets.
Another often-used option, and especially in this part of the world, is family financing. Obtaining money from people who know you and believe in your ideas has its obvious benefits. Family members are often willing to give entrepreneurs loans without interest or at a very low rate. Friends and family may agree to a longer repayment period or lower return on their investment than formal lenders, and they may also seek a lower rate of initial return than commercial bankers. However it is always crucial to have a formal written agreement as well as a defined list of expectations and future plans to protect relationships. Losing family money is often worse than losing an investor’s money, as your relationships may be harmed as well. The lack of a formal agreement may lead to family members looking for more shares or wanting to get more involved or even asking their money back at an inconvenient time, which could prove to be destructive and inappropriate for your business.
The majority of entrepreneurs eventually hope to find angel investors. Angel investors are able to provide businesses with smaller amounts using their own personal funds. According to the Center for Venture Research at the University of New Hampshire, worldwide nearly two-thirds of funding for new enterprises is obtained from angel investors, and this capital can provide a great source of funding for new businesses that have a high potential for growth. The most attractive feature for an angel investor is a business’s potential growth and profitability. Given that they are investing their own money, their terms are often negotiable and more flexible than banks and venture capitalists.
Most business angels are not only sources of capital but are also sources of knowledge and expertise, having possibly been entrepreneurs themselves at one point. It is important for entrepreneurs to recognize this and utilize their expertise where needed, involving them in some daily operations to help their own business being more successful. However it is important to keep in mind that angel investors often expect a share in the company and will often request a high ROI against their investment. Their share in the business depends on the risk involved, so the higher the risk, the higher their share. Unfortunately, there is no registered directory for angel investors, which also make them difficult to find.
Venture capitalists are another possible source of start-up funding as they provide equity financing to both starts ups and established businesses. They function very much like banks, as they become your strategic partner, at an often lower rate. Venture capitalists can provide larger amounts of funding, as they use different sources to pool capital. Like business angels, they often have experience in building up a business and have the relevant contacts that can help a business grow and become successful. Having said that, entrepreneurs need to be careful as most venture capitalists look for a return of investment for between 3-5 years, so if your business plan and financial projection does not expect to reach liquidity during this period, venture capitalists may not be the best option and you may find yourself having to seek the option of a business bank loan.
Traditionally, banks are known to be more conservative and risk-averse than the previously mentioned investors. Unlike most venture capitalists and angel investors, they are more likely to approve a loan for an established business than that of a startup, which is mainly due to the fact that they are investing their depositor’s money. Of course, it is crucial for any loan applicant to have all the required documents ready prior to approaching a bank. Documents may include a strong and detailed business plan, financial statements and projections, pay-back plans as well as contingency plans. Having a good credit history is also very important, while some banks may require an additional equity investment in the business.
Banks are eager to see entrepreneurs personally investing a considerable percentage to the start-up capital of their own business, which is often an obstacle to young entrepreneurs. In addition, the smaller the business the more skeptical bank lenders are in reviewing the application. They prefer to be assured that the business is going to be profitable while respecting the pay-back dates. From the entrepreneur’s side, it is important to know whether obtaining a bank loan is the suitable funding option based on the business model and plan, with restrictions, repayment penalties and interest rates as the obvious drawbacks, but will still offer competitive interest rates and standardized procedure, taking the hassle out of forming agreements and plans with family, friends and angel investors.
With all the different funding options in mind, ranging from self-financing, family, friends to angel investors, venture capitalists and banks, it is most important to have accurate financial statements upon which, feasible predications can be made. This way, an entrepreneur will know exactly how much money they will need for the start-up as well as future phases, resulting in better planning and fewer surprises. In addition, it is always important to keep financial records and accounts for all the expenses in order to not lose sight of spending. Finally, in the unfortunate event that things do not work out as expected, a contingency plan is the non-negotiable to help an entrepreneur stay prepared for anything.