Few entrepreneurs create successful businesses on a shoestring. Most businesses, especially those requiring equipment, inventory, or physical space, need money to get the business off the ground. There is no secret. If you are not independently wealthy or bankrolled by your family, you must rely on loans or investors.
Fund Your Business With a Loan
The traditional way to fund a new business is through a loan. A loan is money that you borrow for a pre-determined period and must repay with interest. Traditionally, businesses obtain loans from:
- Banks and credit unions
- Small Business Administration (a government program)
- Credit cards
- Lines of credit through the local bank
- Government agencies, such as the USDA Farm Loan program
If you do not qualify for a traditional loan or are unwilling to commit to a large debt, consider a microloan. Microloans are small loans ranging from a few hundred dollars up to $50,000. Most microloans involve a smaller amount of money, a higher interest rate, and a short period to repay the loan.
Advantages of a Loan
- The lender is not the owner of your business. This means you retain control and your percentage ownership does not decrease.
- It is often easier to obtain a loan than to find an investor.
- You are a customer of the lender, not a business partner.
Disadvantages of a Loan
- Loans can be difficult to obtain if you have poor credit or your business has not generated any revenue.
- The loan must be repaid within a few years.
- Your lender may limit how you may use the loan. You often cannot use the loaned money for your own salary and living expenses.
- Lenders usually require the business owners to personally guaranty the loan, meaning your personal assets (cash, home, car, etc.) are at risk if the business cannot repay the loan.
- Interest payments. Money isn’t free. You pay to borrow it.
Raise Funds with an Investor
Instead of borrowing money, some businesses raise money by sharing ownership with one or more investors.
There are different types of investors. Many entrepreneurs first offer an ownership interest to family, friends, or a potential successor to the business.
When sharing ownership of your business with family or friends, you need to determine whether the individual is a passive investor or an active investor. Passive investors essentially hand over the funds and expect only to receive a return on their money. They do not want to be actively involved in the business. Active investors, as the name implies, want to be involved in the business operations and decisions.
A second source of investor is the ‘angel investor’. These are also individuals, generally very wealthy entrepreneurs who want to earn money from investing in young businesses and share their wisdom, knowledge, and experience with the business owners. It is very difficult for a new or young business to attract the attention and investment of an angel investor.
A third type of investor is a company in the business of investing in small businesses. Examples are ‘private equity’, or ‘venture capital’ investors. Investment in your business is strictly a business decision. These investors are looking for a specific ‘return on investment’ (ROI).
Like playing the stock market, private equity and venture capitalists are gambling that they will make money by investing in your company. They have a wealth of knowledge and experience to guide financially struggling businesses and provide an outside perspective on the business. The primary motive of these investors is to generate profit. Do not be surprised when they place profit above the long-term benefits to the company and the community.
Before permitting an investor to become an owner in your business, you must consider what you are gaining and what you are giving up.
Advantages of Investors
- There is no obligation to repay the investment (although you may give up your ability to control the business and make the strategic decisions).
- The opportunity for additional funding if your business succeeds.
- You have an opportunity to raise a large amount of funds.
Disadvantages of Investors
- Loss of control. Investors generally want to be involved in the business’s decision-making, particularly if they invest a large sum of money.
- You have a personal relationship with the investor. You are not a customer.
- You must deal with the investor for an unknown period (unlike a loan, which is for a defined period).
Finding money for your new business is an important decision. Contact Concerto Law. We will explore your business, market potential, and your personal goals to decide whether a loan or investor is the right choice for you.