For most startups, the first phase of funding is provided entirely by the company founders.
The following reasons are why company founders should provide most, if not all, of the initial seed capital to get their company started.
- The initial capital required is relatively low.
Initially, the primary focus of a new startup is on conceptualizing their product or service, researching their market, adding people to their business team and writing their first draft of their business plan. Luckily these activities don’t cost a lot of money, and the cost can usually be covered fairly easily by the founding members.
- It’s hard to get outside investors to make an investment in the early stages of a company. The reason for this is because the business idea is not developed sufficiently to demonstrate its’ full market potential.
- The founders are reluctant to dilute their equity position for the small amount of money that needs to be raised in the first round of funding.
The more the founders can develop the company before seeking outside capital, the more equity they will retain in the end. Investors have less risk if a company is further down the path of achieving its’ business goals. This makes the company more valuable and gives the founders more leverage when they trade equity for business funding.
- Investments made by the management team in the company demonstrate their commitment and faith in their business idea.
In later rounds of funding, investors will want to know how much the management team has invested in the business so far. The reason for this is to verify the business team’s commitment to overcome the obstacles that their company will invariably face in the future.
Many startups turn to friends and family for their second round of business funding.
In the United States, over $60 billion of seed capital is raised from friends and family every year. The amount of seed capital raised this way usually ranges from $25,000 to $100,000.
Some words of caution regarding seeking funding from friends and family.
- Always keep in mind that unpaid loans and sour investments can often spoil relationships with people that are near and dear to you.
- Raising money from friends and family that are not accredited investors can potentially poison future rounds of equity funding. The following is a link to an article that discusses how investments made by unaccredited investors can sabotage future rounds of funding.
- When you are raising seed capital from friends and family, it is a good idea to write out an agreement regarding what they will be receiving for their investment.
It is important to spell out if their investment is a loan or if they are getting equity shares in your company? If it is a loan, what are the terms of the loan? When will they be paid back? How much interest will they receive? Make sure that any potential investors that receive equity for their money realize that their shares will be diluted during future funding cycles and when you use equity to attract key personnel.
Startups have two main options for seeking outside business capital for their third round of funding; equity financing from Angel investors and debt financing from an SBA loan.
In the United States, angels provide 90% of the outside capital for startup companies. Angels or angel groups usually get involved in businesses that either need additional seed capital or require startup or early stage funding. The following is a link to more information about how to obtain angel financing.
SBA loans are guaranteed by the Small Business Association. As a result, they generally have much lower interest rates and terms when compared to conventional loans. The following is a link to a discussion of the different types of SBA loans that are available for business financing. In general, SBA loan financing can be used:
- For acquisition of a business
- To purchase commercial land and buildings
- For construction, renovation or expansion of a commercial building
- To purchase equipment and machinery
- To buy furniture, fixtures and office equipment
- For working capital
There are a number of unconventional sources where startups can obtain seed capital.
One potential unconventional source of startup seed capital is crowd funding.
Raising money through crowd funding is very different compared to trying to raise money using traditional funding sources. With crowd funding, you raise money from the “crowd” by pitching your product or service idea on a crowd funding service website such as KickStarter.com and NewBusinessCrowdFunding.com. These web sites monitor the pledges and only collect and release the funding once a defined funding goal is reached.
When you raise money using crowd sourcing, you are trying to get investors to pledge a certain amount of money in order to gain a special reward in the future. In most cases, this reward is your product or service with an added enticement such as a discounted price or a special prize. Some rewards may not be your product or service. An example of this are rewards offering a lunch or dinner with a famous director or an actor if the pitch is for raising capital to fund a movie.
The following is link to more information about raising money using crowd funding.
Credit cards can be considered for short-term business financing.
Credit cards should be used for short-term purchases only. If your company needs to borrow a larger amount of money with longer payment terms, credit cards are not a good option.
If you can’t obtain working capital and are looking for outside-the-box business solutions, NewBusinessTrade.com may be your perfect solution.
NewBusinessTrade.com brings entrepreneurs together with people or businesses that can provide research and development, services, materials, equipment, finished products, skilled workers, office space, retail space, warehouse space, or marketing. In return, these entrepreneurs will give equity, future royalties or a percentage of sales in their business. What a startup is willing to trade for someone’s participation in their business is only limited by their imagination.
There are a number of alternative sources of financing for established businesses.
A merchant cash advance (MCA) is an increasingly popular option for raising unsecured financing.
A merchant cash advance is especially popular with small businesses that don’t have the collateral or good credit to secure a conventional loan. Since a merchant cash advance is not technically a loan, a down payment is not required to get this form of financing.
Another reason why many businesses turn to a merchant cash advance for funding rather than a conventional loan is because most lenders require that a company be in business for at least two years in order to get debt financing. In contrast, companies offering merchant cash advances usually only require that you’ve been in business for at least six months.
Merchant cash advance financing is based on a business’s volume of credit and debit card sales. Payments to the merchant cash advance company fluctuate with daily sales volume. As a result, repayments are tailored to a business’s daily cash flow. The following is a link for more information about getting a merchant cash advance.
It is very important to use a reputable financing company when you go searching for a merchant cash advance. Some companies charge excessive fees for this type of financing. One excellent source of merchant cash advances is Newtek, “the small business authority.” Newtek is one of the leading providers of small business funding in the United States. In most cases, Newtek can usually pre-qualify your business for a merchant cash advance for as much as $250,000 or as little as $5,000 usually within 24 hours. Oftentimes, you can get your money within seven business days.
Accounts receivable financing (A/R Financing) is an alternative way to raise money by getting a cash advance based on your accounts receivable.
Cash advance financing allows companies to quickly obtain the money that is already owed them by their clients. Companies can receive up to 90% of their accounts receivable right away instead of waiting 30, 60 or 90 days.
Cash advance providers will give an advance of up to 90% of customer invoices where the work or products have been 100% rendered or delivered. After providing a cash advance, these companies take over the task of invoice management to make sure your customers pay according to your invoice terms. Once they receive your customers’ payments, they release the remaining portion of the invoices minus their administrative fee. The fee to get A/R financing usually ranges between 1-5%.
A/R financing requires less rigorous underwriting and has a quicker turnaround time compared with conventional financing. The following is a link to get more information about getting an advance using accounts receivable financing.
One good source of A/R financing is Newtek, the “Small Business Authority.” Newtek provides A/R cash advances in as little as two weeks for as much as $1.5 million or as little as $50,000.
An unsecured loan is one option for raising debt financing that does not require collateralization.
The biggest advantage of an unsecured business loan is that you don’t risk losing assets or property if you’re unable to pay back the loan. However, there is a downside to this type of funding. Because lenders are forced to take on more risk with these kinds of loans, they will almost always charge you higher rates and higher monthly payments when compared to a loan secured by collateral.
Equipment leasing is often an ideal way for startups to obtain equipment.
Over four-fifths of businesses in the U.S. lease some of their machinery and equipment. One of the big reasons why equipment leasing is so popular is that it offers smaller monthly payments compared to conventional loans. The other advantage is that a large down payment is not required. In fact, many equipment leases are 100% financed. In comparison, conventional debt financing usually requires a 10-20% down payment.
The following is a link to more information about equipment leasing.